I was on a recent podcast with Steve Symington [Link] and he brought up a question that many investors ask me.
Before I get to the question, let me set the table a bit: One conclusion of my 100 baggers research is that those really big winners took some time to get there. Consider a couple of points:
* The median time for a stock to return 100 to 1 for the stocks in the study was about 26 years. (And so was the average).
* The rough math is that a 20% return compounded for 25 years is 100x.
So, it takes time even at enviable rates of return. Holding on for that long is hard -- for all the usual reasons having to do with our emotions and general impatience. But also, I think, because returns are back-end loaded. The magic of compounding takes time to become magical. You don’t get feedback that is linear.
I always think of the well-known example of the lily pond. Imagine a lily pond where the number of lilies doubles every day such that on the 30th day the pond is full of lilies. On what day is the pond half full?
The answer is on the 29th day. In investing terms, you make as much on the last day as you did in the first 29 days.
You can also see this effect in Warren Buffett’s net worth by age. The amount of money he’s made since he turned 60 dwarfs everything before:
Source: Vintage Value Investing
So, the question is: What can an investor do to hold on to their stocks longer?
Usually, I say something like “focus on the business and not the price movements” - but what does that mean exactly?
Focus on Business Results, Not the Stock Price
Thomas Phelps has an interesting presentation of this idea in his book 100 to 1 in the Stock Market. He gives you the following table with some financial results for Pfizer:
And he asks the question: “Would a businessman, seeing only those figures, have been jumping in and out of the stock? I doubt it.”
I doubt it, too. But many investors clearly did trade it.
And how did Pfizer’s stock do during this run? The stock was up 141x.
What’s remarkable is that the stock trailed the market from August 1946 to May 1949 and again from August 1951 to September 1956. Those stretches can feel like eternity if you’re checking your performance every day, week, quarter, etc... As Phelps said: “Performance-minded clients would have chewed the ears off any investment advisor who let them get caught with such a dog.”
You could easily create such tables for your favorite stocks, with whatever relevant metrics you want to track.
One example: Constellation Software used to put similar tables in its annual letters (the last was 2017). Here is the presentation from the final 2017 letter:
ROIC is return on invested capital. Combined with growth, it is an important performance indicator. In Table 2 below, Constellation continues its presentation with another important metric - cash flow per share:
All looks very good doesn’t it? If you only checked in on this stock every year when you read the annual letter, you would have no reason to sell it. You could live a happy life without knowing anything about what the economy was doing or interest rates or election outcomes, etc.
In Constellation’s case, the stock didn’t test you much. Drawdowns were relatively mild and brief. But still, there would’ve been many temptations along the way to say “I’ve made a nice profit, time to go.” Which would’ve been a huge mistake. The stock is up something like 60x - not including dividends. And, as you would expect, most of the dollar return has been back-end loaded, in the last five years.
Here’s another example I like because the numbers are “mortal” - not knockout like Constellation, but the result over time has still been quite good. Let’s just look at sales, free cash flow and net income profit margin.
You can see the march in free cash flow over time. (The number of shares outstanding has not changed much). What’s the stock done? It’s up ~4.5x in a decade, ex-dividends. Not bad at all and easily ahead of the S&P500.
The company is Brown & Brown (BRO), an insurance broker. BRO didn’t look all that cheap to me when I first bought it for ~$27 in Jan of 2019. (I still have it). I wrote in my notes at the time I bought it that BRO could be a low-risk 10% type returner. It’s done considerably better than that sitting here today at ~$45…
Now, all of these companies definitely enjoyed a lift in valuation. Valuation is important and it’s the thing investors probably struggle with the most today when buying these kinds of quality companies.
Still, I feel I have to say this: Don't obsess too much over valuation, if you really plan to hold on and not trade. I recall a story where an investor told me he passed on SBUX at 40x earnings because it seemed too expensive. It’s up more than 100x since.
You want reasonable prices. But what’s reasonable? It depends! I wish I could give better guidance here. Maybe a topic for another post. The point is it’s not likely you’ll get a steal on a known great company. It can happen, though. Even great businesses occasionally go on sale. (Think back to March!) Make your shopping list now and when you get the chance, pounce.
