When McDonald’s stock was trading in the $90s during 2014 and 2015, I was incredibly struck by the obviousness of the high risk-adjusted returns that would await investors from that price point. While I did not specifically know that each $90 share would go on to produce $106 in capital gains and $18 in dividends over the coming 4-5 years, I could identify the vast real-estate holdings on the company’s books, the immense cost-advantage inherent in controlling one-fifth of the United States chicken market, and an absurdly high marketing budget and entrenched cultural advantage as the cheap go-to fast food source that functioned as an additional competitive advantage. With a P/E ratio that got as low as 15x earnings, it was only a matter of time before the superior returns would come.
Nowadays, when an investment opportunity is spotted, someone will say something like: “If it’s so obvious, why isn’t someone on Wall Street doing it?”
Part of the answer is that, well, they were doing it. McDonald’s stock was trading about 5 million shares per day during 2014 and 2015. There were about 600 trading days where 5 million shares were bought and sold each day. By definition, there was an investor out there buying each of the 5 million shares on a given day for $90 just as surely as there was someone selling it on the other side.
Secondly, I don’t think the investor community realizes at large how many political constraints affect the investment selection process.
Last year, JP Morgan had one of its associated put out a powerpoint slide comparing airlines by occupancy rates and making recommendations accordingly. I found it to be a perfect example of Wall Street’s myopia because airline profits are now more driven by oil price hedging rather than actual occupancy per flight. The success of an airline is more about fuel costs, and the optimization of fuel-timing purchases, than almost any other element. Discussing airline stocks in-depth without studying their fuel costs is insufficient to truly know what you are doing with the investment. And yet, it happens all the time that some JP Morgan intern has an assignment due, and it gets rushed based on superficial elements rather than what really drives earnings for a particular company that only a lifelong observer of the industry might know.
In addition, and I consider this the most important political factor, many wealth managers get paid according to their performance each year. One of the most important academic papers I have ever read was “Incentive Structures in Institutional Asset Management and Their Implications for Financial Markets”, which noted that Blackrock and Fidelity’s management teams get paid according to investment results over a period of twelve months or less.
When a Fidelity manager looked at McDonald’s stock in 2014, he had to figure out whether McDonald’s would outperform over the succeeding year. Given that sales growth was in the 1-3% range, it would have been hard to find the proverbial catalyst that would trigger a higher valuation for McDonald’s stock as occurring within the next year. In fact, McDonald’s stock didn’t recover in 2015 or 2016, so such an institutional investor would have had his short-term concerns be vindicated as well founded.
But the individual investor is not bound by the dictate “outperform now or get fired.” This frees you to focus on undervalued assets without worrying about the timeline of when the value would materialize. If you found McDonald’s stock at $90 in 2014, you could afford to wait until the end of 2016 through 2018 period when the stock climbed from the $110s to the $170s. You didn’t have to identify the timeline between 2014 and 2019 (or even 2014 and 2024 ad infinitum) when the value would materialize. You only had to know it was there.
Only having to answer one question (“Will this company generate far more cash flows plus valuation changes between now and kingdom came than I am paying for at this price?”) is your competitive advantage as the individual investor. For the professionals, their compensation and even job security is tied to answering the “when” question as well. An institutional investor can’t sit by for years and see BP trade in the low $40s. His peer earning 30% with Amazon is going to cause him problems. Meanwhile, the individual investor is free to sit back, collect 6% dividends, and take the outperformance as it comes and when it comes. People put up mental blocks because the phrase “long-term investing” is uttered with such frequency, almost regardless of the context, that it is easy to ignore. But for the individual who can evaluate businesses and identify likely ranges of future earnings growth, the long-term orientation is his best competitive advantage.
Originally posted 2019-05-29 01:51:14.
