“The university’s storied history centers around coaching legend John Wooden who won 10 championships, including a remarkable seven in a row. Mr. Wooden has a library of timeless quotes. One quote epitomizes the extensive research we conduct on your behalf, ‘You can’t have confidence unless you are prepared. Failure to prepare is preparing to fail.’ Our fieldwork equips us to make purchases even during times of adversity.” Letter from Cobleskill Spring 2019
FAM Funds CIO John Fox & FAM Small-Cap Fund Co-Manager Andrew Boord
FAM recently attended KBW’s Winter Financial Services Conference. Here are some key trends from the meeting that reinforce our investment thesis within our small regional bank positions.
- Geographic Shift: The movement of people from high tax states to low tax states appears to be accelerating, benefiting places like Nashville, Dallas, Charlotte, and Florida, while making it harder to grow banks in other areas.
- Industry Consolidation: The merger of SunTrust and BB&T may benefit a number of our bank holdings as impacted bankers and customers migrate to other institutions. More broadly, “merger of equals” may become a trend as there are few smaller banks in attractive urban markets left to acquire on a “bolt-on” basis.
- Loan Growth & Quality: The outlook is for moderate loan growth in 2019. There are no systemic concerns around credit quality. Banks are being a little more careful given how long the upcycle has continued and shrinking exposure in certain areas such as hotel construction.
- Net Interest Margins: Pressure from competition for deposits is easing and margins should be roughly flat or only slightly lower relative to 2018. Stable margins plus high loan quality support our favorable outlook for banks.
- Culture is Key: Spending time with bank CEOs reinforces our view that leadership and culture are paramount because every bank has essentially the same opportunity set.
As someone once said, “The stock market is the only store in America where, when everything goes on sale, people run out the door!” However, the FAM Funds team gets excited and runs into the store seeking to invest in high-quality companies at bargain prices.
We do this with confidence because history demonstrates that stock markets tend to be fairly rational over the long term with prices typically correlating to the true economic value of the enterprises.
Discover what stocks our fund managers purchased in 2018 as well as their thoughts for 2019.
FAM Funds 2018 Annual Letters
We are studying the economic and political concerns of the day. So far, our conclusion is that while these issues are quite real – we see many companies reporting slower growth and thinner profit margins – it remains unclear if they are severe enough to trigger a recession as some may fear.
Meanwhile, there are reasons to be optimistic. Many of the problems facing us will likely be resolved. For instance:
- No matter your political leanings, we can all probably agree that politicians around the world tend to focus on self-preservation – while posturing is sure to be involved, we expect resolutions to both the U.S./China trade conflict and government shutdown
- The Federal Reserve may decide that current conditions no longer warrant further interest rate increases
At the company level, challenges are usually met and overcome through a combination of ingenuity, hard work, and adaptation. With our holdings, this includes:
- Finding suppliers outside of China to avoid tariffs, cutting costs, and raising prices to offset higher costs to the extent possible
- Continuing efforts such as growing through product additions, entering new geographies, and acquiring smaller competitors
The economic and political backdrop in which we invest is always shifting. As a result, Fenimore tries to take advantage of opportunities when people sell due to fear and invest in enterprises that we estimate can do well, and grow, in a wide variety of scenarios.
This is the third in a series of posts about short-termism from FAM Value Fund Co-Manager Drew Wilson.
There are any number of reasons investors may find it difficult to achieve their financial goals. In some cases, unexpected and uncontrollable events can wreak havoc on a financial plan. But it is often an investor’s own actions that lead to the failure of meeting their objectives. There is a branch of science called Behavioral Finance dedicated to exploring how an individual’s propensities and predilections can short circuit rational investment decisions.
Unfortunately, in my opinion, there is a powerful gravitational pull that has fostered a short-term mindset with many investors. This force comes from academicians, practitioners, pundits, and the financial press who promote – wittingly or unwittingly – return-diminishing behaviors such as market-timing and performance-chasing.
How well does a short-term investment approach work? In my next post I’ll highlight a compelling research study that compares performance-chasing versus buy-and-hold behaviors. At FAM, we have a long-term approach; however, despite consistent results for buy-and-hold strategies, this research study exposes a challenge the investment industry faces. Stay tuned.
