Warren Buffett repeatedly says his favorite holding period is forever. He’s held Berkshire “forever” but most of his other stocks haven’t lasted that long. Still, this is one of Buffett’s mantras, held as gospel, that tends to lead investors astray.
Anytime you deal with stocks, you also deal with the fact that the business might change. Tying a stock to a predetermined holding period is a bad idea. I would like to think most people understand that, but I guess not.
In the recent Berkshire letter, Buffett actually took the time to qualify his “forever” statement:
Sometimes the comments of shareholders or media imply that we will own certain stocks “forever.” It is true that we own some stocks that I have no intention of selling for as far as the eye can see (and we’re talking 20/20 vision). But we have made no commitment that Berkshire will hold any of its marketable securities forever. – 2016 Letter
So what’s the deal? (The shareholder base isn’t what it used to be. I think the statement sets things straight for a broader shareholder base that may not fully understand his thinking.)
Well…over time Buffett’s original “favorite holding period” quote got truncated. So here it is in full:
In fact, when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. – 1988 Letter
Of course, the important pre-qualifier got lopped off.
An outstanding business with similar management is what Buffett wants. And he wants it a fair price.
For the most part, he’s followed that creed when buying companies outright. In the past, he’s found wonderful companies at fair prices that he couldn’t buy in full, so he bought shares instead. But most of his “investments” are entire companies that fall into the “forever” camp.
Buffett’s investing philosophy has gone through, I’d argue, three stages:
- Fair companies at wonderful prices (cigar butts)
- Wonderful companies at fair prices (“forever” buys)
- Good companies with poor management at good prices (more recent “forever” buys)
The cigar butts were mostly during his partnership years where “forever” was never really an option. He’d find a cigar butt, take the last puff, then toss it aside to find the next one.
Buying Berkshire – a cigar butt he forgot to toss, mind you – led to the transition into buying wonderful companies fitting his “forever” requirements. His success in that area led to #3 for a few reasons.
The problem with most wonderful companies is that few stay wonderful forever. The battle with competition, innovation, peak market share, consumer tastes, etc. over time can erode the wonderful out of many businesses. Trying to figure out which ones will fall victim to those limits is even harder. You see this in some of Berkshire’s long-term investment holdings, which both Buffett and Munger have admitted aren’t as great as years past. Put simply, there are only so many wonderful companies – much less at fair prices – to be had.
I think it’s safe to say the downside of his success is the ever increasing cash flow that needs to be reinvested at a high rate of return. It’s a good problem to have. But then there’s Berkshire’s size. He needs companies that can move the needle, which makes things more difficult. So absent wonderful companies, he turned to #3.
He pulled a play out of his old activist playbook. His early experience with Dempster Mills and Harry Bottle taught him that great management can turn a poor, and poorly run, business into a decent one.
The 3G partnership gives him access to great management. They can take over a good business, replace the poor management, and get a better business in return.
Most of this is being done with known consumer brands – Kraft, Heinz, Tim Hortons, Burger King, Popeyes – and so far it’s worked. Cost cutting and improved margins get Buffett the high rate of return he needs. He may never get a “wonderful” business out of it, but it’s close thanks to a great management and a good price.
Of course, this doesn’t mean much unless you own BRK shares. I just found it interesting that he took the time to explain the “forever” time horizon in the letter.
- Full Transcript of Warren Buffett’s Interview with CNBC – CNBC
- Buffett and Gates: America Is Already Great – Atlantic
- Most Funds Are Priced to Fail – Morningstar
- Surviving the Continuous Chain of Disappointments – M. Housel
- Stocks Aren’t Overvalued – Bloomberg
- To Buy or Not To Buy (pdf) – M. Mauboussin
- Why We Pretend to Know Things – Vox
- In Praise of Cash – Aeon
- Why It Took the Washing Machine So Long to Catch On – Bloomberg
- The Man Who Broke Ticketmaster – Vice