Circle The Wagons
Mohnish Pabrai gives us more clarity on selling...
After last week's article, I was still struggling with the tension between holding forever and taking profits. Warren Buffett has said many times that his favorite holding period is "forever." But that can't be true all the time. If you never sell, you never make money. And if Buffett is wrong, he doesn't hesitate to sell - look at the airlines he bought and then sold in 2020. Mohnish Pabrai came to the rescue again with a great concept. He talks about circling the wagons here.
The American pioneers who traveled west by wagon trains were incredible. The challenges they faced venturing into unknown lands are unimaginable today. Survival required resourcefulness and resilience. One of the strategies they used was “circling the wagons”. This formed a protective circle around the campsite and their livestock. It also provided a sense of community and security for those on the wagon train. Today the phrase means to come together to defend something. When I heard Mohnish talk about it I pictured an actual circle of Conestoga wagons.
What’s In Your Circle?
This is both a useful concept and a useful visual. If you imagine yourself as a pioneer, you have limited space and limited resources. That's the same situation most investors find themselves in. You can't buy every hot stock and you can't watch every company. You have to be careful about who or what you allow into your circle. Investors do this by being very disciplined in what they buy.
Mohnish talks briefly about concentric circles. I picture myself as a pioneer deciding where to place things for the night. The most valuable assets go into the center of the circle. Less valuable things move towards the outside. This applies to your holdings as well. At first you believe you've bought a valuable asset, but you don't know for sure. As your holdings prove themselves, they become more valuable. More worth protecting. So they move further towards the center of the circle. The things in the center of the circle become your forever holdings. Coca-Cola and American Express are in the center of Buffett's circle.
Your Circle Keeps Good Stuff In
Now let's consider why you would circle your wagons. First, it's to keep your livestock in. As a pioneer, they are a valuable resource. They do work - pulling your wagons and carrying your stuff. They provide food - meat, milk, eggs if you brought chickens. You can't afford to allow them to wander off. As an investor, you can't affort to let your holdings drift away from you. Last week's article talked about holding Amazon from IPO to today. It would be difficult, but the value of holding on is clear.
In this talk, Mohnish talks about the nifty 50. They were the 50 large cap stocks believed to be the best businesses in America through the 60s and 70s. People thought they were such good businesses that no price was too high. Today, most of these companies are either out of business or worth much less than they were in their heyday. The list included companies like Avon, Kodak, IBM, JC Penney, Sears, and Polaroid. Mohnish says that it's debated if Walmart was a nifty 50 stock or not. It IPO'd in 1970, so if it was included, it was a late addition. If you bought the nifty 50, including Walmart, you could have lost everything on the other 49 stocks and still ended up rich. $1,000 in Walmart at IPO is worth over $17 million today. Holding the most valuable assets is clearly important.
And Bad Stuff Out
Second, you're circling the wagons to protect from outside attacks. Thieves and animals want what you have. There is the constant threat of attack. Capitalism puts the companies you own under the same constant threat of attack. Your companies will take hits. Market values will dip. Competitors will come up. A mental circle of protection will help you fight temptations to sell due to market fluctuations.
No matter how careful you are when you buy, creative destruction will get to some of your businesses. Imagine yourself as a pioneer. You're unlikely to get to your destination with everything you started out with. There's going to be some tough decisions. A horse will get injured, and you'll have to decide if it's worth slowing down for the horse, or if it needs left behind. The attacks of the market will breach the moats of some of your companies. Trends may shift and put a business into secular decline. In these cases, you're going to have to sell these businesses. Irrepealably damaged businesses have no place in your circle.
Back to the Nifty fifty - these were believed to be such strong businesses that they were worth any price. In 1965, it was impossible to imagine the Eastman Kodak company as anything but dominant. It was also impossible to imagine the invention of the digital camera. Kodak failed to adapt and filed for bankruptcy in 2012. Capitalism is full of these stories. Netflix tried to sell themselves to Blockbuster. Blockbuster said no, and went out of business in 2013. The decline of their business was primarily due to Netflix taking their customers. This is the un-buying process talked about in last week's article.
Sell When You Can’t Justify Holding
I was still struggling with selling when things went up too much. Circling the wagons protects your holdings from attack, and helps you hold them for the long term. But what do you do when prices get too high? Mohnish gives us a simple heuristic: sell when it's a no-brainer. If you can't justify the valuation, no matter how rosy the glasses you're wearing are, then you can sell. If you're not sure, it's not yet time to sell.
The idea of circling the wagons made things click for me. You have limited resources, be careful what you spend them on. Protect the valuable assets you have. You're going into unknown territory; bad things are going to happen. When things become so damaged that they're not worth holding on to, be willing to leave them behind. Take advantage of crazy prices. If someone offers you way more than something could ever be worth, take the cash. Cash gives you options to buy more assets and gets you further down the trail.