Trivikram Consultants

Enduring a decline in share price in wonderful companies
In his blog, Jon reminds investors that the stocks of great companies are not immune to a deep decline in the share price. In fact, it’s practically guaranteed to happen more than once. Hendrik Bessembinder followed up on previous research with a deep dive into the greatest companies ever.

His first conclusion shouldn’t be too surprising. The most successful company investments in terms of wealth created for shareholders at the decade horizon also involved a very substantial peak-to-trough decline in the share price. Even those investments that are the most successful at long horizons typically involve painful losses over shorter horizons.

Bessembinder looked at the top 100 companies based on shareholder wealth creation by decade since 1950. He then measured the largest decline in share price shareholders faced in that decade. Investors in the greatest companies faced a decline of 32.5%, on average, despite being one of the greatest decades of performance ever. That was just the largest decline, on average. It says nothing of the second, third, and so on a decline during the same decade. AT&T shareholders got off easy, seeing a decline of only 5.9% (over 7 months) in the 1950s. However, Netflix shareholders suffered the worst — a 79.9% drawdown (over 16 months) in the 2010s.

Bessembinder also looked at the decade, prior to the greatest decade of wealth creation, and found shareholders suffered an average decline of 51.6%. Again, that was just the largest decline for the previous decade. The duration of the decline fell in a wide range. They lasted anywhere from a month to three years in the same decade of the company’s greatest wealth creation. In the prior decade (to the greatest decade), in some cases, the decline exceeded eight years!

There are a few important takeaways from this:

First, sometimes great companies stumble. It can take management years to fix the problem (see Microsoft) or come up with a new product/innovation (see Apple) before the company moves in the right direction again. This can create multiple periods of massive wealth creation by the same company as seen in the table above.

Second, sometimes the market gets way ahead of itself in the short term. It gets the growth story right (see Amazon) but the timing is off by a decade. Expectations send the stock price soaring but once instantaneous growth is off the table, the price corrects, sometimes to the opposite extreme.

Third, and not surprising, long term shareholders must endure multiple, and sometimes painfully long decline to reap great rewards. This would confirm that the hardest part of investing is often just holding on.

Fourth, investors have multiple chances to buy great companies at wonderful prices. They usually have ample time too. Now, the usual caveats apply. Neither the buying opportunity nor the greatness of the company is always obvious at the time. But the fact stands. Declines in share price are buying opportunities for patient investors who have done the work and identified great companies in advance.

The broader point is this. It’s up to investors to separate the company from its stock price because declines are inevitable. But a great company’s stock will not only recover but go on to be extremely rewarding.

Good things taken too far are dangerous

Morgan Housel reminds investors that good things can be taken too far – helpful at one level and destructive at another. They can be more dangerous than bad things because the fact that they’re good at one level makes them easier to rationalize at a dangerous level. A lot of things work like that, don’t they? Good things – praise-worthy things – that in a high enough dosage backfire and become anchors?

A few Housel sees in investing:
1. Contrarianism is great because the masses can get it wrong. But constant contrarianism is dangerous because the masses are usually right. Identifying and avoiding times when millions of people have been derailed by bad incentives and a viral narrative is a wonderful thing. Most investment fortunes come from a bout of contrarianism. But a larger group of investors has turned contrarianism into something closer to cynicism. Their contrarianism is constant – at all times, for all things. The quirk is that if you survey the list of extraordinarily successful investors, entrepreneurs, and business owners, virtually everyone has been a contrarian. But none – not a single one – is always a contrarian. There’s a time to bet against mass delusion, and (more frequent) times to ride the progress that comes from billions of people collectively searching for the truth.

2. Optimism is great because things get better for most people over time. But it’s dangerous when twisted into the belief that things will never be bad, which is never the case. A lot of people pick optimism because they rightly, correctly, get excited about the long history of progress mixed with confidence in their own skills. But when optimism is taken so seriously that it assumes things will never be bad – that every period long or short will work out in your favour – it turns into complacency. It encourages leverage and promotes denial. It leaves you without backup plans. Worst, it causes you to wrongly second-guess your long-term optimism when faced with an inevitable setback. You can be right about optimism in the long run but fail to ever see it because you overdosed on it in the short run.
3. Being open-minded is great because the truth is complicated. But being too open-minded backfires because objective and immutable truth exist. Every smart attempt to be open-minded has to be accompanied by a strong nonsense detector. The detector should go off when any of a handful of laws are violated when the author’s incentives favour an outcome, and when a complex answer is given if a simple one would suffice. You have to be firm enough in your views to make confident decisions while being open to new views in a way that lets you occasionally update and change those decisions. “Strong beliefs, weakly held” as they say.