At Longview, we recently recorded a decade of annualized investment returns of more than 17 per cent in our global stock portfolio. While we enjoy success as much as the next person, we realized that the most useful thing for us to do would be to analyze how we could have done even better.
Identifying your investment errors is not as easy as you might think. Apart from the psychological difficulty of admitting that you were wrong, investment results arise from both luck (randomness) and skill. A bad decision can be skated onside by good luck and a sound decision can be side-swiped by unforeseeable events.
The question to ask is: Was it the right decision, given what should have been known at the time? When investing in stocks, the right decision will always include putting the long-term odds in your favour.
Here are three of the major investing lessons that we learned in our first decade.
Avoid too much activity
A useful review we engage in after the end of each year is to see how our results for that year compare with how we would have done had we made no changes to the portfolio during the year. We have always prided ourselves on relatively low portfolio turnover – that is, infrequent buying and selling of stocks.
Despite this, in more years than we would have guessed, the changes we made to the portfolio hurt our return in the short to medium term. The mistake had less to do with the companies we purchased than with the companies we trimmed or sold. It was not uncommon for us to sell shares in a company at a materially higher price than we had paid but, thanks to the continuing outperformance of the business, then watch the price continue to rise for many more years.
It’s easy to ignore the opportunity cost of not owning a company that you sold, but that cost is real. Portfolio turnover has a further disadvantage. A sale triggers tax and, therefore, prevents you from compounding your gains on a before-tax basis. When you own part of a good business run by a highly competent management team, then, in the words of Warren Buffett, “Inactivity strikes us as intelligent behaviour.”
Recognize the durable advantage of today’s technology stocks
The last time we checked, no one had repealed the laws of economics or human nature. However, the global economy has evolved rapidly over the past 20 years.
Today, it is dominated by large, oligopolistic technology companies. We own a number of these companies, but were initially slower than we should have been to recognize their value. Historically, investors have looked to such sectors as consumer products and transportation to find businesses with long, relatively predictable futures. Technology businesses had, on average, shorter business lives.
Today, however, companies such as Amazon, Alphabet (Google), Meta Platforms (Facebook) and Microsoft have durable competitive advantages. This is owing, in part, to network effects – more participants increase the value of the services these businesses provide – and the low incremental cost of providing services to the new customers. We believe these companies, with their strong cash flows and fortress balance sheets, are likely to continue to increase their profits at well-above-average rates for years to come.
Minimize cash holdings
Prior to 2016, the average cash weighting in our portfolio was above 10 per cent. When we trimmed or sold a position, we would often wait, sometimes for extended periods of time, before reinvesting. We justified this on the basis that having cash would allow us to move quickly if an opportunity arose. In the meantime, we would be protected if the market fell.
Most people intuitively like this argument because, at first blush, it sounds prudent to have some “dry powder” at hand. However, investing is necessarily a probabilistic endeavour, and your ability to predict the future is far less than you think. We may believe that we know better than the other market participants that an opportunity has arisen, but even the greatest investors are unlikely to be right more than 60 per cent of the time. And, while we wait for a possible opportunity, our cash is earning almost nothing.
The stock market increases in value more often than it falls. Several long-term studies have shown that sitting on cash in an equity portfolio will, over time, hurt your returns. Today, we generally remain fully invested. (We encourage our clients to hold some cash, but to do so outside their equity portfolio.)
Continuous improvement requires a recognition of errors and a willingness to change your mind. We hope these lessons will prove helpful – not only to us, but also to other investors.
Biff Matthews, Doug McCutcheon and Emily Won are partners of Longview Asset Management Ltd., a Toronto-based investment management firm
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