Chris Mayer: When you should never sell… and other lessons from one of the greatest minds in investing
From Chris Mayer, Chief Investment Strategist, Bonner Private Portfolio:
Edgar Wachenheim is one of the best investors you’ve never heard of.
He keeps a low profile, but his track record is outstanding…
Wachenheim is the chairman and chief portfolio manager of New York’s Greenhaven Associates. The firm manages about $5.5 billion. And over the past 25 years, it’s posted average annual returns of almost 19%.
I’m always interested in studying how great investors do what they do. In this case, Wachenheim made it easy. He wrote a book: Common Stocks & Common Sense (2016).
I’m an investing junkie. I’ve read hundreds of books, interviews, and articles about great investors and their process. And it is striking how much they have in common and what it can teach you…
How to Avoid Mediocre Results
One of the things all great investors have in common is the ability to buck prevailing opinions.
In his book, Wachenheim tells the story of a friend he meets with periodically. “Danny” has been in the investing business for 40 years. He is very smart. He has an Ivy League education. His résumé is top gun all the way.
Yet, his investment results are mediocre at best. Why? Because Danny can’t get past today’s concerns.
Wachenheim says that they often talk stocks. Wachenheim will mention one that he likes – usually a depressed stock facing some temporary problem. Danny never buys these stocks. Instead, he waits for some signal that the problem has eased before he buys.
Naturally, by that time, the best of the stock’s appreciation story is over. Danny confines himself to mediocrity because he waits until the coast is clear.
My own experience is similar. I can’t tell you how many times I get feedback from a reader who will criticize a stock pick by citing all the usual problems with it that anybody can find in a newspaper.
Wachenheim (and I) didn’t get our track records buying other people’s prettily wrapped merchandise. We bought what was on sale – because most people weren’t buying.
When You Should Never Sell
Another trait that all the great investors have is the ability to weather market declines. They don’t sell if there is no fundamental reason to do so. Yet most amateurs (and even some pros) will sell a stock for no other reason than it’s gone down in price.
Wachenheim writes about a friend who sold stock in the 1987 crash, which is a good example because almost all stocks went down that day. (Thus, there were no fundamental – or stock-specific – reasons driving the decline.)
Here is Wachenheim:
I was dismayed by my friend’s logic – or, rather, lack of logic. Let us assume that my friend owned stock X on October 18 because he believed it was worth $14 versus its then selling price of $10. Let us further assume that the stock fell in line with the market on October 19 and closed the day at $7.90. My friend intended to sell the stock at $7.90 even though a day earlier he believed it was worth $14. Such a sale would be nonsensical.
It is nonsensical. And yet a lot of people do it.
Wachenheim and I don’t. When the market offers our goods on sale, we’re more likely to buy more than sell. Good ideas are hard to find. Don’t let the market take you out of them.
Case Studies Reveal All of Wachenheim’s Tricks
Most of Wachenheim’s book is given over to case studies of stocks he’s owned: IBM, Interstate Bakeries, Centex, AIG, Lowe’s, Whirlpool, Boeing, and more.
He tells you his thinking at the time he bought them. You get to see how these play out and how Wachenheim handled the rallies, dips, and changing stories.
Unless you are an investing junkie like me, you might not find the case studies a thrilling read. But there are lots of good lessons in these chapters.
For example, Wachenheim bought tech giant IBM and sold it at $20 about a year later for a 40% gain. But he realized he made a mistake… The IBM story was better than he thought. So he bought it back at a higher price – about $24 per share. Eventually, the shares would trade for $60.
This is something that is very hard to do. Most investors would anchor on what they sold IBM for and would not buy it back that much higher. But great investors never think in terms of price alone. It is always price as compared to what they think a stock could be worth.
Another interesting lesson from IBM is that the once-great company struggled for a good 15-year span. Wachenheim uses it to show that you can’t hold any stock forever – that you have to watch it:
I strongly disagree that the shares of most wonderful businesses can be held forever because most wonderful businesses become less wonderful over time – and many eventually run into difficulties. IBM is one example of why most stocks cannot be held forever. Kodak is another. Coca-Cola is a third.
The case study on Interstate Bakeries (IB) shows the importance of betting on managers who have skin in the game.
Wachenheim became interested in IB when an investor named Howard Berkowitz bought 12% of the stock, became chairman of the board, and appointed a new CEO. Berkowitz had a good track record, and Wachenheim knew he wouldn’t put that much in one company unless he was sure he had a good thing.
Long story short, Wachenheim buys in, too, after doing his own analysis. Two years later, Berkowitz sells the company and Greenhaven more than doubles its money.
This is a tried-and-true part of my own playbook. Of the six stocks we own in Bonner Private Portfolio, investors control four of them. They have skin in the game. And that’s plenty of motivation to make good on the shares.
In his case studies, Wachenheim doesn’t just focus on successes. There are failures, too. But Wachenheim makes an important point about failure: Just because you lose money on a stock doesn’t mean you made a mistake.
There is luck involved in markets. Sometimes you get unlucky. You get dealt a pair of aces. And you still lose to three 10s. It happens. It doesn’t mean when you get another pair of aces that you shouldn’t play.
Some Essential Do’s and Don’ts
After the case studies, Wachenheim lists 25 bullet points of do’s and don’ts.
Here’s a sampling:
*Be wary of companies that have been largely “put together” through recent acquisitions.
One reason is that there is a good chance that the acquiring company had to pay high prices to make those acquisitions. In which case, future returns are not likely to be attractive.
*Do not be overly influenced by the media.
Publications of all sorts regularly call for disasters, most of which never materialize. You have to be able to screen out big-picture stuff that nobody can predict. Focus on finding good businesses at good prices.
*Favor managements that are highly incentivized to achieve higher prices for their shares.
The first thing I read when I look at a company is the “proxy.” That document tells you how management gets paid. It also tells you how much stock they own. Incentives rule the world. Don’t bother investing with people who have no incentive to work for you.
*Do not attempt to time the stock market.
An oldie and a goodie, and yet it is amazing how many people are still trying to “call the market.” They’re wasting your time.
*Structure a concentrated portfolio.
Wachenheim points out that a portfolio of 15 to 25 stocks ought to do better than 30 to 50. Again, good ideas are hard to find. Don’t spread yourself thin. I go even further than Wachenheim – 10 to 15 ideas are all you need. Maybe even less. In my personal portfolio, I own just seven stocks at the moment.
There is, of course, a lot more in the book than I can summarize here. If you are interested in becoming a better investor, then you should read Common Stocks & Common Sense. It’ll be good for you, like eating your vegetables.
Otherwise, you ignore its lessons at your peril. Don’t confine yourself to the lot of mediocrity. Learn from the best.
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