I, along with some other Fools, recently took an investing class run by Tom Gardner. We are a group of curious learners and there's nothing better than being pushed and encouraged to get better at your craft.
Tom recommended we write down why we think our investing process is going to be successful. Why, in essence, are we going to beat the market when so many fail to do so? I'm hopeful that by sharing my list it might help others reflect on their own processes for market outperformance and perhaps even write them down.
My three are:
- Timeline and temperament
- Incentives and intangibles
Here's why I think they're so helpful for me as an investor.
Timeline and temperament
It pays to have a long investing horizon in a myopic world. And the world in which we live is truly myopic. Most investment managers are compensated and experience fund flows based on short-term performance. This results in many mutual funds essentially mimicking the index while charging greater fees for less performance.
The very longest time frames in the professional investment world are found at private equity firms, and even they typically max out at about six years. Venture capitalists play a different game but still max out at 10 years. Because my horizon is longer than both, the short-term volatility doesn't bother me one bit.
Permanent capital allows me to have an investment timeline that is longer than almost every professional investor. But it's temperament that allows me to outperform most individual investors. I don't try to time the market or trade in and out of things. I consistently save and then regularly purchase parts of wonderful businesses. Additionally, I keep an opportunity fund in cash for unexpected bargains.
Although we can all be assured another crisis will eventually happen, I have no way of predicting when it will actually appear. Humility, a sense of humor, and a deep interest in tracking my own decisions and performance are all key to getting better at this over time.
The great Peter Drucker said, "Culture eats strategy for breakfast." While I love that quote, I've come to appreciate leadership much more than culture in my search for great investments.
The problem with culture is that it's too hard to assess from afar without a change in leadership. It takes a very long time to assess just how strong a culture really is. For instance, Starbucks (NASDAQ:SBUX) has built an outstanding culture. It was among the first to offer benefits to part-time employees. It paid above average wages, and the productivity of its employees has been outstanding. But, in 2000 Howard Schultz stepped down as CEO to purchase and run the Seattle Supersonics.
At first growth proceeded unabated, but by 2007 even Starbucks found itself overextended, and the wheels were coming off the tracks. Eventually Howard stepped back in to right the ship. Now I ask you, is Starbucks great or is Howard Schultz great at running Starbucks? Does Berkshire Hathaway have a great culture, or is it blessed to be run by Warren Buffett, one of the great CEOs and capital allocators of all time?
In the end, I think it's easier to assess the quality of a leader than it is to assess the strength and sustainability of the culture of a given company.
Incentives and intangibles
I want to be invested alongside of great leaders whose interests are aligned with individual shareholders. I want to invest in people who love to do what they do and who take a long-term approach to running their business.
Evidence of great incentives could be large ownership stakes or payment structures that allow the CEO to benefit when the shareholders do. For example, Rich Handler and Brian Friedman of Leucadia (NYSE:JEF) have never sold a share of stock in Jefferies or Leucadia unless it was for charitable or tax purposes. In 2014 they refused to take their bonuses because they didn't feel the business performed up to snuff. That's right, they refused over $2 million dollars!
The leadership team at Markel (NYSE:MKL) made a similar decision, coming out of the great recession. You see, the company measures its performance on five-year rolling periods. The business performed admirably during the downturn, but since Markel didn't hit its targets, no bonus. This leadership team is truly in it for the long term.
Intangible assets are often underappreciated by professional investors. The latter's short holding period dilutes the importance of these powerful assets. Why would you care about a brand or a management team if you're going to sell the stock in six to 12 months?
An intangible asset is something that doesn't appear on the financial statements. It could be a brand. It could be the positioning of the company, the organizational structure of the business or some intellectual property that they own but haven't yet successfully monetized.
Network effects and power laws are often underappreciated examples of valuable intangible assets. These allow a company to sustain outsized growth rates over very long time frames. The main point here is that none of these are directly listed on the financial statements but they have become a crucial part of my research process.