This post was first published on capitalmind.in
“You really have to believe in the companies that you’re investing in, and that means having a level of conviction that most people don’t have. If you don’t believe in something, you can’t expect other people to believe it either.” – Warren Buffett.
Long-Term Capital Management, its Nobel laureates and arbitrage trades, Bill Ackman with Herbalife, George Soros with his bet against the Thai Baht, and Buffett himself with the Dexter Shoe Company. High-conviction investments by legendary investors that did not work out.
Carrying on from Identities or Beliefs, here’s why one of our core beliefs is the opposite, and it stems from: The stock does not know you own it.
An image search of the title of this post will tell you Warren Buffett said it, just like most profound things on investing and life. Except, he did not. Probably the kind of thing that annoyed the 16th president of the United States:
It is, in fact, from the book: The Money Game by George Goodman, written under the illustrious pen name of Adam Smith.
If you haven’t heard the name George Goodman before, this might feel like finding out that the first double-century in ODI cricket was not scored by Sachin Tendulkar against South Africa but by a player you’ve never heard of. In a game played in Singapore, between two associate nations. You would be wrong.
From the preface of another of Goodman’s books, “Supermoney“:
In 1970, two decades after it was first published, Benjamin Graham wanted to publish the next edition of ‘The Intelligent Investor’. Graham, visiting New York from his then residence in the South of France, met Goodman and said:
“There are only two people I would ask to do this, You are one, and Warren Buffett is the other.”
Goodman’s response: “Who’s Warren Buffett?” I asked (this was 1970, and Buffett was little known outside of Omaha)
The bonafide of the originator established, this single line ‘The stock does not know you own it,” if internalised, is one of the most potent investing concepts. So powerful that at Capitalmind, we consider it one of our core investing beliefs. We wrote about the difference between Identities and Beliefs and why all investing needs a core set of beliefs to operate from.
Our first belief is the nature of company valuations. Our second is that the stock does not know you own it.
Why is this concept so powerful? Two examples to elaborate.
The “original” Nifty Fifty
Long before the Nifty was the market-cap weighted index of the top 50 stocks in India, there was a set of “Nifty Fifty” stocks in the US.
In 1971, Morgan Guaranty Trust, an investment bank, published a list of 50 stocks to buy, calling them the ‘Nifty Fifty’. “Nifty”, an adjective meaning “particularly good, skilful, or effective.”
And why not? These fifty companies were household names, high-profile large caps, dominant in their respective industries, solid balance sheets, high returns on capital, and healthy profit margins. Additionally, most of them had been growing revenue at double-digit rates.
They were called “One-Decision stocks” because you had to buy and never consider selling. Look at the logos on that graphic, and you can see why.
Then, as a portfolio, the Nifty Fifty did worse than the S&P500 from 1972 to 2001. A paper by Jeff Fesenmaier and Gary Smith showed that the fifty stocks returned, as a portfolio, 11.6% over 29 years till 2001, while the S&P 500 gave 12.01%. And it wasn’t with lower volatility either: by 1974, many of these stocks were down 80%.
Note, it’s not that the companies themselves have been disasters. Yes, a few, like Kodak, Polaroid, and Sears, struggled and eventually declined into irrelevance. Any set of companies sees a certain mortality rate over the long term. Companies like Mcdonalds, Walmart, Disney, and PepsiCo continue to be strong businesses today, over four decades after they were pitched as “one-decision” stocks. Even General Electric and IBM, although struggling today, were iconic companies until just a few years ago.
And yet, an investor from 1972 to 2001 would’ve done better just buying the index. The same research paper found a substantial negative correlation between their December 1972 Price-Earnings and their subsequent return over the next 29 years. (26 of the 50 had P/E ratios above 40, with Polaroid leading the pack at 90 times earnings)
In other words, the problem was not in the businesses but in the stratospheric expectations built into their stock prices at the time.
This ties into our research on stocks that returned over 10x over the ten years from 2012 to 2022, that the bulk of supernormal returns came from multiple expansion or the market’s perception of those companies.
“When” you decide to buy a stock matters. After a run of excellent business performance accompanied by an even faster rise in market cap on the back of a fantastic story, there’s a good chance you’re entering at a medium-term or even long-term peak.
