Dear fellow investors,
The phrase “majoring in the minor” refers to focusing excessively on trivial details while neglecting more important aspects of a situation. This analytical flaw is especially prevalent in today’s investment environment. Quarterly earnings often overshadow the durability of a business’s long-term competitive advantage, with growth being prioritized over profitability and the scarcity of assets. This shift towards short-term investing has been gradual, but it is more pronounced when we consider the reduction in the average stock holding period by mutual funds, which has dropped from seven years in 1960 to less than a year today.1
In today’s markets, investor patience is in short supply. When something becomes scarce—whether it’s a commodity or a trait—its value typically increases. As we will discuss, our process and philosophy are relatively straightforward. It is the consistent implementation and adherence to our discipline, along with the ability to be patient, that provide our differentiation.
As we anticipate more turbulent markets over the next decade, we believe it’s useful to revisit what we at Smead Capital Management consider important and provide further insight into our approach—specifically, how we use our process to remain steadfast when others flinch.
Since our founding over fifteen years ago, we have remained committed to our investment philosophy and process. Our focus is on bottom-up analysis, with a five- to ten-year holding period in a concentrated portfolio of 20 to 30 names. We believe that if we’ve done our work properly, we can find great companies trading at discounted prices that can compound returns over time. These opportunities are typically infrequent; in a typical year, we might get three new ideas. When we find them, we invest meaningfully and allow the statistical probabilities and the miracle of compounding to work their magic.
Our process is not earth-shattering. We are aware of a great number of companies, and for those that appear promising, we apply our eight criteria. If they pass the first test, we drill down to understand the company’s competitive advantage and durability over time. We then attempt to come up with a present value of future success, including a high margin of safety.
Here is the hard part. First, our bottom-up approach often leads us to companies and sectors that are unloved or disliked at the time (as we wrote in “Lonely Contrarian Divergence”). This means we must thoroughly understand the business to confidently handle the inevitable pushback we will receive. Many times, the reasons for the discounted valuations are valid, so to feel comfortable being “wrong” for a period of time, we need to have strong conviction in our research. In many cases, our willingness to trust the rhymes of history is a key component of the risks we take. Hence, there is a high tracking error compared to peers.
Second, holding an investment for an extended period is more difficult than most realize. Think of all the internal and external changes that can impact a company each quarter or year. If your process does not emphasize the bigger picture and a longer-term time horizon, the momentary crises may seem insurmountable when not viewed through a wider lens.
Our holding of Target (TGT) is a great example of this. If we allowed ourselves to think short-term, Target’s alienation of their core customer last year would be a reasonable excuse to exit the position. However, when you understand their moat and look past their missteps, you will see that the value of the Target brand is still very much intact, and the moms who shop at Target do not view Walmart or Aldi as a replacement for their shopping needs. We want to own a company that can survive being run poorly because, as Buffett said, “I try to invest in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.” As long as management identified the error and made the necessary changes, the company would be fine.
Almost all long-only equity funds claim to invest for the “long term,” and while some stay true to that commitment, a closer look at their turnover rates often tells a different story about what “long term” really means to them. Our turnover, on the other hand, is in the lowest quartile among our peers, demonstrating that we practice what we preach.
A good example of our approach is our holding in Home Depot (HD). We initiated our position in 2008, at a time when the market doubted that housing would recover from the Global Financial Crisis. As a result, Home Depot—a strong brand that had produced around 20% return on equity (ROE) from 1990 to 2009 and continued to hold significant market share—was priced as though it were systemically impaired. If we had tied ourselves to a specific price target or internal rate of return, we might have been content to sell after five or even nine years, achieving solid returns. However, because we avoid anchoring our investments to price targets and instead review each company regularly, we’ve allowed Home Depot to continue compounding as long as the original thesis and the return profile remain intact.
Home Depot share price 2008 to 2024
Source: Bloomberg.
Another example is U-Haul (UHAL), a company we added in the first half of 2020, which we continue to believe is undervalued and has the potential to compound returns well into the future. The Shoen family, who founded U-Haul, holds majority ownership and manages the business with a long-term focus. They often make decisions that may be unpopular with investors in the short term but position the company favorably for long-term success. While not one of our formal eight criteria, we appreciate that the stock has almost no sell-side coverage. Lack of sell-side interest is a positive byproduct of a management team that does little in the way of banking and places more of an emphasis on doing what is right versus what is popular.
U-Haul holds over 50% market share, with locations within five miles of 90% of the U.S. population. The company has compounded book value at 18% annually since 2013, and we believe it will continue to improve its ROE as it grows its storage assets within Amerco. Replicating an asset like U-Haul is extremely difficult, and the company consistently invests in widening its moat.
Last but certainly not least, it’s important to emphasize—and this is something we discuss internally often—just how critical our investors are to the success of this investment philosophy. It’s not easy to stay invested when market corrections occur. However, as an employee-owned firm with the majority of our net worth invested alongside yours, we hope you find some reassurance knowing that we are right there with you. Your trust and confidence in our disciplined approach and adherence to the philosophy we’ve developed are what make our success possible.
Fear stock market failure,
Seamus Sullivan
1 Source: A Wealth of Common Sense
The information contained in this missive represents Smead Capital Management’s opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Seamus Sullivan, Senior Analyst, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
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