If you sat down and made up eight criteria for the perfect Olympic swim champion, you would likely describe Michael Phelps. He is tall and has almost web-like hands and feet. He is very competitive, but keeps an even emotional keel. He had access to great swimming facilities and parents who could support his endeavor. Lastly, he lives in a country with a great tradition in short distance swimming and had the support of the U.S. Olympic committee and U.S. Olympic swimming team. He has been a very good template for long duration success in swimming and won more Olympic gold medals than any athlete in history.
The U.S. swim team has their own criteria for developing young athletes. We assume in every ten-year stretch that they support the swimming efforts of 25 to 30 young athletes in hopes of finding an occasional Mark Spitz or Michael Phelps. Most of them share the characteristics we described about Michael Phelps. The U.S. Olympic team is the most successful swim team 'portfolio manager' in the world. What can we learn from them as portfolio managers?
We have eight proprietary criteria for selecting common stocks. Our goal is to acquire shares in 25-30 companies fitting those criteria. Out of those companies, we believe we will find 3 to 5 which will be multi-decade winners and make us more than ten times our original investment.
With all of Michael Phelps' wonderful physical and mental characteristics, a few things ended up separating him from all the other athletes. First, he swam for 6 to 8 hours every day for twenty years. At SCM, we believe that this was the most important fact in all of his success. He got into the pool every day. He ignored what his school buddies were doing. He ignored everything going on around him in his teenage years. Second, he came back for another Olympics in 2012. He'd already set a bunch of Olympic records, but he came back for more even though that meant training and waiting four years.
To us at SCM there are two lessons from this story. You must stay invested all the time because the best performing stocks in your portfolio over 20 years don't get there through market timing. You must be in the U.S. equity market all the time because you don't get to know when the good and bad markets will occur.
Second, you must be willing to reinvest unrealized gains in the short run (1-2 years). A great deal of attention has been given to people who put money into Warren Buffett's original partnership in 1956. Early Buffet investors who kept their shares for the entirety are reported to have over $250 million in Berkshire Hathaway "A" shares. However, to get there, they had to withstand a 50 percent decline in 1973-74. In dollar terms, it was a temporary decline of $6 million.
In a recent interview on CNBC with Becky Quick, here is how Warren Buffet describes staying in the pool despite the distractions around you:
Last word, Warren, is a sort of free word association game that we've been playing lately. I say a word, you tell me what it makes me think of. And the question we get most frequently from people about you coming on is what should they be buying right now? So if I say buy, you say...
I say hold, basically hold. I mean, the idea that the European news or slowdown in this or that or anything like that, that would not cause you to own a good farm and had a run by a good tenant, you wouldn't sell it because somebody said here's a news item, you know, this is happening in Greece or something of the sort. If you owned an apartment house and you got to raise your rents a little, it's well located and you have a good manager, you wouldn't dream of selling it. If you had a good business personally, the local McDonald's franchise, you know, you wouldn't be thinking about buying or selling it every day. Now, when you own stocks, you own pieces of businesses, and they're wonderful businesses. So you can pick the best businesses in the world, and to buy or sell on current news is just crazy. You're in a wonderful business, you've got people running it for you. You know you're going to do well over five or 10 years, and to think news events should cause you to try and dance in and out of something that's a wonderful game is a terrible mistake. So get into a bunch of wonderful businesses and stay with them.
This leads us to a question we get asked frequently about holding shares of stocks like eBay (EBAY), Disney (DIS), Home Depot (HD), Cabela's (CAB) and Starbucks (SBUX), which have been multiple-year success stories. Why are we holding shares which look more like growth stocks than value stocks?
The answer is three-fold. We are more interested in the next ten years than we are in the next ten weeks. In our opinion, these companies will outperform the market over the long haul and their wide moats, high free-cash flows, strong balance sheets and shareholder friendliness will reward us for being patient. Secondly, we believe one or more of them are Michael Phelps-like companies which just keep bringing back the gold medals. All ten-bagger stocks had to double, triple and quadruple first. If you sell your winners you will live with 20-year regrets for sins of omission.
Lastly, they all have wonderful leverage on an improving U.S. economy. With a huge echo-boomer population, affordable housing, strong bank balance sheets, historically attractive Household Debt Service ratios and falling commodity prices, we think the next ten years could be a period of U.S. economic prosperity. Would you really want to sell these companies before the economy has made its comeback?
Therefore, if you play the part of Michael Phelps' parents, you will imitate the U.S. swim team and will keep him in the pool. At the same time, we would ask all of you to ignore what your friends and popular experts are advising on investments. We believe that if a teenager can ignore what is going on around them, so can we. In our opinion, it was the key to him becoming a great champion.
Disclaimer: The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.