“We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.” –Warren Buffett, 1994 letter to Berkshire shareholders
To say that talk of the election dominated the news over the last 6 months would be an understatement. Despite all the noise and vitriol, from our perspective the election was mostly a non-event. We are business owners focused on the long-term ability of our companies to thrive, not on the price Mr. Market may be willing to pay us for our businesses on any given day, and we were thus well positioned regardless of the election outcome.
A key part of our investment process revolves around understanding what will happen to our businesses when something unexpected happens with the world, because eventually it will. By way of example, would women be any more or less likely to buy makeup and thus affect our investment in Revlon (REV) as a result of who is in the White House? Will cities and towns cease to need to update their traffic management systems and thus affect our investment in Iteris (ITI) because of who is elected President? As such, we were no more or less likely to sell our businesses in the face of the election than the entrepreneur who owns a business on Main Street USA. It is always the case that multiples can contract in the near term, but if the intrinsic value of the business at hand continues to grow, in the long term our investment performance will be acceptable.
If this attitude seems blasé, consider that the election served as an excellent reminder that talking heads and “experts” have no ability to predict the future, despite their assertions to the contrary. Moreover, it is interesting to note that in this instance knowing the future (a Trump victory) would have been a negative as the same “experts” who are now screaming “buy on Trump’s lower taxes and infrastructure spending!” were informing the masses that a Trump victory would lead to a 10-15% decline in the S&P500 just a few short weeks ago.
As always, we seek to own a collection of businesses that will appreciate over time through whatever bumps in the road may come. We thus sought to ignore the noise and invest without regard to emotion, except to feel slightly positive given the pervasive sense of negativity. In fact, before the election, a report from B of A / Merrill Lynch indicated that institutional portfolios were holding record levels of cash, consistent with a recession. As a reminder, for long term investors a recession is the time to follow Warren Buffett’s advice and “be greedy when others are fearful.” This backdrop combined with a review of our individual businesses allowed us to remain essentially fully invested in the second half of the year, which is likely to be somewhat of a rarity if the stock prices of our companies continue to appreciate.
While we did not seek to reposition our portfolio before or after the election, our portfolio did lag the small cap indexes from the election through year end with our portfolio appreciating by 7% over this period, while the R2000 appreciated 14.1%. The S&P500 returned 5.4% during this period. The broader rally – especially in small caps – is largely based on the belief that Trump’s plan to lower taxes will increase earnings. For those companies where normalized earnings power is readily visible, the market seems to have easily extrapolated the effect of lower taxes (higher earnings). For our portfolio, which is made up of companies whose normalized earnings power is for the most part presently obscured, the market cannot yet extrapolate the effect that lower taxes will have. This leaves us in the enviable position that if Trump is able to fulfill his promise of lower taxes (far from a certainty in my mind) we should still benefit as our companies meet our operational expectations, but if Trump is unable to achieve his tax cut goals, in theory our companies won’t be punished. In any case, a few scant weeks is far too short of a period to concern ourselves with, and our portfolio is built on the backs of companies that I believe will prosper over time regardless of who is in the oval office.
The above post has been excerpted from a recent letter of Laughing Water Capital.
Disclaimer: This document, which is being provided on a confidential basis, shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified offeree receives a confidential private offering memorandum (“CPOM”) / confidential explanatory memorandum (“CEM”), which contains important information (including investment objective, policies, risk factors, fees, tax implications and relevant qualifications), and only in those jurisdictions where permitted by law. In the case of any inconsistency between the descriptions or terms in this document and the CPOM/CEM, the CPOM/CEM shall control. These securities shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. This document is not intended for public use or distribution. While all the information prepared in this document is believed to be accurate, Laughing Water Capital, LP and LW Capital Management, LLC make no express warranty as to the completeness or accuracy, nor can they accept responsibility for errors appearing in the document. An investment in the fund/partnership is speculative and involves a high degree of risk. Opportunities for withdrawal/redemption and transferability of interests are restricted, so investors may not have access to capital when it is needed. There is no secondary market for the interests and none is expected to develop. The portfolio is under the sole trading authority of the general partner/investment manager. A portion of the trades executed may take place on non-U.S. exchanges. Leverage may be employed in the portfolio, which can make investment performance volatile. The portfolio is concentrated, which leads to increased volatility. An investor should not make an investment, unless it is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. There is no guarantee that the investment objective will be achieved. Moreover, the past performance of the investment team should not be construed as an indicator of future performance. Any projections, market outlooks or estimates in this document are forward-looking statements and are based upon certain assumptions. Other events which were not taken into account may occur and may significantly affect the returns or performance of the fund/partnership. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. The enclosed material is confidential and not to be reproduced or redistributed in whole or in part without the prior written consent of LW Capital Management, LLC. The information in this material is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Laughing Water Capital LP, which are subject to change and which Laughing Water Capital LP does not undertake to update. Due to, among other things, the volatile nature of the markets, an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. The fund/partnership is not registered under the investment company act of 1940, as amended, in reliance on an exemption there under. Interests in the fund/partnership have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws. The S&P 500 and Russell 2000 are indices of US equities. They are included for informational purposes only and may not be representative of the type of investments made by the fund.