The great business (stock) doesn’t know you own it.
If you had a cell phone in the early 2000s, chances are Nokia made it. Most of us know that Nokia was a big player in the mobile phone space, but it’s easy to forget how dominant they were.
Starting from the late 1970s, Nokia literally invented the category of portable phones.
Nokia’s product launches were a set of industry firsts, from the world’s first car phone to the first “compact” phone and then the first GSM phone. From the early 80s to 1999, Nokia grew sales by almost 50% a year. By 1999, its market cap was $70 Billion (about $125 Billion today).
They continued with their steady stream of product innovation into the 2000s, launching the first colour screen phone, the first camera phone, to Symbian, their proprietary mobile operating system.
The Nokia 1100 series launched in 2003 sold over 250 Million units worldwide to become the best-selling consumer device (not just phones) of all time.
They followed it up with the N-series, the precursor to phones that would eventually be known as smartphones.
In 2007, they had nearly 50% of the worldwide mobile phone market share. A bank of America report published in early 2008 mentions how they were starting to make inroads into the Chinese market and the runway for tremendous growth.
Can you imagine being back in 2005 and not investing in Nokia?
The clear market leader in a space expected to grow in high double-digits as hundreds of millions in emerging markets like India were just about to buy their first phone.
Then things happened. Apple launched the iPhone in that iconic Macworld 2007 launch. If you haven’t seen it, it’s a few well-spent minutes on a product launch masterclass.
About a year later, HTC launched the first Android phone.
Fast forward to 2014, and Nokia sold its handset business to Microsoft for $4.6 Billion. Remember, it was worth the best part of $70 Billion at one time.
As of Feb 2023, Nokia has rebranded itself, changing its iconic blue logo to position itself as a business technology company selling to telecom service providers.
Maybe there’s a comeback story in there somewhere.
For every narrative of successful and dominant companies, several went obsolete, whether because of their missteps or inability to adapt to broader market forces.
IBM, JC Penney, Kodak, Yahoo!, Sears, General Electric, Polaroid, Xerox, Blackberry, Motorola, ToysRus. Companies that looked unbeatable in their prime but faded gradually. Closer to home, companies like Premium Automobiles, Onida (Mirc Electronics), Century Textiles, Ballarpur Industries, Hindustan Motors, Karuturi, Suzlon.
Fun fact: Suzlon might be a meme stock today, but way back when, its founder was featured on the cover of Forbes India. Twice.
Combing through business history, you find the “was great but not any more” companies outnumber the “continue to dominate” companies by a factor of 5 or more to 1.
As minority investors in public companies, we should avoid getting attached to specific companies as lifelong tickets to wealth.
The folly of attachment
At Capitalmind, we wrote in 2012:
Less dramatically, we become hostage to our own opinion. We simply can’t let go of what we believe is “normal”, even in the face of facts. If your blood tests show you have a high cholesterol level, your immediate reaction is to hope the problem will go away on its own, or imagine that the tests were incorrect. A person abused at work — sometimes with lewd suggestions — will initially justify it as harmless workplace banter. The victims of a drunken driving accident will side with the driver saying how good a driver he “usually” is. We simply don’t want to see it, even if we know it.
Our conviction is worth the paper it was never written on — but we carry the weight of it on our shoulders altogether too long.
In summary, a stock does not know you own it:
- Because great businesses do not always mean great stocks. Especially if the market already believes it.
- Because great businesses often do not stay great. Some decline rapidly, like Nokia, and many gradually, like GE and IBM.
There’s little to gain from identifying with a company or its promoters as “your own”. In believing that its advantages are insurmountable and everlasting. In reserving an eternal spot in your portfolio because of what it’s done in the past. Instead, practice a level of detachment from your holdings.
Love your craft, your family and your friends wholeheartedly. But don’t fall in love with your stocks.
Read the precursor to this post: Identities or Beliefs?
The Nifty-Fifty revisited – Pomona College
Lessons from the Nifty-Fifty – seeking alpha
Does buying expensive quality stocks work – Capitalmind
This post is for informational purposes only and should not be considered investment advice.