IN THE NEWS

🏰 Disney Explores Amazon Prime Style Program For Members (WSJ)

Explained:

• The entertainment giant is hoping to package various streaming, resorts, parks, and merchandise perks together for members of its new program. Some executives have even referred to it as “Disney Prime.”
• The hope is that special discounts and perks would make their ecosystem more sticky and encourage greater spending through cross-selling. While Disney (DIS) does have an existing Official Fan Club, this new program would target more casual customers and Disney fans.

What to know:

• From exclusive toys to special shirts and children’s costumes, packaged with, say, a Disney + streaming subscription, there are many ways that the company could entice customers to splurge on the membership plan. Disney’s CEO, Bob Chapek, has referred to Disney as a “unique synergy machine” given its myriad of recognizable and beloved content.
• Membership programs have proven quite popular at Amazon (AMZN), Walmart (WMT), and Starbucks (SBUX) in rewarding loyal customers while helping these companies better understand consumer spending habits.
• For Netflix (NFLX), the robust non-streaming related options that Disney can leverage to merge users into their Disney+ platform is concerningly robust. In the three months leading into July, Disney+ added 14.4 million new subscribers, which raised its total to over 152 million.

💻 U.S. Blocks Nvidia AI Chip Exports To China (FT)

Explained:

• In another escalation of the economic struggle between the two rivals, Washington’s move to restrict exports of cutting-edge technology has sparked sharp condemnation from Chinese leaders. U.S. officials have informed Nvidia (NVDA) that they must stop selling two of it signature chips, used in artificial intelligence systems, to Chinese companies.
• The order goes into effect immediately, and it will also extend, less surprisingly, to Russia. China’s foreign ministry official Wang Wenbin compared the move to a “technological blockade.”

What to know:

• Increasingly, geopolitical tension is redefining corporate America’s autonomy and bottom line. For Nvidia, this cost comes to the tune of $400 million in lost potential sales this quarter. But for Washington, this is about restricting U.S. technology being used to power China’s military capabilities, and more speculatively, could be seen as retaliation for China’s unwillingness to sanction Russia and for its threats against Taiwan.
• It appears that for the cloud service providers and large internet companies who mostly use these now banned chips, there are no good direct substitutes, so Chinese companies will be forced to use lower-end processors.

😷 Chinese City Of 21 Million Shuts Down Over Covid (REUTERS)

Explained:

• In more news out of China, the southwestern Chinese metropolis of Chengdu announced lockdowns of its 21 million residents for at least four days, as the city embarks on widespread covid-19 testing. After reports of 157 new infections, residents in the city have been ordered to stay home, as China continues its harsh “zero Covid” policy and struggles to fully re-open its economy without rolling lockdowns.
• Given China’s central role in the global economy, the latest round of lockdowns has triggered concern across financial markets globally. Lockdowns not only disrupt supply chains and manufacturing, but they’ve also contributed to a meaningful decline in consumer sentiment, which only stokes fears further that a weak Chinese economy will pull the rest of the world down with it.

What to know:

• Volvo is temporarily closing its Chengdu plant, and flights to the city have been dramatically scaled down. Shenzhen, another of China’s critically important cities home to internet and tech giants, is suspending large events and indoor entertainment. Chinese factory activity contracted for the first time in three months this past August.
• While we’ve been covering several stories about China lately, there’s a lot unfolding there. From droughts and power shortages to massive lockdowns of major cities, tech feuds with the U.S., warmongering over Taiwan, and a collapsing real estate sector, global investors are watching all of these dynamics quite closely.

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DIVE DEEPER: THE ART OF NOT SELLING

Great investing requires you, for the most part, to do nothing, according to an article we recently came across in Seeking Alpha written by App Economy Insights. Simply buy great stocks and wait for the story to play out. No tinkering or trimming. No fancy strategies or re-balancing may be needed.

Selling is the more difficult part of investing than buying. Holding on is even harder.

Our main thesis today is that our worst mistakes are likely to stem from selling a stock too soon.

It’s certainly been the case for us, but we’d rather not get into “woulda, coulda, shoulda” investing stories. They’re painful for both you and us.

Phil Fisher, who we discussed here previously, had a philosophy around selling — or rather, not selling — that has been a profitable strategy.

Fisher was an iconic long-term investor, who even influenced Warren Buffett to transition from a Ben Graham cigar butt style to buying wonderful companies at a fair price.

While the typical Graham investment may have been held for just a few years, Fisher’s was for decades.

Fisher would say unless your bullish thesis on an investment is fundamentally broken, your best rule of thumb may be never to sell. Executing on such an idea requires a temperament that many investors lack.

As Charlie Munger once said, “It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”

It can be hard to hold on to an investment for the long-haul with the constant negative barrage of news that pummels us daily. Optimism in the face of bad news can be difficult to muster.

