We Buy Companies, Not Charts

“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament…”¹ —Charlie Munger

When it comes to investment philosophies, It’s no surprise to anyone that there are a plethora of ideologies, strategies, and algorithms. Everyone is stalking the forest of the investment world in hopes of finding a winning strategy that will produce consistent alpha, or above-average returns. And with this multitude of hunters in the woods, many of them claiming to have mapped out a victorious course, it makes sense that the everyday investor, and at times even the professional, would feel lost among the trees and trails.

Some strategies focus on price, volume, trend lines, support and resistance levels, momentum, and the like (we will define these strategies as technical analysis). Other strategies focus on the underlying business itself: its earnings, balance sheet, cash flows, durable competitive advantages, the skill of its management, and the value the owner receives in relation to the price paid (what we will define as fundamental analysis).

The technical analyst strives to study the charts. He attempts to discern patterns within a stock’s chart based on its price, volume, and trends, along with the patterns he believes to be consistent. The educated assumption is that the history of a stock’s movement will repeat itself and, if read properly, can be taken advantage of. The technician is constantly on a quest to estimate where the price of the security will go next, when it will get there, and how money can be made from that estimate.

The fundamentalist, by contrast, typically overlooks the technician’s analysis. He looks beyond the security’s chart and dives directly into development of the business behind it. He knows that a stock is ultimately a reflection of the value of the underlying company, so he focuses his attention on the business’s earnings, cash flows, balance sheet, competitive advantages in the minds of consumers, and the character and giftedness of the people running it day to day.

At Holden Family Office, we stand firmly in the fundamental camp. Though technical analysts may possess remarkable intellect and histories of success in their educated predictions, our experience has settled our confidence in the fundamental camp. We are convinced that the surest path to long-term investment performance and emotional steadiness is not built on highly educated but speculative guesses about short-term price movements. Instead, it ought to be built on decisions grounded in the economic and qualitative facts of the underlying companies. Put simply, we care little about what a stock’s price might do in the short term. We care far more about what the business is actually doing. As Charlie Munger put it, “Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns.”²

Charlie’s comment shouldn’t be passed over quickly. He’s right. Over a long period of time, it’s the underlying economics and fundamentals of a business that weigh most heavily on its stock price. In the short term, the market will vote the price all over the place, driven by human swings of optimism and pessimism over microeconomic and macroeconomic news and federal policy. But it’s the company’s performance itself that ultimately provides returns and value over time. Simply stated, if a company maintains growth in its earnings, cash flows, and so on, then it makes obvious sense that the company will become more valuable to a buyer, and the stock will rise in value with it. The opposite holds equally true.

Let’s look briefly at Berkshire Hathaway as a simple example. A CNBC article describes what happened to many companies during the 2008 financial crisis: “After closing as high as $149,200 on December 10, 2007, Berkshire dropped along with the rest of the stock market during the credit crisis, closing as low as $72,400 on March 5, 2009. That was a drop of 51.5 percent.”³ Perhaps on the surface most people would likely look at a chart like this and assume it paints a pretty grim picture. Conceivably, there was money to be made on the drop, but most people would not have felt optimistic about the chart’s short-term performance.

To the fundamentalist, however, that grim picture was far from the truth. The overall and underlying story of Berkshire Hathaway painted a very different picture. Berkshire’s 2008 annual report showed a decline in per-share book value of just 9.6% for the year. So why was the stock dropping more than 50%? Are markets efficient in matters like this? Could it be possible human emotion was to blame for the decline? Our opinion of the matter: the price of the stock dropped by more than half, but the value of the business clearly had not.

The fundamentalist should have the temperament to sit tight, to watch the market overreact to macroeconomic and emotional vicissitudes, and, when given the opportunity, to buy more of a wonderful business at an attractive discount.

This leads to some conclusions that we, as trusted advisors and investors, ought to have firmly planted in our minds. The market will always have people promising new methods of allocating money and new strategies that will crack the financial code. Could some of these strategies work for a short season? Sure. But will they work for decades to come? Our experience says most likely not.

Flashy investing isn’t so flashy when long-term performance is underwhelming. In fact, I would argue it is the unflashy, patient investor, the one who works to understand a business well enough to make an informed decision, is the one who should outperform the rest.

At Holden Family Office, our investment foundation rests on that kind of temperament. We think of ourselves as business owners first. Our work is to understand how a company makes its money, how durable its advantages are, and what it’s worth. When we find a wonderful business at a fair or attractive price relative to its intrinsic value, we’re content to own it and hold it through the inevitable ups and downs of its stock price. That’s the kind of conversation we want to have with our clients: not where a stock might move next week, but what the businesses they own are doing and why we believe in them for the long-term.

This is our conviction, and our commitment to you.