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Holding Period vs Return


AzCactus
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We all know that Buffett says his favorite holding is forever.  Nonetheless, as a spectator regarding the Horesehead Holdings saga you've seen the shares decrease from $16.77 to $2.45---a decline of ~85% I've thought that the holding period only applies when you manage VERY large sums of money.  For example, if Pabrai had sold his holdings at $12.57 (75%) of 52 week high his investors would have seen a decent return and he would have cash for additional market opportunities.  Instead, to get back to the $12.57 mark his investors will need to see a 5x.  Is this a matter of the market not seeing the value of horeshead or pabrai overrating the value of horeshead? 

 

Thanks for the feedback.

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In my opinion, holding period should only be long term when you're talking about high quality, top tier companies. If you have an indefinite holding period for a commodity business, then your long term investment is a short term investment gone bad. Basically.

 

The reason for this is that the profits of most businesses should generally be mean-reverting over time, so there's no real sense holding them long term. You buy them when they're out of favor and sell when the market changes its outlook and awards a higher valuation. Unless the company has a large competitive advantage, new supply will - over time - enter the market and take away the excess profits of the moment. Look at shipping companies in the mid-2000s.

 

They were earning absurd returns on capital because  China joined the WTO... shares were trading at 5x, 6x book value for a time. This lead to increased investment in ships, and along with the financial crisis, sent prices tumbling and the industry has yet to recover.

 

High quality businesses don't really have that problem, because they can't be competed against. At least not very effectively. So they tend to continue compounding owner wealth over long periods of time. These are the businesses you want your holding period to be forever on. Not just any random business.

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Forever should be used sparingly when talking about your investments.  There aren't that many good businesses out there.  At least relative to the size of the total investing universe, and much less ones that are inexpensive.

 

I sometimes joke that a bad business also has a forever holding period.  Forever in that once it becomes clear the business has no competitive advantage, or is just a crappy business, you'll be stuck holding it forever in hopes that your now insignificant investment recovers its losses.

 

A lot of Buffett quotes get thrown around without proper context.  In the case of Pabrai, the jury is still out on ZINC but I'd say it doesn't have the kind of qualities to make it a forever stock.  I find that investors will throw out buzz words associated with a good business (high touch, pricing power, capital light, competitive advantage, ROE, ROIC, among others) when in reality it isn't such a good business.  ZINC probably fits in that category based on what I've heard about the bull thesis for the past few years.

 

And lastly, ZINC is more a story about investors going outside their circle of competence.  What the heck do a lot of value investors know about Zinc smelting and all that jazz?  It's probably a complicated thing to understand.  So we won't really know for a while whether it's Pabrai getting the value wrong or the market being classic Mr. Market.  I'm refraining judgement because I'm one of those value investors that doesn't know anything about Zinc demand, processing, etc.

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Good post too, Picasso.

 

To me mind, "forever" is an ideal, but not something that you can pre-determine. Even if you think a business is very good and should keep creating value for the long-term, you need to monitor it for changes or for indications that you were wrong about it.

 

In practice, "forever" also rarely means literally forever, but if you keep something 5-10-15 years, that might as well be forever compared to the average holding period in the market these days.

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All good posts.

 

I'd mention, though, that it's not clear to me whether profit margins or return on invested capital (or both) mean reverts over time.

 

I suspect it's returns on invested capital, but I'm not 100% sure.

 

They certainly do if the company has no competitive advantage/moat, or if it does but that moat is eroding.

 

But certain industries have better ROICs than others, though, so a software or pharma business that reverts to the average ROIC in its industry might still do better than the average airline or junior miner all else being equal (and it never is, so this is just a theoretical exercise).

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We all know that Buffett says his favorite holding is forever.  Nonetheless, as a spectator regarding the Horesehead Holdings saga you've seen the shares decrease from $16.77 to $2.45---a decline of ~85% I've thought that the holding period only applies when you manage VERY large sums of money.  For example, if Pabrai had sold his holdings at $12.57 (75%) of 52 week high his investors would have seen a decent return and he would have cash for additional market opportunities.  Instead, to get back to the $12.57 mark his investors will need to see a 5x.  Is this a matter of the market not seeing the value of horeshead or pabrai overrating the value of horeshead? 

 

Thanks for the feedback.

 

I learnt a few things from a number of experiences - some active, some passive -  about investing in commodity businesses:

 

1. Be very very skeptical of yours and anyone else's ability to ascribe advantage.  "Low cost", "know-how", "management", "oligopolistic".  Without exaggeration I have found that more than 9 out of 10 times these so called "competitive advantages" never existed. I have a very simple test for this nowadays.  True competitve advantage is when there is a track record of operating very profitably and successfully throughout cycles.  If there is no evidence of this then there may be some kind of "advantage" but it is immensely different to the purest forms of advantage. 

 

For example, a gravel pit that is the only gravel pit near a specific town is advantaged because it massive cost to market advantage compared to competition.  Unfortunately though if gravel is priced high due to high demand and you purchase the pit on that basis but then a year later the town goes into decline and no roads or new builds are going to get built for 15 years.  Notwithstanding the proximity to market this pit can be an appalling investment. 

 

2.  The sell decision is usually more important than the buy because holding through the crash that can see the elimination of multiple rounds of equity and can go on for longer than a decade is fatal.  It is almost impossible to recover from the economics of that - so it is better to have never bought than misjudge the sell.  In that sense it is really a different animal to "investing" because the investment is a mere prologue to the main act: the sale.

 

 

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We all know that Buffett says his favorite holding is forever.

 

But that doesn`t mean its the optimal holding period for everyone. When you deploy capital in tenth of billions, its not really a matter of choice.

There are not a lot of businesses that can compound capital at >20% forever (if they exist at all), so when you want to compound faster than that your only chance is to increase your inventory turnover or to use leverage.

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All good posts.

 

I'd mention, though, that it's not clear to me whether profit margins or return on invested capital (or both) mean reverts over time.

 

I suspect it's returns on invested capital, but I'm not 100% sure.

 

They certainly do if the company has no competitive advantage/moat, or if it does but that moat is eroding.

 

But certain industries have better ROICs than others, though, so a software or pharma business that reverts to the average ROIC in its industry might still do better than the average airline or junior miner all else being equal (and it never is, so this is just a theoretical exercise).

 

I agree. I think my original post was unclear. Let me try again.

 

In the situations where there is mean reversion, what is the metric that mean reverts? Do the profit margins erode or do the returns on invested capital or both?

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I agree. I think my original post was unclear. Let me try again.

 

In the situations where there is mean reversion, what is the metric that mean reverts? Do the profit margins erode or do the returns on invested capital or both?

 

Profit margins erode through competition when there is no true moat or through inflation that can not be passed to the customer, roic erodes because it becomes harder to invest bigger chunks of capital. So in most businesses you see both mean reverting but at some only roic.

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Easier said than done, but I think you have to constantly be reassessing and allocating toward your best investment alternative based on the current prices. The price you bought in at or the length of time you've held should be irrelevant (other than for tax reasons). I find that to be one of the most difficult parts of investing. 

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