The Most Important Word in an Investor's Vocabulary
Your California editor remembers an old man once telling him, “My biggest regrets in life were the things I did not do. I’ve almost never regretted any of the things I did do.” Undoubtedly, lots of other folks would testify to the contrary. They would lament their choices more than their abstentions.
Your editor, for his part, sympathizes with the old man’s perspective…but not to the point of engaging wantonly in high-risk behavior like running with the bulls in Pamplona, base-jumping off the Eiffel Tower in Paris, hypnotizing cobras in Delhi or buying long-dated Treasury bonds in New York.
Let the reader decide whether deeds of commission or omission contain the greater potential for regret. Your editor has already decided the matter for himself. He has resolved to think twice before saying “No.” He has also resolved never to repeat the same mistakes…
He should have asked Melanie Richards to “go steady” in the sixth grade (or in the seventh grade…or in the eighth grade), but he didn’t do it. He chickened out. So if he ever again attends junior high with Melanie, he won’t repeat THAT mistake. He has also resolved to listen patiently to every unfamiliar idea before rejecting it, rather than the other way around. Lastly, your editor has resolved to expand the breadth of his life experiences – like experimenting with pinot grigio in the place of chardonnay. After all, he does not want to end up as a bitter old man, full of regrets.
But your editor’s liberal, adventuresome attitude isn’t for everyone. Embracing novelty involves risk. Taken to extreme, the consequences can be disastrous. We are reminded of that joke about the most common last words of an Australian: “Hold my beer and watch this!” (If you are Australian and are offended by this joke, please direct your indignation toward Joel, the Australian who shared this joke with us).
In most aspects of life, “yes” often contains more intrigue, delight and satisfaction than “no.” But in the world of successful investing, the opposite principal pertains. If you look behind almost any successful investor and you will find many more “no’s” than “yes’s.”
John Laporte, the recently retired money manager of the New Horizons Fund, provides an interesting case study. Laporte surrendered the reins of his fund two months ago, after running it since 1987. If you had put $10,000 in his fund when he started and left it there, you’d have had $78,000 when he hung up his spurs. By comparison, the Russell 2000 – an index made up of small caps – returned $52,000.
“Barely trading at all,” was the key to Laporte’s success, according to Wall Street Journal writer, Jason Zweig. Laporte held his stocks for an average of four years, whereas his peers would hang onto their stocks for only eight months on average. “In seeking the great growth companies of tomorrow,” Zweig explains, “Mr. Laporte looks for creative leaders, a strong corporate culture and innovative ways of doing business. He hunts in service industries and in markets not controlled by a handful of giant firms. He also insists on strong cash flows, high returns on capital and low debt.”
Since companies that meet these exacting criteria are rare, Laporte found himself saying “no” to potential investments far more often than he would say “yes.” “It often takes me years to get confident in the business strategy and the management team,” Laporte said of his due diligence process.
So what were Laporte’s main regrets? The things he did do, rather than the things he didn’t do. In other words, he should have been even less active than he was. He should have held his winning positions even longer than he did.
For example, Laporte’s New Horizons Fund held a venture capital investment in Starbucks. But he sold it after only two years because he was afraid that rising coffee prices would go up and hurt Starbucks’ profit margins. He forfeited hundreds of millions of dollars of gains by selling too soon over a short-term worry.
“I have long held the opinion that the greatest mistakes investors make are not in the stocks they buy and lose money on, but in the stocks they sold too soon,” asserts Chris Mayer, editor of Capital & Crisis. “Academic research, too, supports the idea that investors ought to hold onto their stocks longer. I’ll cite here the work of professors Terrance Odean and Brad Barber. They found that investors do not benefit from active trading. ‘On average, the stocks they buy subsequently underperform those they sell,’ Odean writes, ‘and the most active traders underperform those who trade less.’
“There is more to Laporte than just the patience of Job,” Mayer continues. “He also invested in small-cap stocks in the early phase of their growth cycles. This practice requires a lot of patience as well, but it also requires a lot of digging into more obscure stocks. Again, this is another area where academic research supports Laporte’s record and ideas.
“Odean and Barber, for instance, also found that individual investors are more likely to buy attention-getting stocks – stocks in the news or stocks showing extreme short-term returns,” says Mayer. “Not surprisingly, these buying patterns do not generate superior returns. The professors use the analogy of a great vacation spot with few tourists. A travel writer comes in and writes about it for a national glossy. And soon enough, lots of tourists follow and they wind up complaining about the crowds. Markets work the same way. Odds are if you are reading about it in the paper, it’s too late.”
In the essentials of Laporte’s investment strategy, he continued the impressive legacy of T. Rowe Price, himself. Simply stated, Laporte believed investors should invest selectively, invest early in a company’s growth cycle, and then hang on for the ride. So did Thomas Rowe Price.