Dear fellow investors,

We operate under the premise that alpha can be generated by stock selection, courage, concentration, and long-duration holding periods. In today’s missive, we will talk about long-duration holding periods through the lens of our current concentrated position in the oil industry.

Many years ago, a financial adviser said the following: “Your portfolio is like a bar of soap, the more you rub it, the smaller it gets.” There is brilliance to what he said. First, transactions cost money. Second, taxes cost money. Lastly, and most importantly, activity interrupts the most powerful mathematics in common stock portfolio management.

Here is the easiest way to think about the math of common stock investing. If you look back over the prior ten years in our portfolio, you’ll find that most of our alpha came from about 20% of our stocks. These are stocks that have gone up many times what we paid for them originally. Examples would be Bank of America (BAC), JPMorgan (JPM), NVR (NVR), Home Depot (HD) and Disney (DIS). They went up many times what we paid for them.

On the downside, we pay cash and are limited to losing 100% of our original investment. We use a sell discipline which leans on the “where are we wrong side,” so we usually limit our losses to 20-30% of the original investment. Therefore, we are maximizing our most successful long-duration holdings and recognizing defeats along the way. We think you’d find that great long-duration track records like Berkshire Hathaway, Peter Lynch, John Templeton, Ron Baron and others are long-duration in nature. This is true regardless of whether they leaned toward value or growth strategies.

For these reasons, we’d like to hypothesize that the reinvestment of unrealized gains might be as important to alpha as the stock selection and courage to buy at “points of maximum pessimism” which John Templeton popularized. In the stocks we listed above, there have been some huge drawdowns in price. Bank stock investors have been afraid of their own shadow since we bought in in 2012. NVR has been hit hard each time the homebuilders have a 6-to-18-month price decline since we bought it in 2013. Home Depot and Disney got crushed in 2007-2009 and in 2020 when all economic confidence fell out of the market. All of these have very normal pullbacks of more than 20% in a typical year.

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