There are many who believe that short-termism hinders the U.S. economy. On June 6, 2018, corporate titans Jamie Dimon (CEO of JPMorgan Chase & Co.) and Warren Buffett (famed investor and CEO of Berskshire Hathaway), wrote an op-ed in The Wall Street Journal highlighting the problem of short-termism:
“…Companies frequently hold back on technology spending, hiring, and research and development to meet quarterly earnings forecasts that may be affected by factors outside the company’s control, such as commodity-price fluctuations, stock-market volatility and even the weather.”
“…The pressure to meet short-term earnings estimates has contributed to the decline in the number of public companies in America over the past two decades. Short-term-oriented capital markets have discouraged companies with a longer-term view from going public at all, depriving the economy of innovation and opportunity…”
Additionally, a McKinsey Global Institute study that focused on 2001 through 2014 shows that the economic costs can be material. Their research gleaned that firms with a long-term focus had materially higher revenues, earnings, profits, and market capitalizations at the end of this time compared to those who had a short-term view.
Next time, I’ll discuss how short-termism can hamstring many investors’ returns.
 Source: The Wall Street Journal’s Opinion, By Jamie Dimon and Warren E. Buffett, June 6, 2018
 Source: McKinsey Global Institute, “Measuring the Economic Impact of Short-Termism,” February 2017
By Drew P. Wilson, CFA
Investment Research Analyst
Whether or not you are familiar with the term “short-termism,” it most likely affects you. In my opinion, short-termism is a vicious cycle that negatively affects both the economy and many investors’ returns. I believe that there is a natural tendency toward short-termism that is further influenced by the investment environment. I will address this in a future post.
To begin, though, let’s set the context for the problem with this definition from FCLT Global:
“Too many investors continue to seek returns on their strategies as quickly as possible. Companies are missing out on profitable investments for fear of missing quarterly earnings guidance. Corporate management significantly undervalues and underinvests in longer-term prospects. Savers are missing out on potential returns because stock markets are penalizing companies that make long-term investments. Society is missing out on long-term growth and innovation because of underinvestment.” *
Do you have a short- or long-term view?
* Source: FCLT Global, “A roadmap for focusing capital on the long term.” September 2016
The event was held on October 9, 2018.
- Look at the past 10 years and discover how time in the market, not market timing, can make a big difference
- See how our funds performed
- Watch an insightful Q&A session with our Investment Research Team
We believe there are two key reasons for the recent stock market decline. First of all, there is a small decrease in earnings power. Secondly, company valuations have decreased.*
1. Earnings Power Decrease – In some industries, corporate earnings are not coming in as strong as expected. This is the case with industrials, banking, and some technology companies. These stocks are declining as investors seem to be re-evaluating the earnings power of the underlying businesses. We think that there are many reasons earnings are less than expected.
For example, management teams are citing increased raw material costs, higher wages, and growing transportation expenses. Some of this is caused by tariffs, such as steel, and some by natural market forces in an expanding economy including labor and transportation. These increasing costs are reducing profit margins.
Additionally, while America’s economy is very strong, in our opinion, we are hearing about a slowdown in China and Europe. Some of this is related to tariffs, but there are probably other factors at work.
2. Decreased Valuations – While investors seem to be re-evaluating the earnings power of businesses and there is a slowdown overseas, stocks were also trading at high valuations in our estimation. The stock market has enjoyed double-digit returns for several years as the earnings power of corporations increased and the multiple of earnings that investors were willing to pay also increased. Given the uncertainty on earnings growth, investors appear to be no longer willing to pay those high price-to-earnings multiples.
Due to a small decline in earnings power for some industries and companies, and a big decline in stock prices for many businesses, we are seeking to add to positions and invest in new, high-quality enterprises at a discount to our estimate of their intrinsic value. For more than four decades, Fenimore has seen stock market downturns as opportunities to strengthen portfolios and build wealth over the long term.
*FactSet & Bloomberg financial data systems. Data as of 10/23/18.