Show notes
Show NotesIn this podcast, we explore the fascinating intersection of psychology and investing — why our brains are wired to crave instant gratification and how that shapes our behaviour, valuations and investment decisions. With reference to the behavioural economics concept of hyperbolic discounting, we explore how this can create excellent trading opportunities. We also examine why the type of shareholders a company attracts can define its destiny, showing that investing isn’t just about picking the right business, it’s about understanding who you are getting into bed with.This 16 minute podcast may help you fine tune your investment approach and improve your returns. Have a listen… nothing to lose!Receive more like this direct to your inbox:TranscriptHave you ever wondered why some companies seem to command absolutely astronomical valuations while others, seemingly just as solid, trade at bargain-basement prices?It’s all about the quirky, often irrational ways our brains process time and money.While traditional finance models rely on neat, orderly exponential discounting, where every future period gets discounted at the same steady rate, the reality of human psychology is far messier and infinitely more interesting.Hyperbolic discounting is a fascinating concept, borrowed from behavioural economics, which helps us better understand how investors think and why equities are priced as they are.Economics has long been dubbed the “imperfect science” for good reason. Human psychology doesn’t follow mathematical formulas and our pricing models need to account for these beautifully irrational behavioural quirks.Consider this scenario: I owe you $10,000 and offer you a deal. Instead of paying you back today, how about I give you $11,000 a year from now? Your gut reaction is almost certainly a firm, “no way.” You want your money now, you want instant gratification. You’ve already planned how you’ll spend that money and it simply can’t wait.Now imagine you have a savings account that can either pay out $10,000 one year from now, or $11,000 in two years. Suddenly, waiting for that extra thousand seems like a no-brainer. The math is identical, a 10% annualized return in both cases, yet your willingness to wait changes dramatically based on proximity to the present moment. Immediate gratification is no longer a factor, it doesn’t cloud your judgement and your decision becomes more rational.This isn’t a flaw in your reasoning; it’s a fundamental feature of human psychology. We systematically undervalue future rewards when immediate gratification is within our reach, but we become surprisingly rational when dealing with future-only scenarios. It’s the same phenomenon that makes you promise to start that diet tomorrow while reaching for another slice of cake today.Our modern world has turned this psychological quirk into a business model. Ever notice how online retailers charge premium prices for next-day delivery? Or how people line up to pay top dollar for the latest iPhone on release day, knowing full well the price will plummet in six months? We’re literally paying extra to pull gratification forward in time and companies have figured out how to monetize our impatience.As Charlie Munger wisely observed, “Investing requires a lot of delayed gratification.” This simple statement captures the essence of why most people struggle with long-term wealth building. We’re wired to want results now, even when waiting would serve us far better.Our trade-off between today and tomorrow is not the same and we value them differently.This impatience epidemic extends far beyond consumer goods. If people were purely logical, wouldn’t they budget carefully, live modestly and secure a comfortable tomorrow? Yet in reality, many drive expensive cars, wear designer clothes and fancy jewelry - all while burdened with ugly debts and barely any savings.We buy things we don’t need, with money we often don’t have, to impress people we don’t even know. It’s not stupidity, it’s human nature in all its gloriously inconsistent beauty. This is where hyperbolic discounting is most valuable. Not as a new valuation methodology, but as a lens for understanding the investor’s relationship with value.When you recognize that most market participants are trapped by their need for instant gratification, you begin to see opportunities everywhere.When a company tells a good story about its future prospects, people buy into that narrative. There’s insufficient attention paid to long-term risk and competitive threats, so distant future cash flows are under-discounted and over valued. This leads to what Alan Greenspan referred to as “over exuberance”, where stock prices become too inflated - as can be seen in the premium on the long tail of the hyperbolic discounting curve.Worse still, most investors ignore the long-term reality as they are obsessed with the short-term. Their focus is on the next quarterly earnings report.People become focused on beating short-term expectations rather than building long-term value, and their impatience creates a negative feedback loop. When a company reports disappointing quarterly results, its stock price gets crushed as the investors rush for the exits. The market tends to price short-term earnings quickly but often misses the gradual, multi-year improvements. They’re not necessarily wrong about the immediate pain and lack of immediate gratification, but they’re