However, it is only by holding on to a position for years or decades that allows us to reap the benefits of compounding returns.

The Power of Compounding

Thomas Phelps wrote a book called 100 to 1 in the Stock Market, which shows us some valuable lessons on how important compounding is for your overall returns.

A 100-bagger is a stock that returns 100 times your original investment. So a $10,000 investment would turn into $1 million.

Here’s a table from Phelps’ book that shows the annual returns and how many years you would need to achieve a 100-bagger:

14%           35 years

16.6%       30 years

20%          25 years

26%          20 years

36%          15 years

If you hold a stock that is compounding at 20% annually for 25 years, you would have a 100-bagger. If you held the same stock for ten years, you would return just five times your money. This is a massive difference and a longer holding period is the key.

Let’s assume that you’ve found the investment idea of a lifetime and hold it in your portfolio.

What are the odds you’ll have the fortitude to let your thesis play out over 25 years?

Probably low. It’s too easy to take a profit and move on to the next big idea. However, as we want to reiterate, long holding periods are an absolute necessity for achieving life-changing investment results.

Let’s look at Apple (AAPL), which has been a 250-bagger from 1990 to 2020. For your $10,000 to turn into $2.5 million, you would have needed to stomach a dozen sell-offs of 25% or more and two kick-to-the-gut sell-offs of 80%.

Amazon (AMZN), Microsoft (MSFT), and Starbucks (SBUX) are other examples of great companies with huge returns over the years that also suffered extreme drawdowns.

We can often feel the urge to “secure” our gains, and our caveman brains will often think of all the things that could go wrong after a stock has doubled or tripled, resulting in us exiting our position.

Top Performing Stocks

What do these top-performing stocks typically look like?

First, you’ll rarely find them on the new 52-week low list. They likely will appear overvalued and overbought and will be reaching new highs, which may make you feel like you’ve “missed the boat.” Most investors will hold these companies for a short time frame, book a 20%, 50%, or even 100% return, and promptly sell their shares.

One important fact to remember is that only 6% of stocks significantly outperform the S&P, according to a study done by Meb Faber. And by significantly, we mean by 500%. Even if you are an outstanding stock selector, the odds of picking truly outstanding performers are fairly low.

If we assume your portfolio has a mix of investments spread evenly on a returns distribution chart, only 6% of them will be big winners. In a portfolio of 20 stocks, that boils down to just one stock.

Often, in re-balancing their portfolios, investors sell their best-performing companies that are driving the portfolio’s returns, only to reallocate to new positions with only a 6% chance of being a home run. The problem is you never know which stock will be the precious asset that outperforms the index.

According to App Economy Insights, the solution is just as you would have guessed and incredibly simple: don’t sell any of them.

Pareto and the Coffee Can Portfolio

In his book Zero to One, Peter Thiel explains, “the biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.”

You may have heard this called the Pareto Principle or the 80-20 Rule, and it’s a good rule of thumb to expect your portfolio will also have 20% of your investments generating 80% of your returns.

This brings us to the Coffee Can Portfolio, introduced by Robert Kirby in 1984. The idea, according to Kirby, is, “you can make more money being passively active than actively passive.”

Being passively active is an extreme version of a buy-and-hold approach. The active part is your initial investment selection. The passive part is not to sell at all for as long as you possibly can.

Kirby uses the image of a coffee can to explain his passively active approach by saying, “The Coffee Can portfolio concept harkens back to the Old West, when people put their valuable possessions in a coffee can and keep it under the mattress. That coffee can involved no transaction costs, administrative costs, or any other costs. The success of the program depended entirely on the wisdom and foresight used to select the objects to be placed in the coffee can to being with.”

The Coffee Can approach is, to a large extent, part of the strategy Warren Buffett uses when he describes his ideal holding period as “forever.”

This approach generally results in highly concentrated bets. Nearly 75% of Berkshire Hathaway’s portfolio is made up of just five holdings.

An important aspect of the Coffee Can approach is that you only need to be right once. No need for market timing or constantly checking quotes. You make a wise investment decision and simply let it work over many years.

Takeaway

This article offers three main conclusions to drive our investing philosophy. First, alpha (returns above a benchmark) is derived by a very small number of outstanding performers. Second, accept that you’ll have losers. Statistically, around 40% of your picks won’t work out. And most importantly, don’t sell your winners. Instead, add to them over time.

The two most important virtues to develop for the Coffee Can Portfolio to work are patience and persistence.

Much of this approach flies in the face of traditional portfolio management.

Let us know your experiences in practicing the art of not selling. We’d love to hear from you!

SEE YOU NEXT TIME!

That’s it for today on We Study Markets!

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