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31 - Buying Stocks is NOT a Zero-Sum Game (Investing First Principle)

The DIY Investing Podcast

Release Date: 06/16/2019

93 - OTC Markets Business Analysis with Ralph Molina of Midstory Ventures show art 93 - OTC Markets Business Analysis with Ralph Molina of Midstory Ventures

The DIY Investing Podcast

I interviewed Ralph Molina of Midstory Ventures where we discuss a stock pick: OTC Markets. Stock Ticker: $OTCM

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92 - Discount Rates: Past, Present, and Future show art 92 - Discount Rates: Past, Present, and Future

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91 - GAAP vs non-GAAP Earnings (Amazon Deep Dive) show art 91 - GAAP vs non-GAAP Earnings (Amazon Deep Dive)

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90 - What is Intrinsic Value? show art 90 - What is Intrinsic Value?

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89 - All Securities are owned at all times (Investing First Principle) show art 89 - All Securities are owned at all times (Investing First Principle)

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Every security or financial asset MUST be owned by someone at all times until that security is retired. This holds true for stocks, bonds, cash in the bank, QE, and any other similar financial asset. This is an investing first principle. First-principles are useful for investors seeking to develop investing strategies from the ground up. 

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88 - Satisficing: Why you should avoid attempting to maximize your portfolio returns show art 88 - Satisficing: Why you should avoid attempting to maximize your portfolio returns

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87 - Cost of Growth Valuation and Asset / Earnings Equivalence show art 87 - Cost of Growth Valuation and Asset / Earnings Equivalence

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Growth is not free for most companies. It costs something. The cost of growth valuation model takes into account return on invested capital when valuing stocks. Most companies have to retain earnings in order to grow.

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86 - The Tyranny of Backtesting: Why Backtests are harmful and counter-productive show art 86 - The Tyranny of Backtesting: Why Backtests are harmful and counter-productive

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Investors use backtests in order to test whether a portfolio's asset allocation would have performed well in the past. The use of backtesting is harmful to a portfolio because it ignores uncertainty and overstates the value of empirical evidence.

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85 - Precisely Wrong, Roughly Right (DCFs) show art 85 - Precisely Wrong, Roughly Right (DCFs)

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84 - Would you buy your employer's stock? show art 84 - Would you buy your employer's stock?

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Buying Stocks is NOT a Zero-Sum Game (Investing First Principle) - Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode31

Mental Model: Zero-Sum Games

  • Any gains by one participant must be offset with losses by other participants.
  • The sum total of all value for all participants is equal to zero

Why buying Stocks is NOT a Zero-Sum Game

  • Stocks as a whole don't provide a positive expected value
  • You don’t have to “take” from others in order to receive. When companies create value this is “new value.” The economy grows, everyone becomes wealthier.

Stock Picking vs Index Funds?

  • The thought is that half of the money must underperform an index, and half of the money can outperform an index. The thought, therefore, is that buying stocks is zero-sum.
  • Where is the fallacy?
    • Index’s have historically had a positive expected value. If an index returns 10%, even if half of the money receives 8%, and half receives 12%, both parties are successful in growing their wealth.
    • One party doesn’t lose 10% so that the index can grow 10%. That’s not how this works.
    • Instead, stock ownership is best described as a positive sum game.

What is a Positive-Sum Game?

  • A positive sum game is where the total value received of all participants is greater than zero.
  • This means that you can be successful without worrying about the success of others.
  • Frees you from the need for comparison, jealousy, or envy.
    • Just because someone else made money, doesn’t mean you lose money.
  • Takeaway: You can ignore index funds and focus on your own personal goals
  • Takeaway: You can ignore macroeconomic trends. As long as your fundamental analysis of a company is correct, the broader economic picture is irrelevant.

Why is this true? - Capitalism grows the economic pie

  • Companies are full of employees who go to work each and every day trying to find a way to make your profits grow.
  • While this sometimes involves taking market share from other companies, the greatest gains come from innovation, improved efficiencies, new markets, and new products.
  • This raises the standard of living for all and the overall economic pie for the economy.