The Challenges and Rewards of Holding
“It’s not the things you buy and sell that make you money; it’s the things you hold.”
– Howard Marks, Co-Chairman of Oaktree Capital
“The big money is not in the buying and selling, but in the waiting.”
– Charlie Munger, Vice Chair of Berkshire Hathaway
We believe the best way for us to grow your wealth over time is by owning shares of successful businesses for many years – often a decade or longer. A company’s long-term business success, driven by profitable growth over many years, allows compound interest to work its magic on its stock price. Compound interest has been called the eighth wonder of the world, and we would strongly agree – but it takes many years for its profound effect to be revealed.
Theory vs. Practice
Charlie Munger often states, “The first rule of compounding is to never interrupt it unnecessarily.” This idea sounds simple in theory but is extraordinarily difficult in practice. Given Wall Street’s and the business media’s short attention span, it would seem most investors have ignored this simple and straightforward advice.
To see why, just look at one of many wildly successful companies whose stock prices had risen significantly over 20–25 years, and whose long-term owners made 10×, 20× and even 100× their original investment. Using hindsight as a guide, it’s easy to zoom out over their stock chart and convince yourself it was easy to buy-and-hold over such a long period of time.
Yet very few investors achieve these huge returns. If you zoom in on any short time period (3 months, 6 months, even 12 or 24 months), you’ll see why: The stock prices of these successful companies tend to fluctuate wildly in the short term. These sharp price changes are driven by constant daily noise that can convince even an experienced investor that a portfolio change needs to be made. At times like these, that investor must rely on the courage of their long-term convictions not to sell. The daily drum beat of reasons to sell can be difficult for even the most successful investors to tune out – which is why multi-decade holding periods are so rare today.
Distractions Are Always Present
Today’s unsettled environment provides nervous investors many reasons to constantly reshuffle their portfolio. Here is just a partial list:
- Stubbornly high inflation
- Aggressive Fed policy and surging interest rates
- Heightened economic uncertainty
- The unknowable impacts of artificial intelligence and other technological innovation
- War in Europe and deteriorating relations with China
- The resurgence of labor union power
- Political polarization and dysfunction in Congress
We have written about many of these challenges in recent quarterly commentaries, and truthfully, we don’t know exactly how they will be resolved. But while this list is long and concerning, uncertainty is a constant in business. A similar list existed in 2022, in 2021, in 2020 and every year prior. The particular items on each list were often different, but there are always seemingly intelligent reasons to make tweaks to your portfolio if you choose to. Unfortunately, frenetic investment changes unnecessarily interrupt the long-term compounding of your investments.
We Are Business Owners
We frequently say the foundation of our investment philosophy is a long-term business owner mindset – but what exactly does this mean in practice? At a high level, we don’t view stocks as trading chips to be shuffled in and out of your portfolio. Instead, we believe buying shares of stock is identical to taking a partial ownership stake in a business enterprise. Whether that business is privately held or publicly traded, it is the same mindset. The only difference is that publicly traded businesses are priced daily in the stock market, whereas privately held businesses are priced much less often. As Warren Buffett stated in his 2022 Berkshire Hathaway annual shareholder letter, “[We] are not stock-pickers; we are business-pickers.” That is our mentality as well.
The intelligent owner of a private business doesn’t spend their time each day monitoring what outsiders would pay for a share of their company. Instead, he or she spends all their time focused on the fundamentals of the business. Similarly, we aren’t fixated on the stock prices of our investments and instead focus on the actual business results. For example, these are just a few of the questions we ask ourselves daily:
- Can this business gain market share from its competitors?
- Is it expanding its competitive advantages?
- Are there avenues for future profitable growth?
- Will margins expand or contract over the next five years?
- Is the leadership team intelligently allocating the cash the business generates?
Stock prices can move up and down for all sorts of reasons, including some that are unrelated to the actual underlying fundamentals of the business. Unlike most investment managers, we find it counterproductive and distracting to spend time thinking about these short-term stock price gyrations.
When we buy shares in a business, we are essentially saying that if we had enough capital, we would acquire the entire business, take it private and let the current management team continue running it. We want to own the business because we think that it enjoys durable competitive advantages and has great leaders, and that we can acquire it at a price we believe will generate an attractive return for its owners.
Once we own a business with these characteristics, we follow Charlie Munger’s advice and do everything we can to avoid interrupting the compounding of its business value. We will continue to own the business as long as we feel that its competitive advantages remain intact and the company can continue to produce attractive cash flow for its owners over many years. We follow this sage advice of legendary investor Philip Fisher: “If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never.”
Patience Is a Virtue
However, business results do not move in straight lines. Business conditions change with periods of tailwinds and headwinds. Consistent growth with no setbacks is extremely rare even for the most successful companies. Additionally, there will be mistakes made along the way – there are no perfect CEOs. All of these can create doubt and reasons to sell.
But as long as short-term headwinds don’t change what we think of the long-term outlook for a business, our default is to remain patient and to simply continue holding our ownership interest. Many investors will attempt to sell a business when things get tough, with the idea that they can repurchase it once the dust settles and the future is crystal clear. In practice, we have rarely seen this work consistently because once the future is clearer, the stock price is no longer discounted.
This “in and out” mentality is not our approach. We believe that our steadfast patience works in our favor more often than not.
Our Guiding Light
Warren Buffett’s 58 years running Berkshire Hathway is perhaps the greatest example in business history of the power of longterm compounding. He recently stated, “Our satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years – and a sometimes-forgotten advantage that favors long-term investors such as Berkshire.” In essence, Buffett built a phenomenal multi-decade investment record largely through the long-term ownership of a dozen businesses – and by ignoring all the outside noise and the popular compulsion to trade in and out of stocks. Those twelve wildly successful investments overwhelm any other investments within Berkshire that haven’t worked out as well. He puts it simply: “The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders.”
This strategy of investing that Buffett deployed to great success over the past six decades is our guiding light. We have studied his career and investment decisions in great depth and have tried to adopt his investment mindset and strategies as our own. In our endeavors to help you compound your wealth over time, we keep in mind the many lessons learned from Mr. Buffett.
Today’s investing environment is as noisy as ever with many distractions that can cause unnecessary churning of an investment portfolio. Our aim is to block out all the noise and distractions so that we can focus on our attempt to identify some of the great businesses of the next few decades. We believe that when this strategy is executed well, it can produce excellent results for you, our clients.
As always, we are humbled by your trust, and we are dedicated to growing your wealth for years to come.
Baird Trust Company (“Baird Trust”), a Kentucky state chartered trust company, is owned by Baird Financial Corporation (“BFC”). It is affiliated with Robert W. Baird & Co. Incorporated (“Baird”), (an SEC-registered broker dealer and investment advisor), and other operating businesses owned by BFC. Past performance is not a predictor of future success. All investing involves the risk of loss and any security may decline in value. This is not intended as a recommendation to buy or sell any security and views expressed may change without notice. Baird Trust does not provide tax or legal advice. This market commentary is not meant to be advice for all investors. Please consult with your Baird Financial Advisor about your own specific financial situation.