Stocks rarely perform in the time frames we predict, and it’s why the market only works for investors that have a long-term portfolio focus. Performance is never linear, up and to the right, year after year. You sometimes have to hold onto a position for a few years before it goes up 100% in 3 months.
“I’m accustomed to hanging around with a stock when the price is going nowhere. Most of the money I make is in the third or fourth year that I’ve owned something.” – Peter Lynch
Here is a real-life example: I started buying a company I own today in early 2012 when it was at $0.35-0.40 per share. As my conviction grew I bought more and by mid- 2014 the stock hit $2.00 per share. Today (January 2017), the stock is still at $2.00 per share. Yes, I’m up considerably from my average cost basis but this company has been dead money for 2.5 years. Years!
How do I know if I’m right in holding versus just being entrenched in endowment bias?
Let’s get back to some first principles. Sustainable multi-baggers have three characteristics: Long-term revenue and earnings growth with little to no dilution. When you are holding onto a position ask yourself – Is this business growing and making more money per share than it did a year ago, two years ago? In my real-life example above the company’s business is almost double the size it was 2.5 years ago. Yes, the stock hasn’t gone anywhere but the business is doing really well. I have no problem holding this stock. If the business wasn’t performing, I would sell. Successful investors can differentiate business performance from stock performance and can take advantage of those investors who can’t.
“I don’t want to spend my time trying to earn a lot of little profits. I want very, very big profits that I’m ready to wait for.” – Phil Fisher
In the book, The Art of Execution, portfolio manager Lee Freeman-Shor invests $25-$150 million ($1+ billion total) in 45 of the world’s top investors. His instructions to them were simple as there was just one rule. They could only invest in their ten best ideas. Over several years he tracked their positions, trades, performance and was amazed at what he saw. He identified both good and bad habits and divided the investors into groups – Rabbits, Assassins, Hunters, Raiders, and the most successful group, the Connoisseurs.
“The most successful investors I worked with, those who made the most money, all had one thing in common: the presence of a couple of big winners in their portfolios. Any approach that does not embrace the possibility of winning big is doomed.” – Lee Freeman-Shor
In this excerpt, Lee Freeman-Shor talks about one of the attributes of Connoisseurs.
“One of the key requirements of staying invested in a big winner is to have (or cultivate) a high boredom threshold.
Meeting some of my Connoisseurs could be very, very boring because nothing ever changed. They would talk about the same stocks they had been invested in for the past five years or longer. On the days I had a meeting scheduled with a Connoisseur, I sometimes struggled to get out of bed.
The fact is, most of us will find it difficult to emulate the Connoisseurs because we feel the need to do something when we get to the office (or home trading desk) every day. We look at stock price charts, listen to the latest market news on Bloomberg TV, and fool ourselves into believing we could add value from making a few small trades here and there. It is very hard to do nothing but focus on the same handful of companies every year; only researching new ideas on the side.
Many of us, seeing we have made a profit of 40% in one of our stocks, start actively looking for another company to invest the money into – instead of leaving it invested. This is precisely why lots of investors never become very successful.”
Every multi-bagger will have long periods (even years) of stagnation as fundamentals backfill, old shareholders get bored, and new shareholders enter. Just like a fine wine, sustainable multi-baggers often take their time to ascend and develop. If you’re invested in great businesses that continue to grow and earn more money, don’t let lulls in stock price and boredom scare you out of them.
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(1) Holding a long time works great if you hold the right stocks. Patience with the vast majority of stocks is unlikely to do well. Over the long term only about 25% of stocks make money.
(2) 99% of short term traders lose money or otherwise, for a variety of reasons, give up. I have a close friend who runs a music school for the best young classic musicians from around the world. Yo Yo Ma, for instance, attended her school. I’m managing her retirement account and she recently said to me that most short term traders lose money. I responded that it is kind of like classical musicians. While most classical musicians are unable to make a good living from their music, one percent make millions of dollars a year. Should you become a professional classical musician based on those odds? Should you become a short term trader? Should you try to climb Mt. Everest? Lot of people die doing that. So my thought is: Only take on challenging tasks, tasks that are risky, if you are deeply devoted, deeply passionate, and are willing to stick with it during the setbacks, and have a belief in yourself that transcends reason but that still has some basis in fact and reason. And, especially in investing, only if you are constantly striving to learn and willing to admit mistakes. That’s a problem too though. Admit mistakes too easily and you will sell too soon. Admit mistakes too slowly and you’ll struggle along in a sea of mediocrity. Bernard Baruch said that it wasn’t the losers that were his problem — he could quickly recognize those and deal with them. It was the mediocrities, the investments that prevented him from taking advantage of real opportunities, the situations that absorbed his attention and resources, the situations that he kept hoping would improve tomorrow.
(3) None of this suggests that long term investors achieve substantially better results. Some have phenomenal results, most don’t. They don’t tend to flame out as fast as short term traders, but if you are going to fail, would you rather take a year to fail or thirty years?
(4) Our greatest obstacle in investing is ourselves, in particular our pre-conceived bias. Also as Ian says, our impatience. Kind of the same thing, right? I try to ask myself, what is my preconceived bias and how will that punch a hole in my bucket. Like most of us, I’m inclined to self-deception, to pre-conceived bias, to looking for facts that substantiate my inclination. How many times do you read an investment report that takes a detailed look at the potential problems, in particular, that examines in detail a company’s competitive position. It is a bell-shaped curve, but very very few companies have an extraordinary, sustainable, competitive advantage. They are indicated by high growth, high return on capital, and capital expenditure and debt growth rates substantially less than net income growth. Unfortunately they are only cheap, except in very rare circumstances (American Express during the salad oil crisis is the classic), once every ten or twenty years. Patience is a problem in investing, maybe the problem. If only the solution was have patience and succeed.
