We write today with some thoughts on a few topics. First, how to deal with stocks and other investments that have significantly appreciated in price? To be sure, this is a nice problem to have. Second, our thoughts on a recent article in the Financial Post.
We often field questions about stocks and other investments that have appreciated a lot in price. Naturally, investors may have an urge to sell these investments. Should investors heed the old saws to “take profits” or “rebalance” as many have been counselled? You may also have heard the old stock market adage “you never go broke taking a profit”. Other platitudes such as “locking in profits” or “taking money off the table” also fall into this category. Another practice is to sell a stock because it has reached an arbitrarily determined “target price”.
These strategies sound reasonable as it our tendency to protect winnings. If we buy a stock that doubles we have an itch to sell it – it’s human nature. This tendency is known as the “disposition effect”. The disposition effect says that investors sell their winners too early and hold losers too long. The witty (and very wise) Peter Lynch sums it up nicely: We pull flowers and water the weeds.
In part, the itch to sell is associated with another behavioural pattern – we feel a need or desire to “do something”. Inaction is hard in investing for clients and professionals alike. In most endeavours more activity leads to more output / reward. In investing, however, “tinkering” / intervention tends to detract value in our experience – somewhat counterintuitive, but true. In investing, patience is a virtue. Truly, less is more.
“Don’t do something, just stand there!” – John Bogle
Now in some cases, “taking profits” is a very good idea indeed. Say, for example that you own shares of a high-flyer with dubious prospects and a huge market capitalization.
We can contrast these practices with the example set by Warren Buffett whose favourite holding period is “forever”. Like most things in investing, how active / inactive you ought to be is a contentious issue. Our thoughts are as follows: Generally speaking, the practice of “taking profits” or selling stocks because they have reached a “target price” is anathema to the long term accumulation of wealth. Qualifier: the need or desire to “rebalance” depends on your age, goals, income needs and comfort with risk. However, it is the rare individual who can buy and hold for the long run. In our experience these individuals tend to do very well. Case in point: Herb Wertheim.
Wertheim’s story was told in a recent Forbes article . Wertheim, an Optometrist who resides in Florida, is a billionaire. According to Forbes, “His fortune comes not from some flash of entrepreneurial brilliance but from a lifetime of prudent buy-and-hold investing ”.
Wertheim invested in the IPO of both Microsoft (1986) and Apple (1980). He still holds these stocks today. According to Forbes, “The Microsoft shares he bought during the IPO, which have been paying dividends since 2003, are now worth more than $160 million. His 1.25 million shares of Apple, some purchased during its 1980 IPO and some when the stock was languishing at $10 in the 1990s, are worth $195 million ”.
Wertheim explains, “My goal is to buy and almost never sell ”.
Now, the case of Herb Wertheim is an extreme example. And, clearly he has acumen as a stock picker (you would be pressed to identify two better stocks to own over the past 30 years). But the point we make here is that the compounding effect of buying and holding good stocks can be very powerful. But how many people have the required level of patience? How many people could resist the urge to sell shares of Microsoft during its huge run-up in the 1990’s? How many could endure the big declines of Microsoft stock over this period?
You may recall a period several years ago when Microsoft stock was out of favour with investors. Over the period of 2000-2013, the stock languished in the $20’s – $30’s, well below the 1999 all-time peak price of ~ $58 per share. At that time, the prevailing view was that the PC was dead and Microsoft was destined for a long-term decline in relevance and market share. Today, Microsoft is battling it out with Amazon for the title of the world’s most valuable publicly-traded company. Truly, the market is manic depressive. Sentiment reversed from “hopeless” to “flawless”, to borrow from Howard Marks. Apple was also very much out of favour with investors in the late 1990’s. At that time, practically no one could foresee Apple’s massive string of product hits and financial success that would ensue over the following 20 years. But never mind foresight, how many investors “took profits” on Apple during this period for reasons such as:
- It had reached an arbitrary “target price”;
- They wanted to “lock in” profits; or
- The stock looked expensive. In hindsight, we can say that it was not overpriced – the market had correctly discounted its very bright prospects. According to Yahoo Finance, Apple shares traded @ $4.00 per share (split-adjusted) in December, 1999 . Today, they fetch @ $200 / share.
The itch to sell Apple after it doubled or tripled would be difficult to resist / overcome. Can we learn from Herb Wertheim?
The opposite of long term buy and hold investing is described as “short-termism”, and it is rampant. Stock research is often focused on the near-term prospects for a particular company. Short-termism handicaps the investor. Why? Because a short term mindset, and the buy/sell activity it begets, rests on faulty premises – that you know more or have special insight about the near-term prospects for the stock in question (in most cases you do not), and that the near-term is knowable / predictable. Having a short-term mindset leads to speculation – the antithesis of investing. It is, to borrow a phrase from Charlie Ellis, a loser’s game. We should not lament that we are unable to successfully trade in and out of stocks – the world’s best investors such as Buffett readily admit that they can’t successfully do it either.
