Seeking Alpha
Long-term horizon, dividend investing
Profile| Send Message|
( followers)  

In a tribute to the legendary global value investor John Templeton, the team at Franklin Templeton Investments put together a listing of Templeton's sixteen rules for making sound investments. Under the rule titled "Aggressively Monitor Your Investments", the folks at Franklin Templeton offer this advice:

"Expect and react to change. No bull market is permanent. No bear market is permanent. And there are no stocks that you can buy and forget. The pace of change is too great…Consider, for example, just the 30 issues that comprise the Dow Jones Industrials. From 1978 through 1990, one of every three issues changed-because the company was in decline, or was acquired, or went private, or went bankrupt. Look at the 100 largest industrials on Fortune magazine's list. In just seven years, 1983 through 1990, 30 dropped off the list. They merged with another giant company, or became too small for the top 100, or were acquired by a foreign company, or went private, or went out of business. Remember, no investment is forever."

That is certainly a defensible viewpoint of investing. But that is by no means the only way. After all, just because the pool of stocks that will deliver great returns for the rest of your life may be small, that does not mean that you cannot build an entire portfolio of them. It does not matter if 99% of the stocks in the universe won't be profitable 30 years from now. That's because there are over 15,000 stocks out there, and you would still have a pool of 150 to choose from.

And I think Charlie Munger, the Vice Chairman of Berkshire Hathaway (NYSE:BRK.B), provided a useful template for finding such stocks when he ran the stock portfolio at Wesco (which is now fully owned by Berkshire Hathaway). Although he trimmed and added to his positions over the years, almost every Munger portfolio at Wesco prominently featured five companies: Coca-Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Kraft (NASDAQ:KRFT), US Bancorp (NYSE:USB), Wal-Mart (NYSE:WMT) and Wells Fargo (NYSE:WFC).

The question is: What characteristics do these companies share that enabled them to become permanent holdings (and large positions at that) in the portfolio that Munger used to run? Generally, these six businesses fall into one of two categories: they are either the seller of low-priced brand names, or they are the low-cost producer in the industry.

In Munger's psychology of human misjudgment speech, he explained why he likes name brands that sell low priced goods. He compared Coca-Cola to Tiffany Jewelry (NYSE:TIF). The reason why Munger made such sizable investments in Coca-Cola is because the company is both well-branded and sells a product that only costs a few dollars. By Munger's logic, anyone can find a spare dollar or two for a Coca-Cola if they really want (and they would not deviate to a store brand just to save a couple dimes).

However, in Munger's illustration regarding Tiffany, he points out that selling jewelry can often come with profit margins in the hundreds or thousands of dollars per item. Because of this, Munger explained, there will always be a market for both competitors to try to chip away at Tiffany's moat by selling slightly cheaper jewelry, and there will always be a market for people wanting to buy the jewelry at a cheaper price. In Munger's view, expensive (yet well-branded) items will always face a more intense assault to their business models than businesses that sell relatively cheap (yet well-branded) items.

This explains why Kraft, Procter & Gamble, and Coca-Cola have always found a spot in Munger's portfolio. He knows that they sell essential items (macaroni and cheese, razors, beverages) that prove highly resistant to technological change and fads, and they come with the bonus of strong branding that makes them likely to endure into the future.

Of course, none of these things apply to the other three of Munger's semi-permanent holdings: Wells Fargo, Wal-Mart, and US Bancorp. In the case of those companies, they share one important characteristic in common: they are the low cost producers in their respective industries. In the case of Wells Fargo and US Bancorp, they always achieve the best combination of low-cost deposits mixed with stable operations that generate ancillary income. There's a reason why Buffett owns Wells Fargo and US Bancorp as well. When explaining the advantage of being the low cost producer, Buffett put it succinctly by saying about Wells Fargo and US Bancorp, "The deposits are flowing in. The spreads are wide. It's a helluva good business."

What US Bancorp and Wells Fargo are able to do in banking, Munger sees Wal-Mart doing in retail. Munger has repeatedly argued that Sam Walton was ingenious for realizing how to gain a competitive advantage over peers by making small profits on individual items but making large profits for the company by creating a business environment that generates obscenely high volumes of sales. As of 2012, Wal-Mart only has a 3.5% net profit margin. It is going to be incredibly tough for a competitor to dislodge Wal-Mart as the preeminent low cost retailer in the industry.

Despite the advice from the Franklin Templeton team, making investments that will last the rest of your investing lifetime is still doable if you keep in mind what causes certain successful businesses to fail. As a general rule, "Capitalism inherently means that others will always be trying to replicate any business that is profitable and that means you are always in a battle to keep what you have." The businesses that are most resistant to this, based on Munger's long-term holdings, are those that are the low-cost producers in the industry and those that sell inexpensive yet well-branded goods. When Munger ran the investment portfolio at Wesco, these are the holdings that stood his test of time. These are the types of competitive advantages that market competition is least likely to disturb, and therefore provide fertile soil for the kinds of companies that you can own the rest of your life.

Source: Charlie Munger's Guide To Forever Investing