The Easiest Part?
Past 3 articles have been about the strategy a legendary investor has been using for over 50 years now. This is the last part of it, the most difficult one.
Introduction
We’ve now learned that two of the main pillars of this strategy are about finding great companies with a long durable moat (Article 7) and paying a fair price for them (Article 8). Brief clarification, there’s a lot more work to do in finding great companies, having a MOAT is the essence of it but not everything.
Now, you’d say that we’ve already found the stock we want and if we pay according to its value, we are done. Well, no. Always remember:
“Any approach to moneymaking in the stock market which can be easily described and followed is, by its terms, too easy to last.”
The market has the last word and HE will dictate whether you’ve picked a great company and whether you’ve paid a fair price for its share.
Why Holding for as Long as Possible
In the long run, what matters is how the business has performed and how it’s currently performing, with its current future prospects. But in the short run, almost nothing but valuation matters, which is completely subjective to the financial community.
This image attempts to explain what rules a stock’s performance over time. For example, in a one-year time frame; 29% of the price action can be explained by the revenue growth the company had, 13% by the margin it had, 46%!!! By the multiple contraction and expansion and 12% by the free cash flow the company had.
The key takeaway is that, over a 10-year period, what explains and correlates better to the stock’s price action is the performance of the underlying business. The study claims that over this time frame; 89% of the stock performance will be in line with the business sales and profit evolution. The way Warren Buffet avoids this subjective appreciation and depreciation of his stocks is by holding them for as long as possible, where the fundamentals of the company he selected prevail.
The other main reason supporting long holding stocks or, said in a better way, investing for the true long run is compounding interest:
Resonates with something? Yes, with Warren’s Buffet net worth picture. 99% of his net worth was made after he was 50.
Problems
The reasons why this is considered the hardest part of the strategy are volatility, uncertainty and impatience.
We all know Tesla for its incredible performance, achieving a 22000% return since September 2010, that would be a 220X in 12 years. But what if I told you that, to achieve that return, you’d had to hold Tesla through the following:
30% Drops: 7
40% Drops: 4
50% Drops: 3
60% Drops: 1
Everyone that has now seen what Tesla stock performance was, claim they would have held it through all of this and of course, who wouldn’t knowing it would deliver a 220X return. But you don’t know anything at the moment.
It’s unimaginable the amount of emotional actual pain every single one of this drops generates to an investor. And you can’t think you’ll handle it because you know it will have been a great investment in the future. Because you don’t. You will never be sure whether you’ve selected a great company and paid a fair price for it, only time will tell.
The third problem arises from natural human behavior. We’ve been mentally designed to look for instant gratification. Imagine doing something knowing that you will probably not collect any sort of return in less than ten years. That’s absolutely counter intuitive.
What does this lead to?
“In terms of how long stocks stick around in a portfolio, the average investor holds shares for 5.5 months.”
Warren takes advantage of this and uses it in his favor.
Some Appropiate Quotes:
“In the short run, the stock market is a voting machine. Yet, in the long run, it is a weighing machine.”
“In the short run, your returns will be hostage to Mr.Market and his whims.”
“Life is always easily understood looking backwards, but you have to live looking forward.”
“The stock market is a deice for transferring money from the impatient to the patient.”
Some more for interested:
Final Notes
Investing is hard.
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