Tuesday, July 10, 2012

Invest Long-term, Ignore the Coin Flips

Here's a couple of articles on some of Wells Fargo's (WFC) strengths:

The Big Bank Set For The Strongest Quarter

WSJ's Deal Journal on Wells Fargo

In the first article, Credit Suisse cites strong mortgage-related banking activity as a key driver. In the other article, Jefferies mentions above average profitability, lack of investment banking, and the return of capital to shareholders. Both firms, not surprisingly, seem more focused on the near term implications of all this.

Now, as I've said on other occasions, attempting to judge how well a stock or a business will perform in such a short time frame isn't really where energy is all that well spent. Wells Fargo may or may not have great near-term business results. The stock may perform very well or horribly in the short run for all I know. I'll let others figure that out.

"Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they're going to be higher or lower in two to three years, you might as well flip a coin to decide." - Peter Lynch

A long-term investor in any stock should expect terrible stock price action and real business difficulties from time to time. Yet, it is just not all that important if one has an investing horizon that is truly long-term. (If the money invested is needed in the next five years or less basically none of this applies. Equity investing just doesn't work over a time frame that short.) Even the best businesses (in banking or otherwise) run into tough times. 

Business is inherently messy affair even when things go well and much more so when things do not. As long as a real and sustainable competitive advantage exists (or advantages) in the first place, that inherent messiness isn't the end of the world.* 

The question is whether management deals with problems that may threaten key competitive advantages effectively (not just less than flattering headlines unless they do real damage to the brand). Protecting and strengthening the competitive advantages of a business (widening the moat) while remaining comfortably funded (via free cash flow and, if free cash flow is occasionally compromised, a rock solid balance sheet) under all economic conditions is what matters most. Near-term results do not.**

Unfortunately, some who opine on stocks have spent little time actually running businesses or at least dealing with some of the real world challenges of executing day to day. I'm just a bit dubious of those who lack that experience. Investors have varied backgrounds, of course, but I'd bet on those with at least some relevant senior operational experience running part of a business in any industry over those without it (also those accountable for buying and selling marketable securities over those who just provide their opinion about them). Operational responsibility provides the chance to make plenty of tough day-to-day judgment calls and decisions. What's more difficult, to provide an opinion or analysis of a business or actually being accountable for the results produced by a business? I believe you only learn the big lessons immersed in the thick of it. To me, nothing replaces having been there. Just reading some case study, building and analyzing a complex spreadsheet with tons of data, or talking to those with industry experience to form an opinion doesn't cut it. Those and things like it are important but insufficient. In other words, having had some responsibility/accountability for execution and dealing with resource and other constraints certainly can't hurt one's judgment of a business's strengths, challenges, opportunities, and threats. Mistakes get made. Personalities clash. Competitors do things you don't expect. Disruptive technologies come along. The culture of an acquired company's personnel turns out to not mesh with that of the parent company as well as hoped. 

The list goes on. 

I'll take someone who's dealt with it in the real world any day over someone who has not. 

Opinion are all too easy to come by.

"I am a better investor because I am a businessman and a better businessman because I am an investor." - Warren Buffett

As a result, I'm always fascinated by someone who has never come close to running all or part of a business (of some complexity) telling those actually experienced at running rather complex business operations what they are doing wrong and how they should do it better.

Of course, while there are plenty of capable CEOs, there's certainly no shortage of mediocre or worse CEOs and other senior executives running corporations.

I realize there are some fine stock pickers/analysts who are lacking in operational experience but still are very effective.

There are exceptions, naturally, but I'm just arguing they could raise their game even further if they'd spent some time in their career, for example, running a factory versus just getting a walking tour through it with the CEO.

Adam

Long position in Wells Fargo established at much lower prices

* Still, the stock price action may not exactly be fun to watch. Loss aversion is always a powerful factor and many can't stand to look at that paper loss for an extended period. Even if someone can generally judge the value of a business well, the forceful influence of loss aversion may get in the way. An investor has to know their own limits and that includes the psychological and temperamental stuff. Otherwise, it's often best to ignore monthly statements and focus instead on getting good at judging value and how that value, even if imprecisely, is likely to change over time. (Consistently judging valuation to be meaningfully higher than it actually is can be rather expensive whether you have a strong awareness of the psychological factors, a cool investing temperament, and can ignore short-term price action or not.) Successful investing starts and ends with having sound judgment of value and disciplined buying at a discount.
** The best businesses (those with a real and sustainable economic moat) can remain solidly profitable in good times and the rougher times while having plenty of resources to invest in opportunities further down the road. Now, I happen to not like "paying too much for promise" but that's more a price versus value discipline. I'm happy if a business invests heavily in long-term prospects in lieu of maximizing near-term profits. The businesses to avoid are the ones who only seem to have a competitive advantage for a period of time but actually have no ability to defend their position long-term. Those that tend to reside in fast-changing industries with lots of technological change.
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