The best reason I can think of for why this works has to do with company culture and leadership. These are A+ cultures run by A+ leaders. Think back to your school days. Were the students that scored straight C’s “due” for an A or a B? Were the straight A students more or less likely to keep doing well?
If there was any correlation between the quality of a company or management and its short-term stock price moves, this might make sense. But there isn’t.
A very recent example is Apple. Apple is the same company today that it was a couple years ago. But in between that period, its stock price was halved. Same quality business, crazy stock pricing.
BOFI nearly got cut in half between March and October. So is it a “C” company now? Or maybe a B- since it’s recovered a little bit? Was it an “A” back in March when it hit its local peak?
And you can flip it around, too. Take AIG. After its restructuring, it was hard to argue it was any better than a “C” company (I think most would still consider it that), but it was priced like an “F”. Both MF Pro and Inside Value have done very well with it as the market has slowly priced it closer to “mediocre” than “terrible”.
During the financial crisis, did every company suddenly become an “F”?
Short term market movements are more or less random (both up and down). We like to look for explanations, but it’s futile. We hear all the time Graham’s saying that in the short run, the market is a voting machine but in the long run, it is a weighing machine. But it’s so true! We just forget it when prices are going up and we assume it’s our thesis playing out, and proof that we’ve made a great investment. We give ourselves that pat on the back. And then we’re surprised when prices go down. There must be something wrong with this company, we assume. And there might be, of course – there’s a reason we don’t invest 100% of our capital in a single company – but usually we just need to give things more time and let the signal emerge from the noise.
Last night I watched some show on Netflix where they renovate rental properties. These landlords were thrilled to put up many tens of thousands of dollars in investment with a 5 year payback period based on the rental income they expected to receive. And yet here in the stock market, everyone wants profit today. Folks actively deride the idea of locking up an investment for 5 years. People obsess over daily stock movements and the results of a single quarter (that’s 3 months, folks!).
For must of us, the way to compound our wealth over time is to buy quality companies at reasonable prices, and then ignore all the craziness markets throw at us. 5 years is a blip, both in life and in the world of business. If we genuinely fear holding a company for that long, then I think it’s time to take a closer look at our standards of quality.
Neil
