- Harrison Stoneham
Lessons Learned: For Long-Term Investing
Over the years, I’ve learned a few lessons that have made me a better investor:
Humility Is a Requirement
Check your ego at the door. Being a long-term investor is simple, but it isn’t easy. I’ve found that once you do the work to find a high-quality company, you have to – as Charlie Munger says – “sit on your ass.” Doing nothing sounds easy, but it’s harder than you think.
What do you do during the upcoming election? Or about a trade war with China? Or about some other “market-moving” macro event? Nothing?!?
When your car makes a noise, not acting looks foolish or lazy. Why would investing be any different? But unlike a car, the market is a complex system that is unpredictable in the short term. Anyone who tells you they know what’s going to happen to the market in the next couple of months is not being honest with themselves. No one knows.
Find High-Quality Companies
- The best antidote to the randomness of the stock market is to find the very best companies and hop on for the ride. In Peter Thiel’s book Zero to One, he suggests that there are four conditions that create monopolies:
- Proprietary technology that is ten times better.
- Example: Google Search, whose search engine was faster and more predictive than anyone else’s.
- The more people that use a product, the more useful it becomes, and new competitors face a deep moat when trying to lure customers away.
- Example: Instagram, which wouldn’t be very useful if your friends weren’t on it.
- Strong brands cannot be replicated.
- Example: Apple – while many have tried to emulate its cool product design and stores, none have had the same level of success.
Economies of Scale
- Cost savings are gained by producing something on a large scale instead of smaller.
- Example: Wells Fargo.
When these qualities are combined, a lot of value can be created. For example, Amazon and Apple possess all of these qualities, and they have the market capitalization to back it up.
Management Must Be Adaptable
In the digital economy, the pace of change is rapid, and companies need to be flexible. Those that are going to succeed must be adaptive. Netflix is a great example of a company being adaptable, not once but several times. It began as a DVD rental service that put Blockbuster out of business. Then it cannibalized that business in favor of a new streaming business. Finally, it began developing original programming, which is expensive but has become critical to attracting new customers and retaining existing ones. In the end, Netflix’s management team was successful because they were adaptable.
Quality Is More Important Than Valuation
- Traditionally, a company’s valuation has been a critical factor in investing in it. In business school, I was introduced to various valuation methodologies, and I found these models seductive, because they can give you a sense of precision. I naively thought that using a particular model could provide a good perspective on the future. When thinking of the future, John Maynard Keynes said it best: “It is better to be roughly right than precisely wrong.” It is with this in mind that I have evolved to the point of focusing on the qualitative aspects of the business. It is far more important to determine if a company has a durable competitive advantage and pricing power. Overpaying for a great company can be solved with time.
Let Your Winners Win
- Putting too much emphasis on a company’s valuation can also lead to a shorter holding. When a company has reached “full value,” you have a decision to make: Do you continue to hold the investment or sell it?
Selling creates two problems: a tax problem and a replacement problem.
Tax Problem: If you sell a stock, you have to pay the government 25%. You are left with 75% of your investment. You will need to make up the 25% paid to the government to get back to even.
Replacement Problem: You need to be right about both buying and selling in order to consider the change to be a success. For example, if you were 70% sure that you should buy Google and 70% sure that you should sell GE to pay for it, then you would have less than a 50% chance of being right on both the buy and the sell decision (70% x 70% = 49%).
Selling might make you feel better, but the math is not on your side. Warren Buffett made 99% of his wealth after the age of 52. How did he do it? Compounding is a powerful force, and he is famous for rarely selling. That’s why picking high-quality companies is so important. The majority of Buffett’s investment success is attributed to his choice of high-quality companies like Apple and Geico.
You Can’t Always Win
- As an investor, you can’t always pick the winners, and that’s OK. Just as a management team must stay adaptable, an investor must have strong opinions loosely held. This is hard, because it requires being honest with yourself and humble enough to admit you were wrong. Mistakes are part of life and investing, but as the famous philosopher Confucius said, “A man who has committed a mistake and doesn’t correct it is committing another mistake.” When you make a mistake, recognize it, resolve it, and move on.
Don’t Fight the Fed
Interest rates are like gravity; every valuation is based on the risk-free rate. The risk-free rate is the safest way to make money and is what the government will pay you for holding their bonds, usually for 10-years. In 2000, companies had revenue growth but no cash flows, while the 10-year was yielding 6%. The bubble burst because investors decided it was safer to take the risk-free 6%. Everyone buying assets (stocks, bonds, or houses) is deciding between alternatives.
Fast-forward to the economy today, and some people think there is too much focus on growth and not enough on cash flows. Again we must decide between alternatives; today, the 10-year is .66% vs 6%. This is a HUGE difference, roughly 800%. With rates so low, investors are increasingly more biased toward equities.
Don’t take my word for it; in a 2019 interview, Warren Buffett said that stocks are “ridiculously cheap” if interest rates stay at current levels*.* This was when the 10-year was at 2.5%. Since then, the Fed has injected $3 trillion and signaled that it is going to keep interest rates low for longer.
- Be humble.
- Only invest in the best businesses.
- Quality is more important than valuation.
- The best managers are adaptable.
- Hold on to winners.
- It’s OK to be wrong, but don’t stay wrong.
- Don’t fight the Fed.