Diamonds and flower bulbs

Diamonds These are the shares orthodoxy says you should buy: shares in businesses with exceptional economics and long-term comparative advantage.  They are shares you would buy if you followed the Buffett doctrine: choose shares you would be happy to hold if the stock market closed tomorrow for five years. 

 Flower bulbs These are shares which are cheap just at the moment, but without any exceptional long-term quality. Flower bulbs trade on a P/E ratio of 5, or have net cash per share in excess of the share price, or some other idiosyncratic cheapness – together with no negative “hygiene factors” (see Vernon, Chapter 7). Flower bulbs can usually be relied upon to bloom, but they don’t have any exceptional long-term qualities.  A flower bulb can be a good buy, but only in modest size: you need liquidity to sell when the flower blooms. 

 Which should you buy, diamonds or flower bulbs?  I used to think diamonds, but I’ve come to realise that real diamonds are rare, and very hard to distinguish from fakes.  To recognise a diamond, you need long-term foresight of its durability. I’ve always found this very difficult.  My error rate for false positives as a diamond assessor is too high.

 Flower bulbs are much more common than diamonds, and easier to recognise.  You don’t need long-term foresight.  You just need to recognise something that is going to bloom, and keep your holding small enough to sell when it does.

 I’ve largely given up looking for diamonds. Nowadays, I spend much of my time scavenging the dustbins of the stock market for flower bulbs someone has thrown away by mistake. Less glamorous than prospecting for diamonds, but more reliable.  Remember Bill, Chapter 3: “Investing is a field where knowing your limitations is more important than stretching to surpass them.”