Built to Last

Published On: June 8, 2022

Written by: Ben Atwater and Matt Malick

The bubble has burst.

Like all bubbles that burst, the baby gets thrown out with the bathwater. It has been a tough year so far, even for high quality investments.

In late February, we wrote to you our thoughts on investing and speculating. With markets even worse off in June, we want to reaffirm our message by addressing price and value.

An asset does not require value to have a price, even a high price. Hence, bubbles can not only exist, but persist.

The poster children for the later stages of the bull market were cryptocurrencies, meme stocks and “innovation” stocks. These bubble-like assets fell on tough times last year and have continued unwinding in 2022.

The S&P Cryptocurrency Broad Digital Market Index is down 49% year-to-date. The MEME ETF is down 50% year-to-date. Kathy Wood’s Ark Innovation ETF is down 54% year-to-date. If this is indeed the bursting of a real bubble, then we could see even deeper losses in these categories.

In our opinion, the above asset classes represent areas of the market with high prices and little value. If an asset depends on price momentum to grow, then the asset can count on price momentum to collapse as well.

Without fundamentals to anchor an underlying value, all you have is a completely arbitrary price. Prices are fleeting, value is longer lasting.

In contrast to much of the excitement over the last few years, we maintained our insistence on strong fundamentals in our asset selection process. Our investments represent strong operating businesses.

Ultimately, the lower share prices we are seeing in quality investments will attract capital. Whereas in speculative investments, instead of creating the interest of bargain hunters, falling prices can create panic and then capital flight, a snowball effect.

As assets reprice, we believe the ones we own are not disposable. Of course, even solid investments are going to experience the dramatic knock-on effects of higher interest rates and a tighter money supply, but rest assured, we see strength and survivorship in our holdings.

In selecting investments, we look for strong free cash flows relative to the market. We want our companies to generate cash to share with us in the form of dividends and share buybacks, with enough cash left over to reinvest in the business.

We seek to own established companies with a long history of successful execution. Of course, there are emerging companies that will redefine the future and be huge moneymakers but identifying the ultimate survivors and then not paying obscene prices is an exercise in luck. We prefer having history on our side because the future is unknowable.

We do not assume an investment will go to the moon. Rather, we try to estimate the prospects for long-term returns using current dividends, dividend growth, earnings growth and multiple (e.g., price-to-earning, etc.) expansion or contraction.

We buy businesses with the idea that we can hold the investments for years. We do not buy because we think one day someone will arbitrarily pay us more for the investment than we paid. Instead, we buy businesses built to last and then count on long-term per share earnings growth to deliver robust returns.

With prices falling fast, it can be hard to distinguish the worthwhile from the worthless, but it is a vital distinction, nonetheless. Assets with value have a margin of safety that simply does not exist in assets that only have prices and nothing to justify those prices.