So, does ‘hold forever’ work?
Yes. Maybe too well, at least for now. For reasons rooted in psychology.
In my previous essay (https://buggyhuman.substack.com/p/favourite-holding-period-is-forever), I listed three pre-conditions for ‘favourite holding period is forever’ to stand a chance: duration, selectivity, paranoia. So, does it work, if pre-conditions are met?
Let’s start with assessment methodology. First rule: evaluation is at level of portfolio, not individual businesses. A process has to work in aggregate, on average, over time. It isn’t about getting every decision right. It’s about doing more good than bad, across decisions made using a consistent process. Cherry-picking extreme outcomes is not a good way to study a probabilistic endeavour. This rule is non-intuitive and surprisingly hard to follow. Second rule: evaluation is vis-à-vis an objective, namely delivering adequate long-term returns. Third: evaluation factors in a counterfactual or alternative process. Which meets objective better: don’t sell on valuation vs sell on a certain valuation guideline. Fourth: no hindsight bias, especially using outlier hypotheticals like “imagine buying/holding HDFC Bank two decades back at any price”. Justifying a strategy on the basis of selective winner anecdotes is criminal. Last, no using the phrase multi-bagger. It’s sleazy to peddle and dangerous to pursue.
Assessment that follows is guided by lived experience: actual decisions made without hindsight, real portfolio, meaningful scale and decadal outcomes. No anecdotes, hypotheticals or back-tests. However, I won’t get into names or numbers (since world can do without one more slimeball talking book or returns). An interested reader can validate claims via public data.
Biased as I am, crucial outcome of selective, paranoid approach is a portfolio that’s well above average on safety and quality. High ROCE, no debt, competitively advantaged companies, no dodgy industries etc. Between valuation discipline and personal frailty, I’m sure to miss out on many an Asian Paints. However, I’m unlikely to get anywhere near Unitech or Educomp. This skews outcome distribution across portfolio in a favourable way: high odds of reasonable outcomes, with positive outliers outnumbering rare blow-ups. For a favourable skew, time is a friend. Compounding, most powerful force and all that. Over decadal timeframes, effect of positive outcomes dramatically outweighs that of negative ones . As discussed in prior essay, time also turns valuation correction into a modest headwind. Mathematics of this is trivial, but assumptions behind the math are non-trivial. Beyond unrelenting selectivity and paranoia, sound judgment is a gating factor for ‘outstanding business’ assumption to hold.
Outstanding, check. Favourable skew, check. All we need to do is give time. Not so fast. Temperament is a huge gating factor. Giving time is surprisingly hard, as it requires us to do nothing. Absolutely nothing. For years on end. We’d rather die than sit still. We sit still only after we die. Psychology, not intellect, is at play. What follows covers how the approach in question helps tackle this problem. Here are a set of assertions that I believe to be true, but can’t definitively prove.
Assertion 1: It’s impossible to give sufficient time without ‘own forever’ mindset.
With this method, only question is if businesses are on track. If so, do nothing. Valuation be damned. Businesses might as well be unlisted. Market might as well be closed. In any other method, with stock price as input, it’s psychologically hard to avoid a ‘valuation trap’ (more damaging than ‘value trap’ for quality-oriented investor). It goes as follows: Oh my God, it doubled on me; what XL will justify incremental IRR; fine, I’ll sell at 35 PE; 35 already; 40 tops; oops, 40; I can’t keep moving target without feeling like a flake; fine, I’ll trim, rebalance, whatever; 45, I’m out. <years pass>. I was such a dumbass. I’ve gladly owned businesses for a decade after they first turned expensive. Had I fussed daily about valuations, dissonance and hypertension would’ve got to me in a fraction of that time.
Assertion 2: it’s impossible to know in advance which holds will do fine and which won’t.
While cherry picking ‘winners’ appears clever, it works only in marketing materials. Only reliable way to give time to all winners is to give time to all. Favourable odds arise from ensuring basket is outstanding before giving time to all. Not from picking favourites within basket. I haven’t found a reliable way to rank companies by conviction or prospective risk-reward. Likewise, cute attempts at trimming in anticipation of cheaper restoration don’t work in practice. Worse, they ruin the simplicity of permanent owner mindset. Being both trader and owner muddles up methods, minds and returns.
Assertion 3: Aggregate outcomes will be fine, while many specific outcomes won’t.
I don’t claim that every expensive hold decision turns out right. It needn’t and many won’t. Arriving at buy price is a perennial trade-off between two risks: lose money, miss opportunity. In hold decisions, risks are: hold for inadequate return or prematurely sell out of adequate return. Latter is a bigger risk for a basket of ‘outstanding’ businesses. Erring on the side of former offers better risk-reward in aggregate. Over long run, a few holds will lead to inadequate but not disastrous outcomes, if we’re right about outstanding part. More than a few will be adequate even if not great (unfair to expect great from an expensive starting point). The math of giving these time more than compensates for a few errors in the other direction, leading to reasonable aggregate outcomes. This will not work for a lower quality portfolio, as outcome skew will be in the other direction.
