Before I begin, let me add a caveat. Here I am always referring to something of quality. By that I mean the asset about which I speak has an enduring characteristic and or its long run worth will be higher because it will earn more in the future than it does today thanks to inflation or an ability to reinvest profits at attractive rates of return.
Time is the friend of such businesses and assets. When you were advised to invest for the long term, what you weren’t told is that time is the enemy of the mediocre business. Witness the languishing share prices of Virgin Australia Holdings or Telstra each below the level they were more than a decade ago. So today, when I speak of long term investing I am referring to quality businesses and assets.
With that in mind, my visit to Galargambone (not far from Tamworth) last month yielded an interesting insight. A farmer told me the story of another’s grandfather who had wisely purchased large tracts of coastal land in NSW for a little less than the equivalent of $60/acre. That land today trades in excess of $4000/acre. Surely the man’s heirs are now very grateful for this far sighted purchase? Sadly not.
As an aside, Warren Buffett once disparagingly compared a several trillion dollar investment in all the world’s gold to investing the same amount of money in all of America’s farmland. Pointing out that over the ensuing 100 years that land would have produced Everest-sized mountains of valuable crops and meat he noted that the investor in gold could merely fondle his investment, which was good for little else.
So land it seems over the very long term must surely be a winner. Why then did the grandfather’s heirs not benefit? We’ll answer that question momentarily.
More recently Warren Buffett was interviewed and asked what we should make of pundits who point to this or that cloud on the horizon as a reason not to invest.
His answer provided a genuine clue about how to think about investing and time frames. And given the apparently heightened uncertainty about now, the timing of his answer provides a genuine gift; “I've been hearing it, you know, all my life. And in the spring of 1942 I was 11 years old, and the Dow was at about 100. And we were losing the war in the Pacific at that point…and people said, "Well, this is let's wait till things are clear, let's wait till we start winning the war." There's always a reason to wait and I've listened to that all my life. You know, when I got out of school the Dow had never been above 200. There'd never been a year when the Dow had not been below 200 during the year… But that was a big subject at that time…And the important thing is if you got these wonderful assets out there, to own 'em, and which ones do you own? save money you can buy bonds, you can buy a farm, you can buy an apartment, house, or even buy a part of American business. And if you buy a 10-year bond now you're paying over 40 times earnings for something whose earnings can't grow. And you know, you compare that to buying equities, good businesses, I don't think there's any comparison. But that doesn't mean the stock market can't go down 20 percent tomorrow. I mean, you never know what it's going to do tomorrow, but you do know what it's going to do over ten or 20 years. And people talk about 20,000 being high. Well, I remember when it hit 200 and that was supposedly high. The Dow, I mean, the Dow, in your lifetime. You know, you're going to see a Dow that certainly approaches 100,000 and that doesn't require any miracles, that just requires the American system continuing to function pretty much as it has.
It’s easy to look back over history and ponder, ‘if only’. Much rarer are we offered a telescope with which to see the future.
Broadly speaking equities appear to be expensive right now and understandably investors are hesitant. But ask a room full of people today, would they be buyers if share prices fell by half, and with immeasurable enthusiasm they’d confirm they would.
Sadly, thanks to temperament, that will not be the case.
I have one thing in common with Warren Buffett; I don't have the foggiest idea what the stock market's going to do next week, next month, next quarter or even next year. I do know however that provided a business can retain a large portion of its profits and reinvest that money at high rates of return it will grow in intrinsic value and that will eventually be reflected in the market price.
So there will be businesses, listed in Australia right now, that will be worth many multiples of their price in the years to come. A mere doubling of the population of Australia will ensure the banks will be making mountains more money than they are today. And when the population of the world doubles, CSL should also be making mountains more than it is today.
But what stops investors from benefiting from this almost assured growth? It’s simply temperament.
The fear of loss and the fear of missing out drive all sorts of odd behaviour. Property income yields remain entrenched at low single digits and yet property buyers couldn’t be more enthusiastic. Buying on a lousy gross yield of 2.5%, with the expectation of a capital gain, fails to appreciate that a capital gain will only accrue when a ‘greater fool’ is found willing to accept an even lower yield. But the yield on an oversupplied and vacant apartment is zero; they cannot fall much further.
In Buffett’s interview he also noted “you shouldn't borrow money against stocks.”
When an investment, such as an apartment, is offered with unattractive fundamentals, that investment isn’t made more attractive with borrowing.
It's the fear of missing out that causes people to borrow. Borrowing is an accelerant for those who aren’t patient. And like all accelerants, debt makes investments highly volatile.
Remember that NSW coastal farmer who bought vast tracts of land at less than $60/acre? He lost the lot when prices fell to $20/acre. Borrowing.