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The Art of (Not) Selling

A recent post from Akre Capital Management, "The Art of (Not) Selling", has been making the rounds on financial Twitter. I'm a big fan of Akre - they are damn good investors - and think there are some interesting points made in the article. Notably, I think they make some proclamations that even investors who aspire to be like them (myself included) scoff at on first glance. I wanted to discuss a few of those points here.

First, it's important to understand the kind of investors you're dealing with at Akre. As noted in the post, they are focused on making long-term, concentrated bets in competitively advantaged businesses that they believe are capable of delivering outsized growth for years and decades to come. They enter new positions with the intention of being shareholders for a long, long time.

So, with that established, here's the first big point made:

"Holding on means resisting the temptations to sell - and there are many. We tune out politics and macroeconomics. To the surprise of many, neither valuation nor price targets play a role in our sell decisions."

Valuation and price targets do not dictate their sell decisions. If the firm buys something at $100 and it goes to $150 over the next year, that apparently doesn't factor into whether or not it will continue to hold the stock. They don't sit there and go, "Well, my expected annual rate of return over the next 10 years has fallen by a few hundred basis points, maybe we should sell." Which certainly sounds blasphemous - isn't that the whole idea behind value investing?

I think there are two ways to interpret that statement: either they believe valuation is irrelevant as part of their investment process, or they believe that the kind of businesses they own are almost always underappreciated by other market participants (which is a roundabout way of saying that valuation, as used by most market participants, is not how they think about it at Akre). I bet that if you asked them, they would tell you their thinking is closer to the latter than the former.

Here's the other notable comment from the post:

"In addition, we try to resist the temptation to sell (or trim, even) on the basis of valuation alone. We are unfazed when our businesses are quoted in the market at prices above what we would pay for them. It might be worth reading that last sentence again for emphasis."

This takes the "hold no matter what" philosophy a step further. My explanation for the first comment was to say that Akre's managers believe - based on their actions - that the businesses they own rarely trade at a premium to their intrinsic value estimate (as crazy as this may sound, they may not even think about the world in terms of intrinsic value estimates). But here, they are directly saying that they are willing to own businesses at prices that they wouldn't buy them at.

For what it's worth, Charlie Munger (Trades, Portfolio) thinks similarly to Akre:

"Psychologically, I don't mind holding a company I like and admire and I trust and know that it will be stronger than now after many years. And if the valuation gets a little silly, I just ignore it. So, I own assets that I would never buy at their current prices but I am quite comfortable holding them... Many investors I know are like me. I cannot defend it in terms of logic. I don't defend this logic. I just say this is the way I do it and it keeps me more comfortable to do it this way. And I am entitled to this, it's my own money and I am entitled to do it my own way."

This is tougher one for me. I view the decision to continue owning a stock within your portfolio as indistinguishable from making an open market purchase today (I know it's not that simple due to tax considerations, but those are not discussed at all in the Akre post). In my mind, you are effectively paying "x" if you continue to own something at "x." I'll use Microsoft (NASDAQ:MSFT) as an example. I've owned it for a long time and continue to hold a large position. But, in all honestly, if I didn't own the stock and was looking at it for the first time today, I would not love the idea of making it a new position at $160 per share.

Here's the conundrum: If I plan on owning Microsoft for the long-term, as I do, is there really any difference between continuing to own it in size at current levels and making it a brand new position at the open tomorrow? To me, the answer is quite clearly no (again, this overlooks the capital gains component of the decision, but Akre doesn't discuss taxes at all in their post).

Continuing that train of thought, if you do not focus on valuation as part of your sell decision, I think you are effectively saying that you do not obssess about valuation when holding - or what I view as indistinguishable from "buying" each day you continue own a stock - either.

Now, you would be correct to retort: "Aren't you knocking them for something that you just admitted to doing yourself with Microsoft?" The answer is yes. Which I guess means that I think there's some validity to the way the firm has chosen to play the game. Simply put, when you own a great business, it doesn't strike me as intelligent to automatically sell it just because the stock appears expensive. (My friend Bill Brewster would note that this is the kind of stuff you only hear late cycle, which is a fair point.) So, like Akre, you can argue that I'm either willing to own stuff that's expensive or that I think market participants - myself included - underappreciate how valuable a truly great business is.

To reiterate, I'm a big fan of Akre. Its results speak for themselves.

I doubt the team is completely unconcerned with valuation when looking at an investment. Instead, my sense is that they believe the kind of businesses they invest in - companies like Moody's (NYSE:MCO), Visa (NYSE:V) and American Tower (NYSE:AMT) - are almost always underappreciated by the market if you're willing to think of them as investments that you will hold for 10, 20 or 30 years. A truly great business with a long runway for growth doesn't deserve a slightly higher price-earnings multiple. It deserves something much, much higher than the average business.

And they only think about parting ways with one of these truly great businesses when they begin to question its greatness. They must believe that a merely good business is worth something significantly less than a great business. That's a big idea that I think many investors - myself included - believe. But we struggle to properly incorporate it into our process. We're too focused on whether the price-earnings ratio is 20, 25 or 30. We let concerns about the price of the asset get ahead of our focus on business quality (again, late cycle talk, I know). We compromise on the latter - and end up looking for decent businesses at "great" prices - when we probably should be more willing to compromise on the former.

And that is where I think we can learn something from Akre.

Now obviously, this has some limit. The point is that this limit seems to be different for market participants that live in a world of relative price-earnings ratios than it is for Akre. The firm is first and foremost focused on business quality, while the rest of us are much more balanced in our approach (concerned with the price that we're being asked to pay for an interest in that great business).

I'll end with a quote from Munger:

"Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return - even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result."

As always, I look forward to your thoughts.

Disclosure: Long Microsoft and Moody's.

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