Thoughts on "Long Term Investing"

It is a defining characteristic of Foolish Investing. It is a point of honor among many, here on this board, and elsewhere. It is tax efficient, has been shown to promote higher returns, and encourages one to think of ‘companies’ instead of ‘stock symbols’. It is, of course, “long term investing”. But, what exactly is long term?

I have always taken the rather pragmatic view that “long term” means “until the investing thesis is broken”. For example, here on Saul’s board, we focus on buying solid rapid-growing companies that the market has failed to reward with P/E multiples that most would consider ‘normal’.

Suppose we discover that “XYZ” company is growing EPS by 60% per year, has solid financials, and a wide-open addressable market. Yet it is trading at a P/E ratio of 20. After much research and discussion, we decide that the 1YPEG of 0.33 is too good to pass up. So, we invest.

And we hold.

The price goes up (Yay!), but the earnings continue to grow faster than the stock price. The 1YPEG drops next quarter to 0.25. We buy more.

Then Mr. Market starts to notice. Mutual funds begin buying XYZ stock. Cramer talks it up on his show. The price begins to accelerate upward. Next quarter, the 1YPEG grows to 0.5. Then, a quarter later, it swells to 0.8. And then, the company decides to invest heavily in a new plant to support the growing demand for its products. They pay for the plant out of cash flow – earnings take a huge hit. The PEG swoops up to 2.5, then 4.0 as earnings growth fizzles for the next two quarters.

What do we do?

For me, I would say that the company is still executing well, and a temporary hiatus in earning growth to invest in future manufacturing capabilities is a very wise move. I would gladly hold this company in my portfolio, expecting earnings growth to resume once the expense of the new factory is over. Even if the price drops considerably, I would still hold this company. The investing thesis is not broken, and there is no evidence that the company will not continue to grow, perhaps even faster now that additional capability is brought on-line.

Now let’s assume we look at “ABC” company, which is also a healthy, growing company sporting a 1YPEG of 0.33 when we begin our research. It looks to be well positioned for continued growth, possesses flawless financials, and has accelerating earnings growth. We invest.

Three quarters later, a competitor has a major technological breakthrough, rendering their product much more effective for half the cost of ABC’s offering. Earnings stumble, and the company’s earnings call has the feel of a funeral. The 1YPEG stays roughly the same (around 0.33), but that is because the P/E ratio has tumbled in line with the fall in earnings growth.

Do we sell?

Yes! The investing context for ABC has changed, thus invalidating our investing thesis. Though we have only owned this company for 3 quarters, it is time to sell and re-purpose the funds we salvage to another candidate company.

Are we now no longer “long term investors”? We just got in and out of a company in less than one year! Heaven forbid, we actually incurred either a loss, or a short-term taxable gain! I maintain that yes, we are indeed long-term investors. Only at the extreme (Phillip Fisher comes to mind) are investors unwilling to sell if the circumstances warrant it. I think that such short-term sells would be rare, especially if we always fish for high-quality growth companies. Rare, but not impossible.

Like “zero tolerance” rules, buy-and-hold-forever is just an excuse not to think. Do I think we should be trading frequently based purely upon price movements? Not at all. I think we should enter every purchase of a company’s stock with the intention of owning it for a long, long time. But not necessarily “forever”, and certainly not “despite changing circumstances”. The evidence is overwhelming that trading less often is almost always good for your financial health, but never selling? That is like flying an airplane but never learning how to land. The flight is fun, but the end can be sudden, and unpleasant.

So, fellow investors, let’s strive to use our heads, to manage our emotions, and to invest in great “tiger companies” at prices well below what the market usually rewards growing companies with. Then let those companies and all of their employees work to compound our wealth over time. But, if our tiger proves to have changed its stripes, or if a bigger tiger moves into the neighborhood and starts eating all the prey, we must be smart enough to sell our position and find a better place for our money.

THAT, to me, is “long term investing”. And I think that is the approach that Saul seems to take as well.

Tiptree, Fool One guide, and fellow investor

A lea

72 Likes

Tip, what a great post.

I would add one more scenario to the above that I think still eludes us and keeps us from being able to see it and I am also basing this on a hunch of what Saul would do.

Suppose another quality company comes along, we’ll call it PDQ, and PDQ has an equally compelling 1YPEG of say .25. If XYZ is heading for a few quarters of EPS stagnation and/or reversal, I would say Saul is more likely to jump off of that ship and start a new course with PDQ. Then, if after a few quarters down the line XYZ proves itself once again, Saul could be more compelled to add back in, that is, after the risk of the expensive undertaking causing the EPS reversal has been mitigated.

One thing I’ve discovered in watching what Saul does, he’s not afraid to let things go on without him and it is ok if he misses out on some of the upside. He can catch up later with plenty of room left to spare, that is, if the stock regains those same desired qualities. Saul is looking for those special circumstances of wholesale mismatch between a stock’s price and its real and demonstrable growth-factored-in value. And I think the mismatch is based on our human imperfections. We tend to misjudge the real value when we factor in our pricing biases.

Still learning and absorbing,
–Kevin

9 Likes

TipTree,

I’ll second Kevin’s sentiments on a great post.

I also came to the same conclusion as Kevin after reading the original post. It seems Saul’s nature would be to exit company XYZ as it increases spending while depressing earnings in the short term for future growth.

That said, I can’t think of a concrete example of this where Saul has exited. Maybe Facebook. Saul held Facebook for a short period of time. They are currently investing large sums back into the business. Saul chose to put his money elsewhere.

