Short-Termism – Investors’ Returns

By Drew P. Wilson, CFA

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.

Please see Fenimore disclosure.

Short-Termism – Hurts the Economy

By Drew P. Wilson, CFA
Investment Research Analyst

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…”[1]

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.[2]

Next time, I’ll discuss how short-termism can hamstring many investors’ returns.

[1] Source: The Wall Street Journal’s Opinion, By Jamie Dimon and Warren E. Buffett, June 6, 2018

[2] Source: McKinsey Global Institute, “Measuring the Economic Impact of Short-Termism,” February 2017

Please see Fenimore disclosure.

Short-Termism – Impacts Everyone

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

Please see Fenimore disclosure.

FAM Funds’ Annual Shareholder Informational Meeting Webcast

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

 

Please see Fenimore disclosure.

What’s Happening in the Stock Market?

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.

Please see Fenimore disclosure.

A View from Research: Tariffs and Trade

Tariffs and Trade – Raised tariffs are leading to increased tensions with some of our largest trading partners while creating uncertainty and volatility in equity markets. Nobody knows what will ultimately come from these maneuvers or the eventual impact on business values. At the same time, management teams of the companies we hold are implementing plans to help lessen the negative impacts under various possible scenarios.*

* FactSet & Bloomberg financial data systems. Data as of 8/31/18.

Please see Fenimore disclosure.

A View from Research: Interest Rates

Interest Rates – While interest rates have risen, they remain low. We believe that our long-held aversion to enterprises with a lot of debt, as well as our more recent strategic avoidance of corporations that suffer with higher interest rates, has our portfolios well-positioned should rates continue to rise.*

* FactSet & Bloomberg financial data systems. Data as of 8/31/18.

Please see Fenimore disclosure.