Motivation - The key to great investing

MICE (Money, Ideology, Compromise/Coercion, Ego/Extortion) - a CIA acronym that highlights the main motivations for a person becoming a spy. 

It is crucial for the CIA to understand the motivations of those who give them information. It is just as crucial for investors to understand the motivations of those who say they want to give them money. When you look at an investment opportunity, if you do not understand how the money flows and the motivation of everyone involved then you should not invest.

This is not to say that you have to talk to all the people involved but you must be able to understand the structure and see why each person is willing to play their part. If you cannot see this then you should not invest.

Lets go through a couple of generic examples:

A public company ~ A public company has many stakeholders (people who are interested in how it runs its business). It is important to understand each and how they might influence the course of the company. It is also important to understand if there are certain stakeholders who have more influence than others.  Lets look at a few of the key stakeholders that are common to most public companies.

• Customers: Customers use the product. They want the company to continue to provide its product at as high a quality as possible with as low a price as possible.
• Employees: Employees work for the company and rely on it to sustain them. They want the company to stay in business, grow and provide a good standard of living. Maybe even a level of security.
• Owners (stock holders): Owners stand to gain (and lose) the most if a company is successful (or a failure). They want the company to produce earnings or profits the more the better (notice that this is directly in contrast to what the customers and lenders want). They may want the company to take lots of risk if they believe this will result in more profits.
• Lenders (bond holders): Lenders give money to the company for a promised interest rate return. They want the company to earn enough to pay them back but not to take chances that might jeapordize their ability to pay back the loan.

There are other stakeholders as well (suppliers, environmental agencies, regulatory agencies, the local community etc) who can have an influence. Even within a class the stakeholders have different motivations. The CEO has a different set of motivations and expectations than the intern. They also have very different levels of influence.

The better your understanding of the influence of each stakeholder on a company, the better prepared you are to become a stakeholder. Do you want to own stock (owner) or bonds (lender) of a company - a lot of the answer to that depends on your understanding of the other stakeholders. Is management more friendly to equity or debt holders? You can tell a lot by what management says and even more by what they do.

Now an example of how this can help in investment decision making. Last week on Wednesday and Thursday the markets dropped, a lot. I had many questions along the lines of, "Is this the beginning of the next recession"?  Looking at how different markets were reacting and the motivations of those markets gives us some insight to help us answer that question.  

Owners (stock markets) were down big. They were concerned about the Fed announcement of its intention to raise rates further and faster than previously expected. This is expected to slow down the economy and as noted above the owners are looking for upside (strong profits).

But if you look at the lenders (bond markets) over the same timeframe, you would notice that while interest rates reacted to this news, credit spreads (the extra yield required of risky businesses) did not.  Lenders were not worried. As discussed above, lenders just want to make sure the company can pay them back, they do not share in the upside. 

When you take both of these together it paints a picture of the companies not growing as fast as previously expected but still growing. So, given this evaluation I answer, no, we are not beginning the next recession...yet. 

Keep your equity exposure for now.

Next month I will delve into budgeting and how to decide whether or not it is prudent to invest that bit of money you have set aside. No it is not investing but it is how you get a pool of money so that you can invest.