Another topical piece from the house of Akre Capital. In the past, we have featured Chuck Akre’s Three-Legged Stool investment strategy and Chris Cerrone’s The Art of (Not) Selling. In this piece, another partner at Akre, John Neff reminds us why compounding is so difficult given the markets currently.
“Why do more investors not reap the benefits of compounding? We believe the reason has surprisingly little to do with recessions, depressions, wars, financial crises, political crises, rising interest rates, inflation, stagflation, a global pandemic, or most adverse macroeconomic events. The stock market’s return over the past 100 years includes all of these terrible things. Yet, the stock market still compounded wealth to the point where every $1 invested in the S&P in 1922 and left untouched would have become nearly $13,800 in 2022! Our conclusion: it is not adverse macro events that derail compounding; it is investors’ reactions to them. In short, investor behavior derails compounding.
Examples of such counterproductive behavior are well known to all of us: trying to sell before the next recession, trying to buy just before the next bull market, “repositioning” portfolios based on what is supposed to do better in the new paradigm, dumping stocks during a downturn, which deprives oneself of the means to eventually recover. People do these things because they are intuitive, because these actions appear rational in the face of heightened concern and uncertainty. This is precisely why compounding over the long term is so challenging and rare: it demands counter-intuitive and seemingly irrational behavior.
One of our favorite Buffett maxims is that the stock market exists to serve investors, not instruct them. We think it speaks to the importance of distinguishing between the fundamental performance of a business and the price movement of its stock. Investors minding both can periodically be served by the stock market when business fundamentals and share price diverge. Too often, however, investors are informed only by share price movements from which business fundamentals are then inferred. These investors are not served by the stock market. Rather, they are instructed by it and typically to their detriment when it comes to compounding.”
He then shares a couple of examples of stocks whose fundamentals have been strong yet stock prices have been smashed in the short run and concludes:
“Hopefully, these illustrations for CarMax and KKR demonstrate why we remain steadfast believers in the businesses in which we invest. Our focus is on the fundamentals. We do not infer those fundamentals from share price movements. Rather, we endeavor to let the market serve us when fundamentals and share prices diverge. This is the best way we know to avoid the behavior that history proves so detrimental to compounding.”
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