We want to talk about patience, an important aspect of the behaviour of investors which is critical to their long term returns from equities. Investing in equities is a volatile journey. When you put money into a bank fixed deposit, you are certain about the return you are going to make. It is a different matter that you may not be considering what you are losing to inflation but optically, your return is fixed. In equities, however returns are variable from year to year. You are compensated for the volatility in equity returns by the higher returns they provide over the long term, in comparison with inflation. A wise investor who can stomach the volatility, can make the higher returns over the long term. And when we say “stomach” we mean it, because once in a while, equities go through a stomach-churning decline. Having patience through these periods is a must because a bad decision there can significantly reduce your long-term returns.
Patience is a virtue extolled by many philosophers and thinkers over time. We, as value investors like to buy high quality stocks when they are trading at a discount to their intrinsic value. However, when a high-quality stock is trading at a discount to its intrinsic value, there is usually a reason for it. Either the whole market is down, or there is an issue with the sector the stock is in, or there may be some issue with the specific company in question. In effect there is a lot of bad news out there, when a stock is trading low.
At this point we try to determine whether the problem the company is facing, is a temporary problem or whether there is a permanent damage to the business model, and we will invest in the company only if we are convinced that the problem is temporary in nature. Then comes a long wait a) for the temporary problems to go away and b) for the market to recognise the true intrinsic value of the company. And then there are times, when your patience is really tested. We have had two such experiences in the past few years – first with the IT services sector, starting around 2015 and then again with ITC a few years ago. Both, with IT services and ITC, some clients questioned our judgement as to why we are continuing to hold on to these large underperforming positions. However, we stuck to our conviction about these companies and eventually our patience paid off and delivered the desired result in terms of stock performance.
What we have described so far, is the patience displayed by investors. Patience can also be displayed by our investee companies, when they sacrifice the short-term results to build a stronger organisation and invest for the long term. It applies to one’s own career as well, where delayed gratification can be very rewarding over the long term.
Patience is however, hard work. In the face of a lot of criticism (and there is no better critic than the stock price itself), it is not easy to stand your ground and it takes great fortitude. However, an investor must know when to be stubborn about the decision they have made and when the thesis has failed. In the words of Kenny Rogers, the famous country music artiste, “You got to know when to hold them, know when to fold them”. Practising patience with a poor-quality stock is absolutely the wrong thing to do because you not only lose money, you also lose emotional capital. The business of investing which can be encapsulated in “Buy low, Sell High” looks simple enough, but it is not easy. While navigating these treacherous waters, we are reminded of Warren Buffett’s words “The stock market is a device for transferring money from the impatient to the patient”.