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On Long Holding Periods

Holding a stock for a long time is a worthy endeavor. For one, there are real tax benefits to deferring tax day by holding a long-term compounder. Two, as you hold a company longer, you get to know it more deeply; the flaws and special characteristics. This enables you to sleep better at night and focus on the long-term. Third, most people aren’t thinking beyond the next quarter, so you can take advantage of opportunities where the company may miss analyst expectations but you feel that the 3–5 year view looks much better.


But we aren’t scored by how long we have held a stock, we’re scored by the compounded growth in our portfolio after taxes. Holding stocks for a long time often leads to better results, but not always. So we have to make sure not to focus on the wrong metric. In fact, I believe that long holding periods are actually quite dangerous if the business quality is subpar. If you look at enough stock charts, there are many examples of stocks going nowhere for 20-30 years. That is some serious opportunity cost.


So the ultimate goal is finding a company that just compounds its intrinsic value at super high rates for a long, long time. Finding these special companies is very difficult, especially since they are usually found at high valuations because there is consensus that it is a quality, base-rate-busting compounder.


But the goal of holding for a long time is a worthy endeavor, mainly because it raises your standards for potential investments. What I mean is that if you’re really thinking about holding a company for 5+ years, you have to think about different dynamics. For instance, if there is no clear path to profitability, you are essentially betting that the company will get bought out one day. If you plan to sell next quarter, you can bet on some multiple reversion – you don’t have to remotely think about the cumulative cash flow over the lifetime of the company. There’s nothing inherently wrong with that, it’s just an entirely different game. You have to be aware of the game you’re playing. Because if you think you’re a long-term investor, and you’re really playing the earnings game, then you can’t hold a stock that is exhibiting hugely decelerating growth and margins. Now, the games of investing aren’t always mutually exclusive. Some people place a greater emphasis on the financial linearity of the companies in their portfolio, other people don’t care as much about the quarterly, or even annual, financial metrics. I think it’s important to find a good balance because we still have to monitor how the company is developing – I personally do not play the buy-and-forget game. To play that game, it’s hard to concentrate. You more likely have to take a diversified approach, because a thesis can change. Management teams change. Competitors come in. Mistakes are made. Stuff happens.


But the important thing to think about is that the higher the business quality, the more you can let a company breathe. There may be times where the company isn’t firing on all cylinders and it has a bad quarter, but if you’re confident in the inevitability of the company’s success, then it may not matter so much.


Thinking about the long-term trajectory leads you to ask different questions. You may not be as concerned with the slight degradation from 71% to 69% in gross margin but rather are more focused on management’s incentives, the level of competition coming into the space, or the end-game economics of the company. The former type of analysis is still useful but it’s focused on a different time horizon. That’s not to say that the details don’t matter. They do. After all, the long-run is just a bunch of short-runs all strung together. Imagine if you had access to a company's sales figures every single day. What would constitute too short-term? When would you be able to discern if things were getting off-track? How would you separate the signal from the noise? Is 90 days really a perfect amount of time to judge that? One year? 5 years? The point is that it’s important to understand your time frame in context to how much grace you are willing to extend to a company. And maybe companies don’t deserve any grace and we should just focus on the ones that are firing on all cylinders? The problem is that without a deeper understanding of the business quality, it becomes nearly impossible to hold a company for a while. Though that’s not necessarily the end goal – the goal is returns – it’s an incredibly important part of the process.


So I think there’s a nice middle ground between focusing too much on the short-term numbers and buy-and-forget. Maybe it’s having a quality bar that is so high that only a few companies can even enter the conversation but giving them just enough grace that you aren’t jumping in and out at every sign of trouble. Businesses rarely grow linearly – there will be lumps. But a deep understanding in where the company is headed allows us to hold on for dear life. That’s what is so difficult about investing though – that delicate balance between humility and conviction – we very well could be wrong. Sometimes we do have to move on to greener pastures and cut our losses. It can be a hard balance to strike but it’s important to remember that businesses, like people, make mistakes and deserve at least a little grace if we are to seek long-term relationships.


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