A Safe Place to Hide
“As a money manager, I have frequently looked at an investment decision that I felt had a high probability of success on a three-year horizon, but about which I had many doubts on a six-month time horizon.”
- Robert Kirby, The Coffee Can Portfolio
I heard a friend say there is “no safe place to hide.” It got me thinking. What’s safe?
I think the answer to the question depends on your investment horizon.
So, cash looks really good if you need two weeks. Maybe you need to buy a new car. Cash gets it done. Not much risk.
Cash looks worse, though, if you look one year out, especially with inflation running circa 8%. And it looks terrible over ten years.
If your horizon stretches ten years or more, then owning a good business is one of the safest places to be. Even better: own a portfolio of such businesses. Thank goodness we have public equity markets, where we can easily buy pieces of some of the best businesses on the planet. (The problem is that we can easily sell them, too, but more on this below…)
Look at the historical record of inflation-adjusted returns on “the market” (for our purposes, the S&P 500). Charlie Biello recently shared the following chart with the comment, “Why you need to invest, in one chart…”
A remarkable chart, which captures a lot of ideas in on go. Granted, investors did not get a smooth ride. There have been long stretches where you lose ground. And there are no guarantees about the future. But life itself does not come with guarantees.
Alternatively, you could build a portfolio of wonderful businesses yourself and then – this is the key part – leave it alone for a decade and see what happens. This is the “coffee can” idea. I am a big fan. I’ve written about it in different places before, but you can read about the idea, penned by its original creator, Robert Kirby, in a classic article here:
The appeal of the coffee can is you protect yourself against your worst instincts. You can’t sell when things are going badly. It’s like Odysseus, when he had his crew tie him his mast to resist the sirens' calls. He still heard them, but he couldn't do anything. (His crew stuffed beeswax in their ears).
I quoted Kirby up top. As he implies, in some ways, it is easier to invest when you have a longer-term time horizon. I have have no idea what the stock prices of my favorite ideas will do over the next 5 months. Chance would play a huge role in the outcome. And the odds are decent they could actually be worth less. But over the next 5 years, I'm more confident they will be worth a lot more.
What makes investing hard is that things don’t unfold in an even, or predictable, manner. There are some great runs, there are nasty drawdowns and there are extended periods where you seem to go nowhere. Each presents lots of opportunities for investors to make costly mistakes.
Swedish Serial Acquirers
You can lower the risks of making mistakes, too, by severely limiting the kinds of businesses you own in the first place. Investors usually focus on trying to find ideas that will perform, or perhaps where they feel they won't lose money. But I will suggest another, less appreciated angle: think about the psychology involved in owning the name.
We have to admit part of investing is psychological - maybe the most important part. And we know the market will test us along the way. So, we have to look for businesses we would be comfortable holding even during bad times.
My own template looks likes this, which I often repeat in my quarterly letters:
● High insider ownership (skin in the game)
● A strong balance sheet (we avoid financial leverage)
● A business with consistently high returns on capital
● A businesses we can understand
● An attractive purchase price.
There is plenty of nuance to these elements, but these are the essentials. I know I will miss some businesses that will prove to be great investments because they don't pass through my filter. But that’s okay. The point is to create some template that fits you personally. These are pillars you lean on when times get tough.
So, for example, I have confidence knowing the people running the show at my companies have the proper incentives to make good decisions. Because they are owners, too, like me. Strong balance sheets mean my companies won’t be at the mercy of fickle lenders and can continue to take advantage of opportunities. And so on. You may draw conviction from different criteria.
I also think the structure of the business itself can lend confidence.
For example, I am a big fan of the Swedish serial acquirers, or at least some of them. Several check all the boxes above.
The basic model is a decentralized organization made up of small, usually unrelated, businesses. The chief avenue of growth is through acquisition, financed by the cash flows from existing businesses. The good ones are built around the idea of smart capital allocation. So they tend to talk about things like return on capital, reinvestment, etc. All stuff I love to hear.
The advantages of this model in times like this are two-fold, at least.
First, they are naturally diversified – there are several different kinds of businesses under the hood, and they will respond to any particular cycle in different ways. So, in theory, owning them is less risky than owning a business that does just one thing.
Second, during bad times, deploying capital becomes more attractive as prices come down for targets, and this has started to happen. As you may have heard, I recently acquired Teqnion shares (TEQ in Sweden). Last week, the company held a “Qapital Markets Hour,” in which CEO Johan Steene and CXO Daniel Zhang (in charge of acquisitions), fielded questions from attendees.
I will write about Teqnion another day, but suffice to say I really like the team and model. Johan and Daniel are thoughtful capital allocators and they have the right ideas and temperament. There is a lot of skin in the game here, too. And I believe Teqnion has a long runway. I’m happy to be a shareholder. (It’s in the coffee can, for me!)
Anyway, on the call Daniel said they find their own acquisitions, as opposed to using brokers. One reason is they thought broker prices were too high. But prices have come down on the broker side and so Teqnion is talking to brokers again.
I have several stocks that should benefit from this dynamic in addition to Teqnion. Again, they are easier to hold because I think about the high returns these firms may generate as they deploy capital.
Again, if investing is part psychology, you want to create a portfolio where you won’t get shaken out. I often think a key reason to get to know a business well is not because I expect to learn some secret. It’s more to build up enough knowledge and confidence in what the business is doing so that I don’t panic when the next bear market rolls around. As Munger says, the first rule of compounding is not to interrupt it unnecessarily.
You want to find a great investment. Yes. But you also have to find a great investment you can hold on to and see become a great investment.
The Conventional Wisdom is Wrong on Acquisitions
A word on acquisitions: Some people might be reluctant to look at the serial acquirers because they believe acquisitions often destroy value. I held this view myself for a long time. I unlearned it when I started to study companies that had great success acquiring other companies -- lots of other companies over a long period of time. Constellation Software is exhibit A here. (I own it). But there are many others.
Check out the Serial Acquirers Primer an easy-to-read handbook that covers the topic well and includes an appendix with ideas to research. (Link)
Another good resource is this piece by Scuttlebutt, which also includes links to other research. (Link)
More recently, I came across a book that should forever change your opinion on M&A: Deals from Hell: M&A Lessons that Rise Above the Ashes by Robert Bruner. (Hat tip to @CostaVerdeCap for the recommendation).
If nothing else, just read the Introduction and the first couple of chapters. Excerpts:
“M&A failures amount to a small percentage of the total volume of M&A activity. Investments through acquisitions appear to pay as well as other forms of corporate investment. The mass of research suggests that on average, buyers can earn a reasonable return relative to their risks. M&A is not a money pump. But neither is it a loser’s game. Conventional wisdom seems to think otherwise, even though the empirical basis for such a view is scant.”
“[A]n objective reading of more than 130 studies supports the conclusion that M&A does pay. These studies show that the shareholders of the selling firms earn large returns from M&A, that the shareholders of the buyers and sellers combined earn significant positive returns, and that the shareholders of buyers generally earn about the required rate of return on investment.”
Bruner points out the big failures get all the press. So it tends to skew our view of what's happening.
The track record of the successful serial acquirers show that the rewards for mastering M&A can be immense.
That’s all for now. Thanks for reading!
Published: September 21, 2022
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