(4) I’ve been studying the long term records and portfolios of the best 1% of money managers over the last five and ten years. I’ve been surprised at their low average returns — 8% to 12% over the last ten years, including Warren Buffet — and at the low average return on capital of the companies they are currently accumulating. In other words, they are betting on change. They are betting that (1) This company has a competitive advantage that is not yet apparent in the results or (2) This company has strong results and so it doesn’t matter whether or not it is currently reasonably priced. I notice the same characteristics in the analyst reports I read, of which I’ve read hundreds in the last year. You read very few reports, or see very few companies under accumulation by the best professional money managers, that have both a displayed competitive advantage and that trade at reasonable prices.
I’ve concluded that the best money managers invest in anticipated change, and they are better at anticipating change than other money managers. Even so, they earn results for their investors that would be considered unsatisfactory by the vast majority of small investors. And most small investors do worse, over the long term, than the best money managers.
I could say that I’ve also concluded that the only way to achieve spectacular results is to put all your investment capital into one, two or three companies with high returns on capital, above average growth, low capital expenditure requirements, low debt at below twenty times earnings and free cash flow, and hold those for ten years or more, but again, it is my opinion that investing doesn’t lend itself to simple statement like that. Look, for instance, at the investment record of Jim Simons/Renaissance Technologies. According to Wikopedia Simons:
“contributed to the development of string theory by providing a theoretical framework to combine geometry and topology with quantum field theory. Simons was a professor of mathematics at Stony Brook University and was also the former chair of the Mathematics Department at Stony Brook.
“In 1982, Simons embarked a business career where he founded Renaissance Technologies, a private hedge fund based in New York City with over $25 billion under management. Simons retired at the end of 2009 as CEO of one of the world’s most successful hedge fund firms. Simons’ net worth is estimated to be $16.5 billion.”
I don’t know a lot about what he does, and I’ve tried, have studied his portfolio over the years, but I do know he doesn’t take long term positions in quality companies.
Rod, thank you for your comments. I think in the end there are successful investors with all sorts of strategies, even opposing ones. Concentrated low turnover. Diversified but high(er) turnover. Etc, Etc. I think the common thread is all of them pay close attention to their downside at all times. They take losses from time to time but they keep them small and when stocks are down due to external forces they know when to double down.
I have some comments on your comments to Ian’s article.
the base assumption here, is that you buy a part of a business after you thoroughly checked the fundamentals, and bought it cheap, with a big margin of safety, especially when considering investing in Micro cap companies. I say investing, and not betting.
you write “Only take on challenging tasks, tasks that are risky, if you are deeply devoted, deeply passionate, and are willing to stick with it during the setbacks”, well I agree that one should always perform thorough investigation, and deeply and passionately devote himself to studying his/hers investments, but I disagree with you direct linking challenging tasks with risk. yes, they can be risky, but an important point of value investing is reducing the risk, and investing only if you think the risk to you is minimal. yes, everyone makes mistakes, but we learn from our mistakes.
finding cheap investment opportunities is not rare. they are difficult to find, a lot of the times, but they exist!!, and not every ~20 years.
Please do not think I am attacking you. I am only commenting, and this is always good to have different point of views. this make us think harder.
Thanks for your response Shachar. And no, I in no way think you are attacking me and I appreciate the opportunity to clarify.
“Only take on challenging tasks, tasks that are risky, if you are deeply devoted, deeply passionate, and are willing to stick with it during the setbacks”
I was referring to short term trading as opposed to investing. Short term trading seems to me to be an endeavor based on the assumption that the market is driven by people, by others, “in the know”, and the idea is to anticipate what those in the know are doing based on volume and price patterns. That, and trying to profit from short term swings in emotion, but investing is that too I think.
As far as how often great companies trade at cheap or reasonable prices, I perhaps should have said the top 1% in terms of sustainable competitive advantage as evidenced by long term return on capital, growth, debt/capital expenditure trends. In fact, one way to find these companies is to identify low volatility stocks with a very long term uptrend in stock price — narrow, constantly rising channel.
These could also be called “reliable compounders” — companies that can reinvest their earnings at the same high return on capital . You can put your money in them and forget about it for ten years. That’s where the big, smart money likes to go. I used to have a client, as a young stockbroker during an oil boom in Calgary Alberta, who had made a fortune in the oil business. He wanted, he said, to “institutionalize” his money — avoid risk, put it in premium names, and let it compound at very low risk. These companies could also be considered royalties on the economy. Advertising agencies and dominant city newspapers used to offer that. So the risk is change, unlike in most companies, where the risk is no change.
On the subject of feedback, again, I welcome all feedback like yours that is advancing a point of view contrary to mine. That’s how I learn. Challenge anything and everything that I write that doesn’t make sense to you. I’ll likely learn something as I try to explain myself. Maybe I’ll see things in a new way and become a better investor.
Well done, Ian. I needed this discussion today.
Thanks Mike, glad you enjoyed it.
This is probably your best post ever. I really speaks to the heart of successful micro cap investing
Good one Ian, gem of a post.
What you quoted from the book sums up pretty well ”
—The fact is, most of us will find it difficult to emulate the Connoisseurs because we feel the need to do something when we get to the office (or home trading desk) every day. We look at stock price charts, listen to the latest market news on Bloomberg TV, and fool ourselves into believing we could add value from making a few small trades here and there. —-
Especially the last bit 🙂 “It is very hard to do nothing but focus on the same handful of companies every year; only researching new ideas on the side.”
I’m trying to do the same and Yes..it is very difficult 🙂
Thanks for this powerful and “short” post.
Thank you Vikas for the comment. Glad you enjoyed it.