If you’re looking to take your game to the next level, here’s an excellent habit to develop: Anytime you encounter a data point or statistic that tells you about the supposed quality of a given investment, quickly follow that up by asking the question, “Is there any countervailing force that will offset this?”
I’ll give an example. If you read analyst reports about Altria (which was called Philip Morris up until about five years ago) anytime between 1983 and now, you would have encountered this line dutifully added in the “risk” section of the analyst reports: Gross tobacco volume shipments in the United States are declining by about 3-4% annually.
This is a permanent structural change in the tobacco industry. It is a very real risk of tobacco investing, and the analysts are right to note it in investor presentations. Yet, relying on this fact to make an investment decision would ultimately be an unfortunate way to proceed as an investor because the analysis is incomplete. It doesn’t take into account a countervailing force that would allow Altria to be an intelligent investment in spite of this fact.
An investor that sold his or her Altria stock pretty much anytime in the past three decades would be regretting the decision. Since ’83, Altria compounded at 20.19% annually, turning a $10,000 investment into $2.8 million. Since ’87, Altria compounded at 17.75% annually, turning $10k into $800k. Since ’91, Altria compounded at 14.77%, turning ten grand into a middle-class house ($230k). Since ’95, Altria compounded at 16.60%, turning ten thousand dollars into $179,000. Since ’99, $10k into $86k, for a compounding rate of 15.69%. You get the idea.
The analysts were right. Tobacco volumes did decline substantially along the way. Yet Altria shareholders continued to get rich. That’s because the Marlboro brand’s market share has remained resilient, Altria picked up an almost 30% stake in SABMiller (which is carried at only about $6 billion in Altria’s books, yet could be sold for $24 billion today before including the effect of taxes), and it has diversified into smokeless tobacco, electronic cigarette, and winery sectors that have allowed Altria to enter new fields that provide very, very high returns on profit. Also, despite the higher taxes, Altria has been able to raise profits at a rate much higher than expected over the past decades. Not many people thought paying $8 for cigarettes would “become a thing”, yet it has.
In the case of Altria, you would have done yourself a favor by asking yourself about countervailing factors when you hear about declining values. Having the skill set and knowledge to do so would have enabled yourself to turn a tidy profit for your household over the past decades.
A good current example of this habit could apply to Coca-Cola. Most analysts point out that soda volumes in the United States have been declining at a steady 2-3% clip in the past ten to fifteen years. Yet, the analysis is incomplete because it doesn’t take into account that (1) Coca-Cola has over 500 brands, many of which are non-carbonated beverages. And (2) the company only makes 20% of its profits in the United States, making the analysis of soda volume here only a small part of the company’s total profits.
The profits for Coca-Cola are still growing at 7% per year, despite the fact that the company set aside a whole lot of capital to restructure the bottlers (my guess is that Coca-Cola shareholders will receive a spinoff sometime in the next decade once it becomes fashionable for Coca-Cola to release the bottlers as a standalone company to shareholders so that the KO holders can go back to focusing on the business that produces 30% returns on equity: flavored syrups).
Analysts are right when they say that soda volumes are declining in the U.S. Yet, it ignores the fact that when someone gives up drinking Coca-Cola, they might take up drinking Minute Maid, Powerade, or Dasani Water (other products under the Coca-Cola corporate umbrella). And it also ignores the fact that outside the U.S., there are volume increases in soda consumption which profit KO shareholders. The “countervailing force” question saves you from selling your stock after reading about U.S. volume declines and then wondering why shareholders continued to receive 10% returns for the next decade.
When you hear bad news about a company you own or contemplate owning, get in the habit of saying, “What forces exist that might offset this?” It can be a disastrous habit if it leads you to develop horse blinders that allow you to rationalize away all the bad news, but it can also be a secret weapon in your arsenal if you answer the question independently without emotional persuasion. Have the persistence of a pit bull yet the sangfroid of a bridge player under stress when it comes to doggedly putting together the other pieces of an investment puzzle.