Our approach to investing rests on a few principles: humility, simplicity and patience. We do not set or pay heed to short-term target prices – we simply try to buy and hold good stocks as long as their competitive position or “edge” remains intact. As well, we consider the relative attractiveness of what we own vis-à-vis what else is available in the marketplace.
The economy and individual companies tend to wax and wane, and in turn, stock prices fluctuate. All companies go through rough patches – business is not linear and all positive news. The short term trajectory of markets, companies, etc. is unpredictable. The real money is in the waiting. Short-termism is a “snare and a delusion” to borrow a phrase from Munger.
“The stock market is designed to transfer money from the active to the patient.” – Warren Buffett
Now, to our final topic of discussion. A recent article in the Financial Post struck a chord with us and prompted this discussion. The title, “The storm is coming and investors need a financial ark to see them through ”, touches on a topic that we have written about at length in previous notes – the observation that investors “have grown comfortable with hefty stock market valuations ” and complacent about risk.
This is a worrying sign because investor complacency is often exhibited during market peaks. We share the author’s view. We are big fans of Howard Marks and have previously shared his thoughts on market cycles. His big idea, and it is a very useful one, is that the market is unpredictable however, it is important to have an understanding of “where we stand”. In his words, “We never know where we’re going, but hopefully we can figure out where we are, and understand what that implies for the odds. ”
According to Marks, there are indicators of cycle peaks that include:
“A high level of investor optimism….investors who are spurred on by greed. Recent successes, because what makes people more optimistic and greedy than having made money recently? Investors who are happy with their gains, or jealous of the gains of others — and jealousy is one of the strongest forces all around the world. Unwise risk tolerance, and eagerness to supply capital. Things like this denote a market which is elevated and a market which is against you. And when are these things seen? At market highs. When the cycle reaches its high, the probability is that these things have occurred and that the odds are against you .”
When are the odds in your favor? Marks identifies these signs of cycle lows:
“A shortage of optimism, a high level of fear, poor recent market performance, widespread losses, excess risk aversion and a reluctance to supply capital. When are these things seen? At market lows. So if we can focus on cycles, if we can understand where we are in the cycle, we can get the odds on our side .”
Marks’ thoughts on “getting the odds on your side” is precisely the way that we think about investing. The really good investors wait for these opportunities. This requires, to some extent, the willingness to go against the grain; to think independently. The FP author makes the point that “where we stand” feels a lot like the conditions described by Marks as prevalent during cycle peaks. Our take: This is not the time to back up the truck with Timmy’s RESP funds.
When market conditions are unfavourable and the odds are against you the proper response, in our view, is remain invested but don’t be complacent about risk. When good opportunities are few be patient – this can mean holding more cash or fixed income securities than you otherwise might despite their unpopularity and unsatisfactory yields. In doing so, you will be positioned to exploit the inevitable setbacks (cycle lows, as Marks puts it). As Marks puts it, “When there is nothing clever to do it’s a mistake to try to be clever”. Do not try to time market tops. We conclude with some words of wisdom from Charlie Munger that sums up our thoughts on this issue :
“Warren and I have not made our way in life by making successful macroeconomic predictions and betting on our conclusions. Our system is to swim as competently as we can and sometimes the tide will be with us and sometimes it will be against us. But by and large we don’t much bother with trying to predict the tides because we plan to play the game for a long time. I recommend to all of you exactly the same attitude. It’s kind of a snare and a delusion to outguess macroeconomic cycles…very few people do it successfully and some of them do it by accident. When the game is that tough, why not adopt the other system of swimming as competently as you can and figuring that over a long life you’ll have your share of good tides and bad tides?“
Best wishes to you and your family from your Apex team: Shawn, Scott, Mike, John, Will, Denise E., Paul, Tina, Denise N., Lisa, Marta, Darlene and Sharon.
The information contained herein was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. This report is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell any securities mentioned. The views expressed are those of the author and not necessarily those of ACPI.
Aligned Capital Partners Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.
 “The Greatest Investor You’ve Never Heard Of: An Optometrist Who Beat The Odds To Become A Billionaire”, Madeline Berg, Forbes, February 19, 2019, https://www.forbes.com/sites/maddieberg/2019/02/19/the-greatest-investor-youve-never-heard-of-an-optometrist-who-beat-the-odds-to-become-a-billionaire/#1079ae5022e8
 “The storm is coming and investors need a financial ark to see them through”, Larry Sarbit, Financial Post, July 19, 2019, https://business.financialpost.com/investing/investing-pro/the-storm-is-coming-and-investors-need-a-financial-ark-to-see-them-through