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Circle of Competence Issue #68


"Truth is ever to be found in simplicity, and not in the multiplicity and confusion of things." - Sir Isaac Newton


Chris Leithner's letter on speculation vs. investing (July 2019)

I got introduced to Dr. Leithner's work several months ago and have enjoyed each of his monthly letters since. This one was particularly refreshing in the age of infinite information, constant activity, and lack of boredom (read: lack of time to sit and think). Dr. Leithner lays out the case that most money managers today fall more in the 'speculator' category than the 'investor' category. One fact I found incredibly interesting was that this decline from long term ownership in American securities to speculation occurred around 1985 when the average holding period for a manager for a public security declined to around 13 months. 35 years ago, speculation began to overtake American securities markets. Fast forward to today and the average holding period is around 8 months. It was 5 years in the 1950's.

I have a rule when buying stocks: don't buy a stock you don't want to hold for less than 10 years. Hold until the original thesis changes e.g. business model changes, industry shock occurs, regulation, competitive landscape changes significantly, rates of return on capital employed appear to decline, etc. This forces you to think about why you are buying the business and under what circumstances you'd want to sell.

This leads me to my last point. Because of the fact that public securities are so easily exchanged in high quantities and at high frequency today, this lack of friction leads to a much quicker price discovery mechanism and leads humans (full of emotional biases) to participate at a more rapid pace than in private markets. Private markets are distinct from public markets in these two important facets: price discovery is much slower and transactions take a lot longer to close. It would be great to get stats juxtaposing the holding period of various asset classes: stocks vs. private businesses vs. real estate etc. The obvious question is "who would ever hold a private business or large piece of commercial real estate for 8 months and expect good fundamental results?" Sometimes deals take 8-12 months just to close! As public markets get more efficient and holding periods continue to compress, I am more and more convinced every day that the patient, long term holder of private and public businesses who make 'infrequent but big bets' (Munger) will continue to outperform the speculators due to tax-free compounding businesses unburdened from transaction costs.

Marvel's blockbuster machine - how Marvel created a massive superhero franchise (Harvard Business Review)