Wayne and Shane,
The question of how long it takes for the market to recognize value is a very important one, especially for small investors. The problem, as you point out, is that there is little predictability regarding when Mr. Market will recognize the value in a company and raise the price accordingly. I believe there are two possible solutions: 1) diversify widely enough (40-50 stocks, minimum) so that the average time for your stocks to reach fair value is about the same as the value-stock universe, or 2) buy only value stocks whose intrinsic value is growing at a rate high enough so that you don't mind holding virtually forever.
I believe I'm correct in saying that Buffett started out doing (1), which is more Graham-like, he has evolved more into (2), which is more Fisher-like.
I also have evolved more towards (2) over the years for the following reasons:
-- easier for the individual with limited research time to follow a few stocks and hold for long periods
-- tax deferral advantages of holding for long periods
-- lower trading costs
-- fewer mistakes because research on each stock tends to be more thorough
I'm sure there are more advantages that don't come to mind right now.
Institutions with large research organizations have the option of using either strategy.
These two strategies can be seen at work in four mutual funds that I follow. Mutual Series (MQIFX, MDISX, etc.) has taken the Graham-like highly-diversified approach while putting little emphasis on intrinsic value growth rates. Sequoia and Tweedy-Browne have taken the Fisher/Buffett approach of buying a few good companies with predictable growth at low prices and holding virtually forever.
I also follow Longleaf Partners, which seems to take a middle road between these two. They hold 25-35 stocks vs. Mutual Series' 50-150 and Sequoia/Tweedy-Browne's 10-20. They pay attention to management quality and intrinsic value growth, but buy companies with second- and third-rate management quality and economics whereas Sequoia/Tweedy-Browne tend to buy only companies with first-rate (and sometimes second-rate) management and economics. Mutual Series will go pretty low on the quality scale in search of value. Of the three approaches, I've been most concerned about the predictability of long-term returns for Longleaf. I wonder if they've got the right balance of predictable intrinsic value growth and diversification. I believe the record shows that their short- and medium-term returns are more volatile than the other three. I'm sure that there's not enough data to make a good statistically-based judgement about the predictability of their long-term returns vs. the others.
Brendan |