(Aboveassertions are unnatural at many levels. Our brains reject them the way immune system rejects a transplant. First level, we have to think process over outcome. Second, odds over certainty. Third, ignore over analyse, that too something as all-consuming as stock prices. Fourth, unit of analysis is aggregate portfolio, not individual company. While we pay lip service to future unknowable, predictions bogus and all that, we don’t truly buy into it. Deep down, we ‘know’ just how each investment will turn out. Accepting that we don’t know jack shit about any individual outcome creates severe dissonance. Mental void is painful. In many instances, I’ll have to suspend specific judgment and trust the process when holding on feels plain wrong. Then again, this isn’t supposed to be easy.)
Assertion 4: Psychologically, ‘hold forever’ mindset makes inactivity easier.
This is a non-trivial second-order benefit. This method entails a focus on what changes quarterly at the exclusion of what changes incessantly. Few things mess us up as much as having our pattern-seeking, story-telling minds stare perennially at meaningless squiggles. It’s hard to sit still if we tie actions to something that doesn’t sit still for even a second. Not having to do this frees the mind. To exclusively focus on businesses and business problems. To better assess all risks, not just valuation risk. To make peace with inactivity. To make waiting more bearable. To sleep better at night.
I don’t think I’m alone here. Publicly available information on investors such as Terry Smith or Chuck Akre suggests that this approach works. Smith’s succinct philosophy is ‘only invest in good businesses, don’t overpay, do nothing’. Akre recently said “We don’t have sell targets on anything we own”. Legendary Lou Simpson opined on similar lines: “If I’ve made one mistake in the course of managing investments it was selling really good companies too soon. … you’re investing in something you wouldn’t buy at current prices, but you don’t want to sell because it’s a really good business and you think it’s ahead of itself on a price basis. It might be worth holding on to it for a while”. There are more examples, but it’s hard for me to do justice to others’ methods beyond a point. More generally, research has correlated low portfolio turnover, especially when combined with high active share, to higher investment returns.
That said, efficacy is a leap of faith for any messy world process with probabilistic outcomes. It’s also highly subjective, as individuals and interpretations matter. No one admits to their businesses being short of outstanding. It’s tricky to figure out whether a bad result was due to method or flawed implementation. Also, given institutional constraints, very few can adopt this method in entirety, resulting in too few real-world data points to prove this in a generalized sense.
But, let me log the biggest problem with my argument before you do. It’s a bad time to tout this method, because it’s had it too good. In silly pursuits like turning money into more money, too good comes in two flavours: too good to be true, too good to sustain. Past decade has been unduly charitable to decent businesses and their holders. Any approach has cyclical ebbs and flows. Coming off an upcycle, I am more likely to get carried away by an unrepresentative experience. It’s better to extol an approach at a time when I look stupid for following it. I sneakily switched from ‘It worked’ to ‘It works’. It worked when portfolio PE went from mid-teens to low-thirties. Over the long run, as a part of this reverses, it might still work ok but it will certainly work less well. Over short-medium term, it may not work at all (not that any other method does). While I believe in the efficacy of this method on an over-the-cycle basis, this is the sort of essay that could look silly a few years out.
Warnings out of the way, what’s my summary. Sticking to outstanding businesses ensures way more good than bad at portfolio level. Owner mindset shifts focus to endurance of businesses quality over price movements. In turn, this makes it easier to give more time for a favourable skew to compound, notwithstanding valuation headwinds. Done right, I believe that applying an owner mindset to select outstanding businesses is the most reliable way to healthy long-term returns. And yes, it offers more peace of mind too. Even when adopted directionally and not entirely, a bias towards better businesses held for longer will be beneficial.
Investing is about temperament and judgment, in that order. Judgment takes us to safe and good businesses. While time is a friend for such businesses, temperament isn’t. Activity addiction needlessly interrupts compounding. The mindset shift from long-term equity investor to permanent business owner appears minor. Almost semantic. However, accompanying psychological shift is dramatic. While it’s tempting to quibble over long-term vs permanent, the real difference lies in equity vs business. Psychological effect of exclusively focusing on business, while ignoring stock price, boosts temperament to the point where we can sit idly as good things happen. Psychology is why ‘own forever’ works.
PS. ‘Own forever’ is one of those love it or hate it things. I know 60 seconds into my spiel which camp other person belongs to (mostly latter). Even if interpreted figuratively, there’s discomfort. Buy-price but no sell-price? How dare you call yourself a value investor? I’ll discuss philosophy of such matters in next essay. So, my prediction of a 2-part essay is wrong by 50%, making me feel like an economist.
So when do you actually sell?
Great essay, learnt a lot!