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The Science of Hitting
The Science of Hitting
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Long-Term Investing and 'Unprecedented' Worries

Some thoughts on how traders and investors navigate choppy waters

July 26, 2018 | About:

In early 2018, Gene Munster of Loop Ventures appeared on CNBC to discuss Facebook’s (NASDAQ:FB) fourth-quarter results for fiscal 2017. When asked if it was “all clear” for Facebook, he said:

“For an investor over the next few quarters, you should feel really good – that there are some opportunities, that their core business is doing fine, and that they have big opportunities around Messenger and WhatsApp and Oculus that they haven’t even started to make money from.”

Three months later, Munster was on CNBC again to discuss Facebook’s results for the first quarter of fiscal 2018. It was a short segment, but he called the results “impressive.” In a research note on the Loop Ventures website, Munster noted that the strong daily active users number for the quarter suggested that “the Facebook brand is bulletproof.”

When the social media giant reported second-quarter results on Wednesday, Munster was decidedly less impressed than he had been in the recent past. Just to be clear, I think that change in sentiment is completely fair (as Munster noted, this truly was “an unprecedented guide down”). But here’s what he said when asked what viewers should do with their Facebook shares:

“I think you need to let it settle out here. There’s a good chance that they do in fact end up beating some of these lower numbers, but we shouldn’t be having that conversation over the next couple of months. I think you just stay on the sidelines and let the investor base process this and revisit where things are at in two months.”

When pressed on that point, Munster said:

“You may miss a bounce here, there’s that risk, but I think the prudent approach here is to let this flush through all the analyst models and let people kind of rebase [expectations]… I think you just largely stay away from it for the next quarter.”

It’s worth putting some numbers on this timeline. When Munster appeared on CNBC in January, Facebook was trading around $190 per share. During his remarks yesterday afternoon, the stock was fluctuating between $165 and $170 per share. Call it an approximately 10% decline on the recommendation from January, where it sounded fairly clear that he thought this stock was worth owning. I’m taking his recent comments as a recommendation to sell the stock (“stay away from it for the next quarter”).

If you’re a trader, I guess this advice could be helpful. Whether the stock will be stuck in tight range for a few weeks or a few months is important to you. On the other hand, if you’re a long-term investor that does not assume short-term market movements are predictable (as I do), this way of thinking is antithetical to your approach. Said differently, it’s a bunch of noise that doesn’t help you toward your objective: finding businesses that trade at a meaningful discount to intrinsic value.

That’s not to say Munster and the other analysts that follow Facebook are not smart people. It’s probably a safe bet they know more about the company than we do. But I’d argue that this isn’t much of an advantage in their favor becausethey are playing a completely different game.

Whether we’re talking about 12-month price targets, buy, sell and hold recommendations or quarterly earnings per share estimates, their job description requires them to live in the short term. Does that mean they completely disregard long-term considerations like competitive advantage? Of course not. But what I’ve found over time is most people overestimate their ability to straddle that line. Inevitably, they end up becoming more focused on revenues and earnings per share relative to consensus estimates next quarter or year, as opposed to focusing on if the strategic decision-making of the management team makes sense for the long-term health of the business.

Part of what makes this game difficult is that both periods do matter. When Facebook comes out and says operating margins will trend toward the mid-30’s over the “next several years,” that’s a big deal. To put it in context, that implies roughly 1,500 basis points of margin contraction from where they were at in 2017. Whether you’re looking at earnings per share for fiscal 2019 or the intrinsic value of the business, what you assume for run-rate earnings before interest and taxes margins has a huge impact on the output.

But here’s my point: Long-term investing is already hard enough. Adding another layer of complexity by trying to decipher and trade around the short-term noise of quarterly results (which is how I would describe what Munster recommends) is unlikely to improve your results over the long run – especially after accounting for the trading costs and tax implications associated with jumping in and out of a stock over time. It blurs your focus from what’s truly important.

Long-term investors will still be forced to deal with the occasional disaster (like we just saw with Facebook). If you own even the best businesses for long enough, these periods are all but inevitable. But if you can stay focused on what matters to the intrinsic value of the business as opposed to what it means for earnings per share estimates in the coming quarter, I think you will be able to more effectively navigate periods of “unprecedented” change than other market participants.

Disclosure: None.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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