I’ve been investing in the stock market since 2013. I’ve always wondered how the idea of stocks came about. The origin of things intrigues me, pretty much like taking apart a radio when I was a kid to see how it worked or opening up a frog in biology class. Knowing how things originate has always helped me understand how it evolved to the present and possibility where it may go in the future. There’s too much talk of how to invest in stocks — financial ratios, investing styles, allocations, etc. — very little is spoken on how this party began. The origin of the first ‘paper shares’ ever recorded, surprisingly, reveals investing principles that are valid to this day.
I was fascinated to find out the first ‘paper shares’ were issued in 1602 by the East India Company. The East India Company would send ships from Europe to all corners of the world seeking all kinds of bounty from spices, textiles, precious metals, food, supplies and more.
There were great opportunities in the world, but each journey was also fraught with risk. To name a few, there was the risk of: unpredictable weather, pirates, mutiny, ability of the captain and crew to navigate, unfriendly locals, other ships, etc.
Rather than put all their money in one voyage (venture), the Company decided they could “share” the ship’s risks with the public and in turn, “distribute” a part of the profit. This way the Company could set multiple ships to sail, try new risky routes and hedge for a few failures along the way.
The public that bought a ‘share’ of these voyages, got a piece of paper that would legally guarantee them a part of the profit. They became the world’s first ‘paper investors.’
As time went on I’m guessing some of the savvy investors, started to study the quality of the ship’s build, the experience of the captain and crew, the risks involved in the journey itself, the demand for the goods procured and, ultimately, if they would be treated fairly in the distribution of profits. Finally, this savvy investor would try to figure out if the future expected profit was much higher than the price they paid for each share. Sound familiar?
Not much has changed. While anecdotal, there are lots of similarities we can draw in today’s share market. Modern companies are much like these ships that have set sails towards with a certain mission (think Amazon, Nike, Domino’s etc.) Today’s finance gurus popularly break-up stock picking in 4 broad criteria: quality of the management, competitive advantage of the business, long-term growth and margin of safety in the price.
Let’s try and explain this financial jibbies into our ol’wooden ships metaphor. For this example, let’s look at Amazon as ship on it’s voyage across the world:
1. First is the captain, the entrepreneur (Mr. Bezos) and his crew’s experience. You got to ask yourself, are they ethical and capable of navigating rocky seas? Do they treat crew and shareholders fairly? Is there a risk they’d skim some of the profits when no one’s looking? (aka Quality of the management)
2. Second, how has the business model navigated past economic storms, threats from modern day pirates, copycats and enemies. Can anyone with a few dollars load up another ship and beat them to their destination? (aka Competitive Advantage)
3. Where can they sail from here? We know the different ports (countries) they have set up base presently. Where to next? Can they grow deeper in the ports they already in? Can they re-invest their profits to set out new ships for sail or pay back ‘dividends’ to their share holders? (aka Long term growth)
4. If we are lucky enough to find such a beast of ship, we got to ask ourselves how much are we willing to pay for a piece of the action? If we pay Rs. 100 for one share today, can this ship send back say Rs. 300 in 5 years? In the worst case of a mutiny, fight with the locals, damage from icebergs, pirates and ghouls, would we still get Rs. 200 back in 5 years? (If yes, then the price you are paying today has what is called a Margin of Safety.)
As I’ve enumerated above, principles behind buying a ‘digital’ share today is no different as it was 400 years back. Probably wont’ change 400 year hence. It’s important to note, eventually every company is like a ship and it’s journey must come to an end. It’s between then and now: how much money can be generated at the table and how much are we willing to bet on it.
Next, I’ll cover why the prices of our “shares” move so damn much and what should we do about it. Till then, sip on some rum and happy sailing.