often spectacularly wrong about the long-term opportunity. This creates a “present bias” where immediate outcomes are too heavily weighted. It’s like judging a marathon runner’s potential based on their performance in the first hundred meters.Since the share price was initially over-valued, the sudden pendulum swing in the opposite direction looks even more dramatic, causing short-term panic and often leading to a significant under-valuation. This is where patient investors with a deeper understanding of hyperbolic discounting can find their greatest opportunities.The beautiful irony is that by understanding and working against our natural hyperbolic discounting tendencies, we can capture the value left on the table by those seeking instant gratification. Companies with durable competitive advantages and predictable long-term cash flows are often available at attractive prices, precisely because most investors struggle to properly value the future and place too heavy a weighting on the present.When you can train yourself to think beyond the next quarter, to see through the noise of short-term volatility, and to properly value businesses based on their long-term potential rather than their immediate prospects, you’re essentially arbitraging human psychology. You’re buying what others can’t properly value and holding what others lack the patience to own.In essence, hyperbolic discounting doesn’t just explain market behavior, it reveals the path to potentially superior returns. The key is recognizing that investing, like so many aspects of life, is ultimately a battle between our immediate desires and our long-term interests. The winners are usually those who can consistently choose delayed gratification over instant satisfaction, turning one of humanity’s greatest psychological biases into their greatest competitive advantage.But the story doesn’t end there. It’s not just about investing in a company at the right price. The real plot twist comes when you realize you’re not just buying shares in a business, you’re climbing into bed with a cast of characters who might have wildly different ideas about where this relationship should go.When we analyze potential investments, we dive deep into all the usual suspects. We scrutinize the market dynamics, dissect customer loyalty, examine supplier relationships, and evaluate management quality. Some of us even peek behind the curtain to gauge employee sentiment. But there’s one critical group of stakeholders that most investors completely overlook: the other shareholders.Who are they?What are their objectives?Are they helping or hindering the business?Are they exerting undue influence on management?Why has the company attracted this type of investor? Are the interests of these people aligned with yours?These questions matter far more than most investors realize, because the answers can make or break your investment returns.Sometimes, two investors analyzing the same company, will see it completely differently. This could be because one is looking at it through a microscope, while the other is using a telescope.The investor with the microscope zooms in on spreadsheets, hunts for hidden value in the numbers, searches for any statistical anomaly that screams “bargain!” This is precision investing: surgical, calculated, and decidedly short-term. The second investor prefers a telescope, scanning the horizon for companies with visionary leadership, sustainable competitive advantages and business models built to weather decades of change. This type of investor isn’t looking for quick wins; they’re seeking businesses they’d be comfortable owning forever. They may not have found a bargain, but that’s not the point. What matters is whether management can grow the business, reinvest wisely and compound value. For this kind of investor, management quality, culture, vision, passion and a competitive edge are everything.Here’s where it gets interesting: neither approach is inherently right or wrong, but they’re fundamentally incompatible when forced to coexist in the same company’s shareholder base.The microscope investor lives in a world of catalysts and special situations. They’re betting on near-term events: regulatory changes, management shake-ups, spin-offs, or market sentiment shifts - anything that could trigger a stock rerating. They’re seeking that immediate gratification we discussed earlier. They want aggressive share buybacks, regardless of valuation, because they’ll inflate earnings per-share. They would welcome cost-cutting to amplify margins even at the expense of the long-term prospects of the business. They acquiesce in the divestment of core assets to realize cash, increasing dividends at the expense of reinvestment, capitalizing costs that should be expensed, or stretching depreciation schedules. None of these things is value accretive to the company but they’ll juice short-term valuations, so the short sighted instant gratification seeking investor raises no objectionsOnce they pocket their gains, they’ll move onto the next opportunity. The company’s five-year plan? The quality of its leadership team? Its competitive moat? All irrelevant noise. This type of investor will be long gone before any of that moves the needle.Meanwhile, the telescope investor inhabits an entirely different universe. They’re evaluating management’s ability to compound capital over decades, assessing whether the company can reinvest