Just remember: The magic of compounding works wonders over time, even overcoming seemingly so-so initial valuations. Of course, you can always add to your favorites over time at better prices if/when the market gives you chances. Maybe start small on those stocks where the valuation makes you queasy.
Great businesses, too, have a tendency to deliver positive surprises. For this style of investing, you should spend way more of your time understanding the business and much less on valuation.
One obvious objection to the above: it’s backward looking… I’m sure Kodak looked great until it didn’t. I agree.
I’m not saying you bury your head in the sand and pay no attention to the view ahead. I’m saying lean on the track record of great companies more than on the concerns in the headlines. I know it doesn’t sound right to say investing is as easy as buying companies that have done well… but actually, it can be.
Businesses that have done well in the past, tend to keep doing well. Microsoft, Home Depot, Domino’s Pizza… These have been great businesses for a long time. Yes, plenty of great businesses have also failed - and some have not failed but have not been great investments… There are other factors at work (like what price you pay).
But a portfolio of ten such businesses, held for, say, 10 years will deliver surprises, good and bad. The good should overwhelm the bad. Which brings me to the “coffee can” idea…
The Coffee Can Portfolio
This is also usually part of my answer to the question above: How to hold on to your stock longer?
Robert Kirby (read an interesting obit here) hatched the idea and wrote about it in the fall of 1984 in a classic article, which I recommend to you. [Link].
As Kirby puts it:
”The Coffee Can portfolio concept harkens back to the Old West, when people put their valuable possessions in a coffee can and kept it under-the mattress… The success of the program depended entirely on the wisdom and foresight used to select the objects to be placed in the
coffee can to begin with.”
Applied to investing, you create a portfolio of stocks and leave it alone, akin to putting it under your mattress. Maybe you create a separate account to do this -- so you’re not tempted to trade.
Kirby had the idea after one experience he had managing a client’s account. After many years the client’s husband dies and Kirby gets that account as well. Upon reviewing it, he finds the husband had been secretly piggy-backing on his ideas the whole time -- with a twist:
“He paid no attention whatsoever to the sale recommendations. He simply put about $5,000 in every purchase recommendation. Then he would toss the certificate in his safe-deposit box and forget it. Needless to say, he had an odd-looking portfolio. He owned a number of small holdings with values of less than $2,000. He had several large holdings with values in excess of $100,000. There was one jumbo holding worth over $800,000 that exceeded the total value of his wife’s portfolio [!]”
Lesson learned - and the idea of the “coffee can” idea was born.
Boyar Value Group recently published the results of a real-time example of a coffee can portfolio held from 2010 to 2019. Here’s a snapshot that I posted on Twitter:
This is a typical coffee can portfolio in several ways. There is one stock that dominates - McGraw Hill. Who woulda thunk it? And there are a couple of misses. But overall, this portfolio handily beat the S&P500 and it required you to do absolutely nothing after you made your selections… just hold on.
What would I put in my Coffee Can?
For me, there’s a few things I’d like to have in a company to take for that long of a ride:
* Strong balance sheet -- to survive and be opportunistic during “bad” times
* Good business -- one that generates healthy free cash flow, good returns on the capital invested and has reinvestment opportunities. These are the basic building blocks of value creation
* Alignment -- I like management with skin in the game and proper incentives, ideally a great corporate culture of invested employees, etc.
* Reasonable starting valuation -- no hard and fast rules here, sorry to say
Of course, this will miss lots of things -- businesses that aren’t making money today, but will make lots of money in the future, etc. - but this is a reasonable filter for my tastes. Yours will be different.
So what’s one company I’d put in my coffee can?
I like Heico, which reported earnings yesterday (and maybe that’s why I think of it, as it's fresh in my mind). Heico checks all my boxes. (My average cost for the A-shares is about $71.) You can learn more about what they do here.
Over the last decade, the stock is up roughly 10x. And when you look at some basic financials, it’s not hard to see why:
Heico, too, has enjoyed a big valuation lift over that time. At least in this case, the business is performing at a significantly higher level (better margins, better ROICs, etc.). But still, it’s a familiar issue investors have had to face in recent years.
I suspect Heico will be able to grow its business by double-digit rates for years to come. It’s going through a hiccup now because of its aviation business. But this hiccup may give you the chance to get it at a “reasonable” price. And they have other businesses that could be much larger over the next decade.
Thanks for reading!
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Published August 26, 2020
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