Yesterday on Bloomberg two respected Street professionals—blogger Barry Ritholtz and strategist Tony Dwyer of Canaccord Genuity—were discussing the topic of long-term investing in equities, Buffett style. They basically concluded it was impossible for the average individual investor to be a long-term investor. I quote, with slight changes in wording to improve clarity:
Ritholtz: “Most people can’t do what he [Buffett] does, it’s that simple. . . .They lack the belief system, they lack the discipline and they lack the long-term perspective. You can’t invest like Warren, so why even try? “
Dwyer, when asked about investors who hold stocks not just for 5-7 years but for 12-15 years: “The issue is, it is impossible [to invest for 12-15 years] unless you are investing as though you own the business instead of a stock symbol . . . because the odds are that at some point over a five or seven year period there will be a recession or a credit event and you will shake most people out.”
Three reactions to the wisdom of Barry and Tony (B&T)
First, as a characterization of how “most” individuals invest, they are correct; most people don’t own stocks for years and years.
Less obviously, they are also describing how most Wall Street pros invest. Worried about fund performance, portfolio managers try to dump stocks that are out of phase with the economy or are going through a difficult period. Conversely, many PM’s crowd into “what’s working” – healthcare, at the moment; tech in the late 1990s; energy in the late 1970s. The mediocre performance of most mutual funds suggests this is difficult to do successfully, especially after taxes. And it is very risky to aggressively overweight a popular sector.
Third it is ridiculous to claim that people “can’t” be long-term investors or that it is “impossible” to invest with a fifteen-year horizon. On the contrary, this is the way most individual investors should invest—hold their good stocks for decades and dumping the mistakes. They should own a mix of mature but still growing “blue chips” and some smaller, high-quality growth companies that either pay a dividend or eventually will do so. I call this “creating your own conglomerate” which has four advantages:
- Low commissions and low or no management fee.
- Low taxes: You pay tax on dividends, but you don’t pay capital gains tax for years and years. If you own the stock until you drop dead, you never pay capital gains tax because the cost basis is stepped up to the market price when you die.
- No market timing. Investors tend to get in near the top and out near the bottom. And if you own individual businesses that you understand, rather than “the market” you are much less likely to panic in bear markets.
- No guessing whether other investors consider a given PE ratio “attractive” or “over-priced.” Provided you pay a reasonable PE multiple, changes in PE won’t matter too much, because in 20 years EPS will rise 570% if it rises 10% per year.
An underlying premise of “create your own conglomerate” is that macro trends are not predictable. As Larry Summers recently noted, economists never accurately predict recessions. And totally weird, unpredictable stuff (like a 50% drop in oil prices or zero Fed funds rate six years into an economic expansion) happens all the time. Focus on buying good businesses that benefit from secular economic and social trends.
Mother Biggs, Inc.
A good example of what I am talking about is the mother of the late, great Morgan Stanley strategist Barton Biggs, whose investments were described in Mr. Biggs’ excellent book Hedge Hogging. Mother Biggs turned a small fortune into a large one by owning a portfolio of growth stocks selected by her sons, who made occasional adjustments to the portfolio.
What It’s Not
Just to be clear, here is what “Create your own conglomerate” is not. It is not:
- Trading hot IPOs and momentum stocks
- Buying “turnaround” stocks that look cheap but are often value traps
- Shifting funds toward the “hot” region of the globe—currently Europe.
- Trying to catch the bottom in cyclical situations – such as the energy sector now, or the Big 3 autos in 2009 (it worked for Ford but not GM and C).
- Buying names that “activist” investors such as Carl Icahn are involved in.
Don’t get me wrong; these are perfectly fine ways to make money in stocks. They’re just not part of the “create your own conglomerate” approach and in any case are best left to professionals who have the time and expertise to execute these strategies effectively.
B&T, Meet Wendy
She’s no Warren Buffett, but she is better looking. And she is a long-term investor (and a relative of mine) who does what B&T deem to be “impossible” – buy boring blue chips and mid-sized “growth stocks” and hold them for years and years. She showed me the brokerage statements documenting a few of her more successful holdings:
- She bought shares of JNJ in January 1996 at a price of 23.7; now they are trading around 100. The dividend yield on her purchase price is 11.8%.
- She bought some Starbucks shares (not enough!!!) in July 1996 at a price of 3.1; now the stock is 93. Yield on her purchase price: 40.7%.
- She bought Altria in May 1991 for 5.38 a share; now the stock trades around 56. Yield on her cost: 38.7%
- Admittedly copying Saint Warren, she bought Wells Fargo in January 2002, six years before the financial crisis. Not great timing, but the stock is still up 134% and yields 6% on her purchase price.
- She bought Thermo Fisher in 2005 for 30.6; the stock has more than quadrupled and yields 2% on her purchase price.
Admittedly these are some of her better investments, and there were times in the past when they looked like duds. For example, during the 2008 real estate bust Starbucks (which had over-built to meet Wall Street’s expectations) plunged 74%; the company had to shut 500 stores and bring back the founder to revive the company. Altria was cut in half in the 1993 “Marlboro Friday” sell-off, when it announced an earnings disaster after losing market share to discount cigarettes. Wells Fargo was cut in half during the financial crisis; Borg Warner declined 68% and eliminated its dividend.
Another admission from Wendy: A few investments in apparently solid, widely owned “blue chip” stocks turned out to be disasters. Wendy bought shares of General Electric for 42 in 2001; now the stock is languishing at 25. And don’t even ask about the Lucent shares she bought in 1999. Wendy claims to have gotten better at avoiding bubble stocks like Lucent, and selling losers before they turn into terminal disasters. I have my doubts.
Three Co-Conspirators Against Long-term Investing
Wall Street pros, such as B&T, who try to own the right stocks for a given economic environment. They are constantly on TV and Radio opining about the best stocks to own, given current macro trends, valuations, and investor sentiment.
Wall Street sell-side firms that peddle whatever is “new and different” because new products that have not yet been commoditized have higher profit margins. Because they are geared to selling, brokerage firms tend to push whatever is in vogue and easy to sell.
The financial media, which is culpable on two fronts:
- It is endlessly flogs a handful of glamour stocks—right now it’s biotechs, Tesla, Facebook, Alibaba, Apple, Apple, Apple, and Apple.
- It is always doing its best to scare investors, turning every macro trend into an incipient disaster. Recently it was, “Oh my God, the strong dollar and declining oil prices are causing deflation!!!!” (Remember when declining oil prices were a bullish “tax cut for consumers”?)
We need more articles providing level-headed advice about how to construct a sensible portfolio of high-quality stocks you can own for the long term. Wall Street firms should put more effort into helping clients do this, charging a reasonable fee for same.
Copyright Thomas Doerflinger 2015. All Rights Reserved.