profits wisely, and determining if the business model can adapt and thrive through multiple economic cycles. They couldn’t care less about quarterly earnings beats; they’re focused on the net present value of cash flows stretching far into the future.These investors champion patient capital allocation: reinvesting earnings into growth initiatives, sacrificing short-term margins for market share expansion and building competitive advantages. They’d happily own a company that never pays dividends if it means superior long-term compounding.Okay, so you get the idea why these different types of investors are incompatible, but let’s now consider other kinds of investor incompatibility.What about those at opposite ends of the wealth spectrum?On one side, you have the already-wealthy - perhaps through inheritance or previous business success - who view investing primarily through the lens of wealth preservation. They need steady income streams to fund their lifestyles, and they’re naturally risk-averse, not wanting to jeopardize the wealth that they already have.On the other side are the wealth builders, hard-working professionals saving for retirement, young entrepreneurs bootstrapping their financial independence, or anyone trying to compound their way to financial freedom. These investors don’t need income from their investments, they have day jobs for that. What they crave is long-term capital growth, even if it means accepting years of reinvested earnings with no immediate cash returns.These two groups make for spectacularly incompatible bedfellows. Their fundamental objectives create an irreconcilable conflict that no amount of corporate diplomacy can resolve.History provides a stark illustration of what happens when companies allow the wrong investors to drive strategy. In 2008, Microsoft had earmarked over $44 billion to acquire Yahoo, a move that could have fundamentally altered the search and online advertising landscape. When that deal fell through, the company faced a crossroads.Pressured by income-seeking shareholders who viewed the retained cash as an opportunity for immediate gratification, Microsoft distributed the capital as dividends rather than pursuing alternative strategic investments. Shareholders with a short-term mindset pocketed their windfall checks, but Microsoft found itself increasingly marginalized in the search and online advertising markets, where Google subsequently established an unassailable dominance.Ironically, many of the shareholders who pushed for the dividend payment soon exited their investment in Microsoft - their mission was accomplished - they were moving on to the next windfall opportunity.Microsoft had allowed itself to be influenced by the wrong type of investor, and the opportunity cost was enormous. They prioritized appeasing transient shareholders over building long-term competitive advantages.Charlie Munger captured this dynamic perfectly when he observed that companies get the shareholders they deserve. It’s not random chance that certain types of investors gravitate toward specific companies, it’s the natural result of corporate actions and communications creating a magnetic field that attracts like-minded investors while repelling others.Companies like Amazon and Berkshire Hathaway, which famously don’t pay dividends and instead focus relentlessly on reinvestment and capital appreciation, naturally attract growth-oriented, long-term investors. Their shareholder bases are filled with people who understand and embrace delayed gratification in pursuit of superior compounding.Contrast this with family-controlled businesses or utilities that prioritize steady dividend payments. These companies become magnets for income-focused investors who value predictability over growth potential. The result? A shareholder base that’s inherently conservative, risk-averse, and likely to resist bold growth initiatives that might temporarily reduce distributions.The lesson here is profound: companies should be absolutely fanatical about attracting the right kind of capital. They shouldn’t roll out the red carpet for hot money, day traders, or opportunistic investors looking for quick profits. Instead, they should cultivate shareholders who think in decades, not quarters, investors who understand that building lasting value requires patience, reinvestment, and sometimes sacrificing short-term returns for long-term competitive positioning.It’s about filling the bus with passengers intent on reaching the same destination, rather than picking up hitchhikers who’ll demand detours, complain about the route, and jump out at the first rest stop. When shareholders and management are genuinely aligned on the journey ahead, magic can happen. When they’re pulling in different directions, even the most promising companies can find themselves stuck in neutral.So here’s the question that should fundamentally change how you evaluate potential investments: Ask yourself what kind of investor a company is attracting. You need to understand who you’re getting into bed with when you buy shares in a company.The answers might be more important to your investment success than any other financial metric you could analyze.That’s it for today - plenty to think about. I hope it helps improve your investment returns.Receive more like this direct to your inbox: Get full access to Rock & Turner Investment Analysis at rockandturner.substack.com/subscribe