Revisiting Ground Rules
It’s been a while since we’ve revisited the guiding principles behind our investment operation in our notes. We thought this year’s letter should address them for a few reasons.
First, our clients entrust us with their life savings and, therefore, we should all be clear about the way your investment portfolios are managed. Second, disciplined execution of an investment process, rather than short-term trend-following or flailing from one approach to another, is critical to generating satisfactory long-term results.
And third, it's easy to lose sight of guiding principles when it seems that nothing can stop stocks from climbing higher during good times or when panic sets in and it’s hard to look at all the red numbers on the TV screen. We want to make sure that our investors know the way we are likely to behave, especially during these extreme periods.
1) We practice long-term, patient investing. Unlike many in the stock investing industry, we do little buying and selling. The most important job is to buy into the right investment and hold it until the investment is unlikely to produce attractive returns. An investment horizon measured in multiple years is typical.
2) Quality is king but valuation is also important. We prefer high-quality businesses run by people of skill and good character. High-quality businesses possess advantages that are difficult for competitors to overcome. Think strong brands or intellectual property, for example. In addition to high-quality businesses, we may invest in highly cyclical businesses ideally during their cycle troughs and in special situations with attractive risk-reward profiles.
Focus on management quality is not accidental because management is tasked with executing on the revenue opportunity and protecting and strengthening competitive advantages. Philip Carret, a Great Depression-era investor said, “Good management is rate at best, is difficult to appraise and is undoubtedly the single most important factor in security analysis.”
3) Short-term market timing does not work. We’ll have no opinion on where the general market is going in the near term as we are yet to find anyone who can practice such forecasting consistently and successfully. We do know though that U.S. companies tend to create more value over time. Their exemplary track record from the depth of the Great Depression, through the two world wars, countless recessions, an oil embargo, many political crises, and a devasting pandemic speaks for itself.
We’ll aggressively invest in new stocks and add to existing positions during market downturns. Panicky markets, however painful in the moment, create great buying opportunities for investors with multi-year time horizons. On the flip side, we’ll take gains off the table and realign portfolios in times of market exuberance when it seems like nothing can possibly go wrong.
4) Concentrated portfolios. We tend to hold fewer stocks than other investment managers. Fewer stocks allow for a larger impact from each stock position and add rigor to our investment research effort. As Charlie Munger put it, “The goal of investment is to find situations where it is safe not to diversify.”
5) No-labels investing. With terms like “value stocks” or “growth stocks” having been widely adopted by many in the investment industry, we instead take an agnostic approach by considering growth to be an element of value we are trying to capture from each stock position.
6) Independent research. We do our own research on companies. We use corporate regulatory filings and industry sources, among others, to form our views. The obvious risk with following someone else’s investment recommendations is that they may not be right, outdated, or influenced by incentives unrelated to the best interests of our clients.
7) Clients are partners. Your portfolio manager invests his family’s savings in the same securities as your portfolios. To that end, our clients are really our business partners when it comes to investing in our portfolio companies.