You may have come across the term arbitrage. In investing, arbitrage is buying a security at a cheaper price from one market and selling it for profit in another. If the price of a security is 10 in New York and 10,05 in London, you buy it from New York, sell it to London and pocket the difference. Time arbitrage, however, means taking advantage of inefficient stock prices due to Mr. Market’s short-term outlook and inability to focus on long-term fundamentals.
Since markets are so highly automated, I doubt the individual can access these small inefficiencies faster than computers. Therefore, the way to go is time arbitrage.
Time Horizons Matter
Our aim is to buy businesses for less than what they are worth. The longer your time horizon, the better the time arbitrage. Volatility shows, that in many cases Mr. Market seems incapable of thinking beyond a year. Or even 6 months. If earnings look bleak now, it may price a stock at a huge discount to what the business is worth.
Let’s say a company’s intrinsic value is 10, and is selling for 5. If your valuation is correct and you have a time horizon of 3-5 years, you’re looking at a compounded annual growth rate (CAGR) between 14% – 26%. That is a heck of a lot better than the average “professional”. If Mr. Market realizes his mistake sooner, the CAGR surges.
“Professional” money managers under-perform due to different reasons including career risks, short time horizons and herd behavior. If other professionals think a company is not worth further research, you don’t want to risk your job or looking foolish: It’s better to make a mistake collectively than risk standing out.
Time is on your side ♫”
Rod Stewart may not be an investor, but time is on the side of the investor.
Sticking To Your Guns
Thankfully, the intelligent investor is not bound by the constraints of Mr. Market’s moods, or potential career risk. Besides sticking to your circle of competence and other items on your checklist, time arbitrage is a massive advantage in your investing arsenal. In fact, it might be one of your best.
Don’t worry about looking foolish in the short-run. You are the tortoise, and the market is the hare. Don’t be seduced by recent gains from the “hot” new trend. Be comfortable with a mentality that you like to watch paint dry.
“All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” – Blaise Pascal, French mathematician
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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