1Q Newsletter- April 2022

Hunting for a Lollapalooza                                                                       

  • Great oaks from little acorns grow.
  • A single voter by himself wields little influence, but if millions vote the same way

they can change the direction of a country.

  • Termites are tiny insects, but working together they will collapse a mansion.
  • A person labors all his/her life in a low-paying job, but saves and intelligently invests part of each meager paycheck – and becomes a millionaire.
  • Tiny drops of rain may combine to become a devastating flood.

These are a few examples of what Charlie Munger, Vice Chairman of Berkshire Hathaway, has termed the Lollapalooza Effect – many small, inconspicuous contributions all tending in the same direction, perhaps over a long period of time, that result in an extraordinary, stunning result.  This occurs in many areas of life, and can bring either great harm or great benefit.  As investors, this is a phenomenon we should understand, and try to harness in our favor.

It is every investor’s dream to latch on to some great growth stock that will multiply his money by a multiple of two, or ten, or a thousand, preferably in the shortest time possible.  Once in a while this happens, and the news media glorify the happy investor.  We like instant gratification as much as anybody else, but the chances of reaping a quick bonanza are not good.  As Ben Franklin noted, the man who depends on luck is never sure of his supper.  For every Microsoft, Facebook or Tesla, there are hundreds of promising new ventures that fizzle out.  Chasing hot stocks is fun, but not a very dependable way to build wealth.  We have not seen anyone who can do it consistently. 

We favor patient long-term investing, not because we enjoy waiting around, but because the odds of success are better.  The stock market is risky in the short term – anything can happen! – but the risk decreases for longer holding periods, especially if you own multiple stocks.  Good companies are not that difficult to recognize after they become established, and there are quite a lot of them.  They may thrive for many decades, which is plenty long enough to lift a determined investor into a better standard of living. 

A Money-Compounding Machine – – Right Here in our Town

The Lincoln National Life Insurance Company was founded in Fort Wayne in the early 1900s.  A local company until the headquarters was moved to Philadelphia in 1999, Lincoln National stock made many Fort Wayne families wealthy.  Everyone in town had neighbors who went to work at “the Lincoln” each day.  Some people knew the top executives personally, maybe even went to church with them.  Coming out of the Depression, it was a serious, sober business, and management took that responsibility to heart.  Lincoln Life made its money quietly, selling insurance policies – usually a little more volume each year – and investing its money, mostly in bonds, which in those days (unlike now!) paid a reasonably attractive rate of interest.  Looked at as a whole, the company was a compounding machine, and a wonderful investment for those who owned shares through the great growth years of the 1940s, 50s, 60s, 70s, 80s, 90s….  Other companies came and went, and they were flashy for a while, but Lincoln kept cranking out decent returns, year after year, for decades.  Like the tortoise that beats the hare, the stock kept on growing and made its owners rich.  In its prime, for most of the 20th Century, Lincoln Life was the jewel of the Fort Wayne economy.  Thousands of employees made good careers there, but the ones that really got ahead – and it wasn’t only the top managers – were people who bought shares, then bought some more, and then held on tight.  It was far better than having the money in a savings account.

Investing success in a growth stock like Lincoln Life does not come overnight, because any business has its ups and downs, and compounding takes a long time to work its magic.  You may see some progress after a few years, but the really big gains need a longer runway.  To take advantage of compounding, two things are required:

  1. A company with the strength and vitality to stay in business and be profitable for a long time.
  2. An investor with the fortitude to buy the stock and stay with it for a long time.

In America there are actually quite a lot of excellent companies that would satisfy (1), though nobody can see into the future, and it is not always easy to spot winners before the decades pass.  That’s why we diversify. 

Requirement (2) can be more difficult.  Sometimes the money is needed for family expenses.  Over the years there will be situations that tempt an investor to loosen his grip and sell the stock.  We ourselves become the reason for interrupting the compounding.  Sometimes there will be another company that appears even better than the one we are holding.  But is it?  That is the difficult question at the heart of investing.  When in doubt, maybe the best answer is to own both!

America, the Land of the Possible

In our country, if you work hard and save some money, and invest wisely, you can make your fortune.  It takes grit and persistence, and it’s not handed out free.  Success is not guaranteed – to anybody.  Nobody said it will be easy, but it can be done.  It is possible.

That is the American Dream, and that is why millions of energetic people all over the world want to come and live here.

Sustainability and ESG Investing

Investment funds that boast of their concern for Environmental, Social, and Governance (ESG) issues are quite popular these days.  Dozens, probably hundreds, of funds now have terms like “Sustainable” or “Environmental” in their names.  A lot of this is marketing, the pursuit of a competitive edge, because nowadays many investment committees and boards of directors want and expect such virtue-signaling before they will buy a fund.  Such a name carries the message “Growth and profits are good, but those are not enough.  OUR Fund is more concerned about the environment, about fairness, about social justice.  WE are morally superior.  If you invest with us, you’ll be morally superior too.” 

High-class ethical behavior, such as concern about protecting the environment, is of course a desirable quality, but the investor needs to consider whether it is (a) worth paying higher fees for, (b) a distraction from running the business.  Honorable people may completely disagree over whether a given business is sufficiently virtuous to be in the portfolio.  Just as an excellent person may also have a few unpleasant qualities, the same can be true of a corporation.

There is nothing new about the idea of sustainability.  It is fundamental to long-term investing, and is something we have always sought in choosing securities.  Since we expect to hold our portfolio companies for years, we look for intelligent and honest management and try very hard to avoid unnecessary risks.  We therefore aim to steer clear of social and political forces, and hostile government attention, any of which can wreck a company’s best-laid business plans.  They are prime sources of external noneconomic investment risk – hazards that cannot be spotted by studying the company’s past financial statements.  The numbers will not warn you of approaching danger.

Recently we read about some ESG funds that got caught with large investment positions in Russia, now severely compromised or near worthless following the invasion of Ukraine.  It might be asked what they were doing in a place like Russia in the first place.  Under an autocratic regime, your money is at risk of government depredation every minute of every day.  That goes for China too, where the law is whatever Xi Jinping says it is.  The USA is not perfect, but it is a much safer country for savers and investors; and we should strive to keep it that way.  Never take lightly the blessings and protections we have here.

As for sustainability, it is hard for an investor to look at an industry and know which companies will prosper into the future.  A tragic example might be Eastman Kodak, which had a near-monopoly position in the photo chemicals and film business … until seemingly out of nowhere, digital photography appeared and in a few short years the film monopoly was worthless.  Or consider the disruption Amazon brought to the world of retailing.  So that kind of risk – unforeseen, devastating business competition – is always a threat, and if you add the dangers of punitive regulations, investigations, lawsuits, fines, etc., it really lowers one’s odds of investment success.  We do our best to avoid them – not always successfully.

                                                                                                                                  — Written by George Donner