Two Mindset Shifts for Stock Market Success

Flashing green. Flashing red. Money won. Money lost. Ticker symbols moving 2-3% in a day or 10-20% in a month, seemingly detached from economic reality. 

The stock market is incredibly volatile day-day and month-month, and most investors struggle to manage their emotions through that volatility. Many investors get too aggressive in good times and too despondent in bad times. 

Two mindset shifts I’ve implemented recently have helped me manage the psychological impact of the volatility and improved my decision-making. They may help you make better investments, too. 

Mindset Shift 1: Rather than buying shares, think about your ownership of a company in % terms

Shares are abstract - 10 shares vs. 100 vs. 1,000. On the face of it, it doesn’t mean much. 

It is much easier to buy and sell shares when you think of each investment as a ticker symbol. That mentality can shift investors into short-term, gambling-type behavior. Two key signs of a gambling mindset are excessive trading and buying stocks that aren’t well researched - i.e. “I’ll just buy 100 shares and see what happens!”

What I found helps me is to think about ownership in percentage terms of the whole company before I buy the company’s stock. Yes, the percentages I (and many of you) own are tiny. But when I think of myself as owning 0.001% of a company, I find that it helps me to think more as a business owner the way Warren Buffett recommends versus when I weigh buying an abstract number of shares in the company. 

Before I buy a stock now, I calculate what percentage of the company I will be buying. In my mind, I treat the decision as if I am speaking to the owners of the company and thinking about buying that percentage stake at the company’s current valuation. That mindset shift helps me think more like a business owner and make better decisions. 

Mindset Shift 2: Try to visualize the future cash flows of the company far into the future (and the higher valuation, the further you need to think ahead)

Investors often take one of two approaches: 1. They overly focus on near-term ratios such as P/Es based on the company’s projected earnings in the year ahead, or 2. They think future of a high flying stock is bright, so they buy it. 

However, when you start thinking about a company in terms of the annual free cash flow the business will generate, that may help you think about the company differently. 

As a recent example, I have seen many investors on Twitter recommend buying Facebook/Meta stock from $300 all the way down to $90. These investors often argued that the forward P/E is reasonable for a good tech company with excellent barriers to entry. 

When I thought about the company, I tried to think about how the free cash flow of the company would develop for years on end. Is it highly likely that Facebook/Instagram would be just as profitable or even more profitable 5 and 10 years from now? Would the company’s outlook at that point look as bright as it does today? Will new competition such as TikTok or other products not yet released impact the battle for customer screen time and erode Meta’s competitive advantage and profits?

Buying a stock even at 20x forward earnings means that cash flows must grow for many years in the future and stay persistent for many years just to justify the current valuation. 

To me, I put Meta in the “too hard” camp. With thousands of stocks out there, I couldn’t visualize the cash flows of the business years in the future with a high degree of confidence. 

With Meta now at $90/share, a bet today is different. I am still in the “too hard” camp and there are other stocks I find more interesting. However, the far lower valuation on the stock vs. when it was $300 has reduced the stock’s risk. Meta at a $250B valuation needs to generate far less free cash flow to justify its valuation than when Meta was at a $1 trillion valuation. 

Yet today, most investors now view Meta as too risky at $90 after the stock has been pummeled over the past year. However, the reality is that it is a less risky stock now because a buyer has to have confidence in its cash flows for a far shorter time period in order to justify the stock’s valuation than when the valuation was four times higher. 

When you look at a stock, weigh your confidence and ability to understand the company’s cash flows in the years ahead. That mindset will help you think about the stock with a business-owner’s mindset rather than only looking at headline price/earnings multiples. 

Let me know if these mindset shifts help you, and have a wonderful weekend.