Favourite holding period is forever. Conditions apply.
My take on an investing approach that's simple yet complicated (Essay 2 in long-termism theme)
“When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.” – Warren Buffett, Berkshire Hathaway’s 1989 Annual Letter
My ‘long-termism’ theme cannot be complete without addressing the biggest elephant in that room, at least from an investing perspective. Does it make sense to own (certain businesses) forever? Does this make for superior returns? This is a complex and controversial topic that I may not be able to do justice to. Nevertheless, here’s my attempt, spread over two long essays. Brace yourself.
I dug out the original quote, in entirety, from when it first appeared to get the right framing before elaborating on a philosophy that I am lucky to practice. Conditionality and nuance get missed out in popular (dangerous) misrepresentations that emphasize the last five words.
Synopsis: It works well. Maybe too well. Offers peace of mind too. But, stringent conditions apply.
Now for the detailed review. First, statutory warning. No method in messy world works in a “30 minutes guaranteed, nahi to free, no questions asked” sense. There’s massive subjectivity in implementation and method cannot be separated from practitioner (covered in depth at https://buggyhuman.substack.com/p/is-value-investing-dead). Works = Worked for me, in my context. I believe it offers favourable odds more generally as well, but reader beware.
There are three pre-conditions that need to be met for this method to even stand a chance of working. I’ll cover these before getting into efficacy.
1. Long time horizon
What’s the biggest problem with an approach that I define as: if valuation is only reason to sell, don’t? It entails holding onto (hopefully outstanding but) evidently overvalued businesses. To avoid arguing over silly hypotheticals (“What about 200 PE?”), let’s assume overvaluation that’s material but not absurd. Valuations tend to be mean reverting, with some correlation to risk and quality. Short-run voting machine, long-run weighing machine and all that. So, no matter how outstanding a business, valuation correction will be an inevitable headwind to returns. Quantum of headwind, in annualized terms, is inversely proportional to duration. A material correction is an insurmountable headwind even over medium-term, but a modest one over decadal timeframes (I stay fuzzy to not make this about XL-giri).
(I don’t recommend overpaying on entry. I certainly want valuation to be tailwind over the entire duration of an investment, since margin of safety is essential when my frailty meets others’ money. It doesn’t need to be a tailwind all the time and a likely headwind, in itself, isn’t reason enough to exit.)
2. Selectivity, bordering on absurdity
What can offset a (modest) valuation headwind? Certain compounding. Both words matter. I re-emphasize that compounding ≠ growth, especially of the made-up, click-drag, futuristic kind. I am more concerned with certainty, than magnitude, of compounding. This requires real, not XL, inputs to be in place: trustworthy focused prudent people, analysable attractive industry, well placed company gaining within its domain, wide moat, high return on capital, no distractions or big M&A, disciplined capital allocation. Longer discussion on elements of compounding is at https://buggyhuman.substack.com/p/growth-is-overrated. This is a high bar, which seems natural for anything we’d like to own forever. As all ingredients lining up is rare, consideration set is probably a high-double-digit number of businesses. This is an absurd level of selectivity that’s way easier to write about than adhere to, especially as such businesses spend most of their lives at unbuyable valuations. It’s perennially tempting to lower the bar. However, without ‘outstanding’ part, ‘forever’ part is void ab initio.
3. Paranoid, no-bluffing reassessment
‘Outstanding’ is far from static. Businesses can and do lose their way, although not for reasons popularly ascribed. Self-goals are way more dangerous than disruptions. The only way to not take ‘outstanding’ for granted is to integrate paranoia into process. Obsessively track not just absolute performance, but relative performance at granular level, including against unlisted peers. Be wary of balance sheet deterioration, in terms of working capital and receivables, especially of the long-dated kind. At least once a year, solicit feedback from diverse industry insiders and triangulate with secondary data and management commentary. Don’t take distracting forays lightly, even if they seem small or innocuous. Keep sniffing for anything that smells funny. It’s like Groundhog Day, repeatedly reliving the “does this merit owning forever” question from first principles. Done well, we should catch any material slip-ups well before they become more broadly apparent. A corollary to my earlier statement is: if irredeemable business problems arise, sell without fussing about valuation. No unconditional love, ownership or ‘outstanding’ tag.
Everything so far sounds extreme, starting with ‘hold forever’. Nothing is forever and hold period is only known in hindsight. Pre-conditions seem unreasonable for most in light of fickle flows, NAV pressure and incentives that punish short-term relative underperformance. Taken literally, this whole spiel appears impractical, if not utopian. To avoid this trap, let’s go with a figurative and directional interpretation. Interpret forever as indefinite, not infinite. Conditionally indefinite. Pre-conditions are directional guidelines, not definitive rules. Even without taking it to extremes, there’s benefit to sticking to better businesses, not taking their quality for granted and giving them more time. While stricter adherence is better, reasonable adherence is feasible for most investors. Own forever mindset is about not interrupting compounding in good businesses for an extended period without getting too hung up about valuation at every point.
So, does this philosophy work? I’ll cover that in the next part of this essay.
Nice one. Would like to know your views on 'How to know if we are overpaying for a fantastic business or not?' in the next essay. :)
Great insights shared. Would like to know more on how do you balance the qualitative (management & Industry competitiveness) and quantitative aspects(ROCE & valuations) while identifying growing small businesses.