Friday, March 26, 2010

Capital Productivity

From a recent white paper by James Montier:

"According to data from the New York Stock Exchange, the average holding period for a stock listed on its exchange is just 6 months. This seems like the investment equivalent of attention deficit hyperactivity disorder. In other words, it appears as if the average investor is simply concerned with the next couple of earnings reports, despite the fact that equities are obviously a long-duration asset. This myopia creates an opportunity for those who are willing or able to hold a longer time horizon."

James Montier: Was It All Just A Bad Dream? Or, Ten Lessons Not Learnt

The average holding period for stocks from the early 1930s until the late 1970s was in the 4 to 8 year range. So for 40+ years or so 4 years was the low end average holding period for stocks. In the 1980s it dropped below that to levels similar to that of the 1920s (the last time we obviously had troubles with excess speculation and leverage) to just under 2 years.

These days the average holding period is down to more like a 6 months.

"When we should be teaching young students about long-term investing and the magic of compound interest, the stock-picking contests offered by our schools are in fact teaching them about short-term speculation." - John Bogle in his book, The Battle for the Soul of Capitalism

John Bogle calls this a "rent-a-stock system".

Intuitively, most know what happens to an asset like a automobile when it's rented vs owned. The adverse effect of a large percentage of US businesses being "rented" for 6 months at a time is not much different.

With that time horizon, "renters" are not going to worry much about with long-term prospects and challenges of the business. This is a major disadvantage over time. The wisdom and quality of investment decision-making by the owners and managers has a huge impact on future wealth creation and living standards. This happens to be one of Berkshire's great assets; most of the shareholders are patient capital oriented. It's just more likely that assets will be mispriced when such a short time horizon is the dominant force at work (i.e. who cares if I paid too much I'm gonna sell it to someone else who'll pay even more too much).

Hardly optimal. Consider the trends in our capital productivity numbers. Just after WWII, it took around $2 of investment to produce $ 1 of GDP growth. Recently, this article by Byron Wien pointed out the following about trends in US capital productivity in the 1st decade of this century:

"Because of profligate spending on over-priced housing and other assets that declined seriously, as well as deficit spending by the government, by the end of the decade it took $6 of capital to produce $1 of growth" - Byron Wien

As for the "other assets" that Byron Wien refers to in the quote, I'd say that technology stocks circa 2000 are a good example.

James Montier points out the situation does present opportunities for patient long-term investors. While that is true, the status quo is far from satisfactory.

Capital is being misallocated more frequently than it should because of the culture in place and systemic defects.

Not fixing at least some of what's broken likely means that improvements to living standards end up less than what they might be otherwise.

Adam

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