At any rate, I’d be interested to hear what others have to say. The tricky part here is getting out at the right time. And even trickier is getting back in at the right time when growth resumes. That is a mantra of buy and hold investing obviously - not having to make “timing” calls.

Regards,
A.J.

Yes! The investing context for ABC has changed, thus invalidating our investing thesis. Though we have only owned this company for 3 quarters, it is time to sell and re-purpose the funds we salvage to another candidate company.

Are we now no longer “long term investors”? We just got in and out of a company in less than one year! Heaven forbid, we actually incurred either a loss, or a short-term taxable gain! I maintain that yes, we are indeed long-term investors. Only at the extreme (Phillip Fisher comes to mind) are investors unwilling to sell if the circumstances warrant it. I think that such short-term sells would be rare, especially if we always fish for high-quality growth companies. Rare, but not impossible.

Like “zero tolerance” rules, buy-and-hold-forever is just an excuse not to think. Do I think we should be trading frequently based purely upon price movements? Not at all. I think we should enter every purchase of a company’s stock with the intention of owning it for a long, long time. But not necessarily “forever”, and certainly not “despite changing circumstances”. The evidence is overwhelming that trading less often is almost always good for your financial health, but never selling? That is like flying an airplane but never learning how to land. The flight is fun, but the end can be sudden, and unpleasant.

So, fellow investors, let’s strive to use our heads, to manage our emotions, and to invest in great “tiger companies” at prices well below what the market usually rewards growing companies with. Then let those companies and all of their employees work to compound our wealth over time. But, if our tiger proves to have changed its stripes, or if a bigger tiger moves into the neighborhood and starts eating all the prey, we must be smart enough to sell our position and find a better place for our money.

THAT, to me, is “long term investing”. And I think that is the approach that Saul seems to take as well.

Thanks TipTree, I couldn’t have said it better myself
Saul

1 Like

I would add one more scenario to the above that I think still eludes us and keeps us from being able to see it and I am also basing this on a hunch of what Saul would do. Suppose another quality company comes along, we’ll call it PDQ, and PDQ has an equally compelling 1YPEG of say .25. If XYZ is heading for a few quarters of EPS stagnation and/or reversal, I would say Saul is more likely to jump off of that ship and start a new course with PDQ. Then, if after a few quarters down the line XYZ proves itself once again, Saul could be more compelled to add back in, that is, after the risk of the expensive undertaking causing the EPS reversal has been mitigated.

One thing I’ve discovered in watching what Saul does, he’s not afraid to let things go on without him and it is ok if he misses out on some of the upside. He can catch up later with plenty of room left to spare, that is, if the stock regains those same desired qualities. Saul is looking for those special circumstances of wholesale mismatch between a stock’s price and its real and demonstrable growth-factored-in value.

Hi Kevin, I’d agree with all of that too. Thanks.
Saul

“Long term investing” depends on who is doing the investing. Probably somebody in his 80’s is better off not investing in planting walnut trees or something else that takes 40 years to pay off. But it is fine for the Harvard endowment.

Mere human beings should take into account that lots of things , bad or good, can talk place before their own personal long term arrives. Some of these things could take money- your payment letter to the insurance e company was lost in the mail and you face a series of expensive treatments and being to of work for many months. Your “long term” has become "very short term’

Investing is not a one time decision like deciding to jump test that new parachute design.

You can change your mind. And should if the data changes.

I think definitions are best known by measuring the outcome. By that means most of Saul type stocks are not long term for a 30 year old. But they aren’t day trading either. For a real tong term you may have to be in a company just starting its growth phase. Most of these are still privately owned. Or you have to be in on tsunami type growth lasting for decades, a MSFT, INTC when it first went public. A 20 or 30 bagger now paying astronomical dividends based on your purchase price.

Long Term isn’t some investment Medal of Honor, it’s just a name.

2 Likes

I also came to the same conclusion as Kevin after reading the original post. It seems Saul’s nature would be to exit company XYZ as it increases spending while depressing earnings in the short term for future growth.

Hi AJ, I might exit under those conditions. A good example would be Avigilon (Which is now selling at nine something). The problem with those situations is that you often can’t tell whether or not the spending for growth will pay off or not, and if so when (again, if ever). I’d rather buy a company spending for growth and growing earnings too!

At any rate, I’d be interested to hear what others have to say. The tricky part here is getting out at the right time. And even trickier is getting back in at the right time when growth resumes.

That’s the key, AJ, you don’t have to “get back in at the right time.” If you sold out of Company One and put your money in Company Two that was growing without the “pause”, and you are happy with Company Two’s continued growth, what do you need to get back into Company One for? Unless you really want to. You don’t have to worry about it. There are lots of fish in the sea.

Saul

10 Likes

Investing is not a one time decision …You can change your mind. And should if the data changes.

I’m with you on that, Mauser

1 Like

"Three quarters later, a competitor has a major technological breakthrough, rendering their product much more effective for half the cost of ABC’s offering. Earnings stumble, and the company’s earnings call has the feel of a funeral. The 1YPEG stays roughly the same (around 0.33), but that is because the P/E ratio has tumbled in line with the fall in earnings growth.

Do we sell?

Yes! The investing context for ABC has changed, thus invalidating our investing thesis. Though we have only owned this company for 3 quarters, it is time to sell and re-purpose the funds we salvage to another candidate company."

I would think that determination would be quite difficult to make in just a few quarters. Typically those assessments are made in hindsight. I would also say that often times analysts (or any other prognosticators) saying those things do not really know what would be a major breakthrough or what the impact of that new things would be to existing solutions.

tj

1 Like