Averaging down is a skill. Done well it can be your greatest asset. Done poorly it can mean disaster.
The key to unlocking wealth in the stock market is changing your mindset to stop renting stocks and start owning businesses.
The key to unlocking wealth in the stock market is changing your mindset to stop renting stocks and start owning businesses. I find that most investors say they focus on the long-term but very few actually practice it. Focusing on the long term is hard because it is counter to our human nature that craves action and immediate gratification. The truth is that short-term thinking paralyzes your returns. If your goal is to achieve maximum capital gains, then your intention with every purchase should be to hold for years.
Look at Warren Buffett’s holding period compared to the average US investor:
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When we look at the greatest investors of all time with the longest track records, most are long-term investors:
[image class=”folio-2″ src=”http://microcapclub.com/wp-content/uploads/2015/08/best-investors-of-all-time.jpg” link=”true” lightbox_caption=”Top Investors”]
Many try to misrepresent buy and hold investing as buy and forget. Nothing can be further from the truth. The best long-term investors conduct constant maintenance due diligence to reinforce their long-term investment thesis. Their edge in investing is finding great companies early and knowing them better than most. This deep understanding of what they own gives them the conviction to hold and the ability to sell before the masses.
You will have an edge on most investors if you make investments based on expected 3-5 year returns instead of 12-month returns. 95% of investors are investing for the next quarter or two, not the next few years. If you can train yourself to think in multi-year time horizons it frees your mind to think more clearly. Investing is one of the only art forms where opportunities and decisions become clearer when you look out further. There is a high degree of farsightedness in successful investing.
Short-term thinking is a disease and the best way to kill it is focusing on great companies and setting a high bar/hurdle. Great companies at good prices don’t come around very often. For me a great mental hurdle is limiting my investments to those I think will increase 500% in three years if I’m right and increase 100% if I’m wrong. Wait for your pitch. When I look at the 12,000 microcaps that exist on North American exchanges, I own 5 and follow 25 others closely. In the last four years I’ve swung the bat 7-8 times. In the last 21 months I haven’t swung the bat at all. If you set a high bar often times your biggest risk is boredom. When you concentrate on your best ideas you can devote the time to knowing them better than most. To achieve a multi-bagger in the portfolio, you have to hold a multi-bagger. Don’t bother finding the next multi-bagger if you aren’t going to develop the conviction to hold them. Only after you hold onto a great company as the stock goes up 5-10-20x+ do you realize how wealth is truly created.
During earnings season I judge my positions quarterly progress against my 3-5 year expectations. I use a range of 3-5 years because some businesses I can form a reasonable five year expectation and others three years. The 3-5 year expectation is derived from doing countless hours of quantitative and qualitative analysis. If the quarterly result fits within a spectrum or range that keeps your 3-5 expectations on track, then you are good to go. If the quarterly result impacts your 3-5 year expectation you need to dig further. Even though I haven’t swung the bat at any new pitches in 21 months, I have sold two positions because they broke from my long-term expectations, and I redeployed that capital into two other existing positions that are performing. I want to be invested in the best companies I can find at all times. This can be three, five, eight positions, etc. The market and company execution will decide this for me.
David Rolfe, CIO of Wedgewood Partners, manages approximately $6 billion in assets under management. In this great interview he talks about focusing on great businesses and how Wedgewood only swung the bat once in 2014.
If you want to be a better long-term investor get rid of all distractions that promote short-term thinking. Listening to financial pundits, watching your positions every second of the trading day, and watching hundreds of other stocks that you would never own at any price are big distractions. Focus on owning the best companies you can find. You will be amazed at how well you can focus by getting rid of these distractions. Don’t let the daily price action in your positions influence your long-term resolve. For me, this is also why I don’t swing trade a portion of my position. It promotes short-term thinking. It’s hard to be a long-term investor when you watch your stocks every second. Retraining your mind to not care if a position is making a 52-week high or is down 10% in a day will make you a better investor. Similarly, who cares how many Apple iPhones were sold this quarter, or that the ISM Manufacturing Index hit 53, or that the Jobs Report last Friday was weak. Does any of this impact any of the great companies you own? No, not if they are great. You know you are doing it right when your wife is telling you about what happened in the market at dinner.
A long-term focus is imperative to successful investing, and it’s equally important that the management/CEO’s you invest in share this quality. Warren Buffett said, “I am a better investor because I am a businessman and a better businessman because I am an investor.” Great investors and great businessman (aka intelligent fanatics) focus on the long-term.
If you were to analyze intelligent fanatic CEO’s of today and yesteryear like Warren Buffett, Henry Singleton, Phil Knight, Elon Musk, Steve Jobs, Howard Schultz, Bill Gates, Jeff Bezos and others, what sets them apart is their extreme focus, energy, and intelligence combined with an iconoclastic and long-term vision.
Intelligent fanatics have no interest in attracting investors that don’t’ share their long-term vision. In 1997, when Amazon.com went public, CEO Jeff Bezos devoted most of his Shareholders Letter to “It’s All About The Long Term”. You will find similar things said by Howard Schultz in his first shareholder letter after going public in 1993.
[blockquote cite=”Warren Buffett, BRK Letter 1988″]We try, through our policies, performance, and communications, to attract new shareholders who understand our operations, share our time horizons, and measure us as we measure ourselves. If we can continue to attract this sort of shareholder – and, just as important, can continue to be uninteresting to those with short-term or unrealistic expectations – Berkshire shares should consistently sell at prices reasonably related to business value.[/blockquote]
When I evaluate my past and present multi-bagger CEO’s they too have this same long-term focus in common. They were/are not interested in attracting short-term focused investors. Very few, if any, provided guidance of any kind. All guidance does is reinforce short-term thinking. No guidance requires investors to come to their own assumptions and expectations. It attracts a shareholder that is willing to dig deep to understand the business that they own. The short-term focused lazy investor will be quick to complain and say a lack of guidance is a reflection of management’s lack of understanding of the business. But lets see what Warren Buffett says about guidance.
[blockquote cite=”Warren Buffett, BRK Letter 2002″]“Be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom operate in a tranquil, no-surprise environment, and earnings simply don’t advance smoothly (except, of course, in the offering books of investment bankers). Charlie and I not only don’t know today what our businesses will earn next year – we don’t even know what they will earn next quarter. We are suspicious of those CEO’s who regularly claim they do know the future – and we become downright incredulous if they consistently reach their declared targets. Managers that always promise to “make the numbers” will at some point be tempted to make up the numbers.”[/blockquote]
Intelligent fanatics long-term focus isn’t just hyperbole. It is a competitive edge in their businesses, just like it is in investing.
[blockquote]“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people,” Bezos told Wired in 2011. “But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that.”[/blockquote]
As investors we want to find great companies early and develop the conviction to hold them. How can we find the next Elon Musk or Howard Schultz? It’s great to read about them after they’ve made other investors billions, but we want to find them early in their careers. I want to find Reed Hastings 12 years ago when he was leading an $80 million market cap microcap called Netflix (NFLX). A dominant character trait of intelligent fanatics is their ability to focus on the long-term while repelling short-term thinking within their organizations. As investors the way we find them early is to start thinking like them.
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Averaging down is a skill. Done well it can be your greatest asset. Done poorly it can mean disaster.
Nicolai Tangen is the CEO of Norges Bank Investment Management, Norway's $1.4 trillion sovereign wealth fund.
Dilution is the subtle erosion of ownership. This hidden, persistent addition of new supply of shares leaves shareholders with less and less of the company’s value. Dilution, like inflation, is a silent killer of returns.