To us, these debt problems of a high-spending, heavily-borrowing Middle Eastern emirate can serve as a helpful illustration for investors.
Imagine that you are the founder and owner of a successful little taqueria in your neighborhood. Perhaps many years ago you moved to California and noticed that there was no place nearby to get a particular kind of burrito or taco that you craved. Sensing a business opportunity, you began a restaurant to provide those special dishes, which became incredibly popular. Your restaurant became a daily lunchtime destination for all the workers in the area, from day-laborers to software developers to local doctors and CPAs.
While it had been difficult to start it up and build its reputation in the beginning, ten or fifteen years down the road the business is a well-oiled machine, providing a steady stream of profits, in good times and bad. Perhaps you receive occasional offers from envious businessmen to buy your restaurant, but you have no desire to sell for many more years, as you are proud and happy of your little taqueria, you view the employees as part of your family, and you have noticed that the profits are increasing every year and believe they can continue to grow for many years to come. You may even have plans to expand to other locations, or you may have already expanded to one or two nearby cities and seen accelerated growth with each new site.
It may seem like a slightly ridiculous question, but do you think -- given the situation described above -- that you would open the newspaper over the past weekend, notice that a far-away emirate in the Persian Gulf was asking for an extension in paying back its debts, and decide that you'd better sell your restaurant immediately and cash in your chips?
Of course not, unless for some reason you had loaned some sum of money to them and believed that you might go out of business if they failed to pay it back. If, as is more likely, your restaurant had had no dealings whatsoever with Dubai, you would probably flip to the sports pages and then head down to your taqueria to have a cup of coffee and see how things were going over there.
The purpose of this illustration is to encourage investors who own shares in businesses that they have carefully selected, businesses with innovative products or services and competent management teams, businesses whose profits are growing and which they believe have good prospects for continued growth, to keep the short-term "crisis of the day" being splashed across the headlines of the various media outlets in perspective.
We have written on this subject many times previously, such as in this important post. While the Dubai problem only concerns about $60 billion of capital (a large amount for that emirate but a small amount in the grand scheme of the global economy) and will probably pass from the headlines fairly soon, we would go as far as to argue that the same lesson can be applied to much larger news events as well.
For example, we have argued that the most recent recession was primarily caused by a financial panic that impacted banking and Wall Street, but that did not derail many innovative firms operating in other industries. Although the crisis may have set them back temporarily, selling out of them because of the panic would have been as foolhardy as the owner of the taqueria described above selling his shop this morning because of the Dubai headlines (or even because his sales hit a slight bump in 2008 and early 2009 as customers dialed back their lunchtime dining-out budgets for a while).
Of course, the difference between owning an innovative and growing local restaurant and owning shares in a publicly-traded innovative and growing company is that it is almost impossible to own the second one outright, and thus investors in publicly-traded companies must put up with the behavior of all the other owners of the company.
Since many of those other shares are held by large institutional investors who think nothing of selling their shares at any hint of an adverse headline, no matter how unrelated to the long-term business prospects of the company in question, investors who take a longer view must be prepared for short-term gyrations based on all kinds of interim events. This is why we feel it is so important that investors understand this issue.
Finally, we would add two caveats. First, investors must be very careful that they own truly innovative, well-run companies. We have written on this subject many times, such as here and here. Second, we would note that we are not saying that owners of any business (taqueria or otherwise) should never consider selling their ownership. We have discussed at some length the subject of selling one's ownership in a business in "The importance of a proper sell discipline," among other places.
However, in general we would advise investors that the next time some "crisis of the day" (or crisis of the week, month or even year) arises, they may want to visit their local taqueria, order a burrito, and carefully consider this important concept.
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For more recent posts dealing with this same subject, see also:
- "March 9 anniversary" 03/09/2010.
- "Another black swan?" 05/13/2010.