Dear Fellow Investors:
Instead of behaving wisely, we think investors have been "throwing babies out with the bath water" this year. We believe speculators have fled out of the Biotech ETFs and have unwittingly sold Amgen (AMGN) between $129 and $109 per share because it is the largest holding of most of these targeted vehicles. From our vantage point, investors have tossed out EBAY (EBAY) in the internet space, Gannett (GCI) in media, Pfizer (PFE) in Pharma and Bank of America (BAC) and JP Morgan (JPM) in the banking sector. They sell despite the fact that these companies have made long-duration investors wealthy in the past and have the attributes of our eight criteria which have been predictive of future wealth creation.
From our years in the investment world, we at Smead Capital have developed a couple of assumptions about wealth creation and would like to share them with you.
Smead Assumption Number One:
Wealth is created by the ownership of wonderful companies over a long-duration.
At Smead Capital, we avoid young untested companies and like to see a history of profitability over a period of approximately ten years before we consider buying-in. Take McDonald’s, for example: when McDonalds reached its ten-year IPO anniversary in 1975, it was trading at $72.50 per share, and 100 shares would have cost you $7,250. Today you’d have 4,063 shares, worth approximately $418,000 as of this writing. And dividends, which didn’t begin until 1976, were not included in this calculation.
Warren Buffett bought 5% of Disney in 1965, 25 years after it went public, and sold it a year later for a 50% gain. Today it would be a 1000 times his original investment, not counting dividends. He calls it the biggest mistake of his career. Which bear-market bathwater or temporary-correction rinse water would have been a good reason to throw those babies out? We at Smead Capital Management believe that trying to determine who will be succeeding and prospering 20 years from now is much more useful than trying to time the market. We believe a number of our 29 current holdings are capable of producing exceptional long-duration returns if given the chance.
Smead Assumption Number Two:
The will to reduce risk and volatility damages long-duration wealth creation as "babies get thrown out with the bath water."
We have attended many of the top annual gatherings of investment professionals over the last five years. It is a bit like the movie “Groundhogs Day.” At a recent conference in Boston, the most popular speakers we saw were all about risk reduction and reducing volatility through diversification. It was the same topics and nearly the same logic of four years ago when investors were mortified by the 2007-09 financial market meltdown. To us, this preoccupation with reducing risk is a contrary indicator.
Even though we don’t fear risk or volatility, we felt at the start of the year that corrective forces would hit frothy, conceptual tech stocks and small-caps. We argued it would be similar to "stealth" bear markets like 1983-84, 1994 and 2004. In the case of frothy tech and small-cap stocks, we think it could initiate a period of years where they under-perform large-cap indexes like the S&P 500. In all three prior examples, the declines were limited in large-cap indexes and the near-term volatility should have been a time to add to worthy, long-duration large-caps holdings.
We believe that by attempting to time the market, investors are missing the one thing they need to control the most: their own activity. It seems humans appear to pile into the shares of attractive companies near high points and flee at low points. As many advisors have told us, your investment portfolio is like a bar of soap. The more you handle it, the smaller it gets.
Warm Regards,
William Smead
The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.
