I recently had lunch with Preston Athey, who used to manage the T. Rowe Price Small-Cap Value Fund. In his 20+ years at the helm, his fund earned 12% annualized, easily beating all the benchmarks. He stepped down in 2014 and is now retired. I count him among the best investors I know.
I told him I had started a fund. At lunch, his first question was:
“What’s your ideal turnover?”
“Well… ideal?” I said. “Ideally, it’d be zero.”
“That’s the right answer,” he said.
I first met Athey in 2012 after he gave a talk at a Baltimore CFA event. His talk was full of timeless wisdom. I published an essay about his main ideas in my newsletter at the time. (You’ll find it as an Appendix at the bottom of this post.)
One of the things he talked about was buying stocks for keeps. When he ran his fund, his turnover was around 10%. That implies a holding period of ten years.
Not too many people can hold on to stocks like that. Then again, there aren’t many investors of Athey’s caliber either. At our first meeting, we talked about the idea of the coffee can portfolio. We’re both fans of the idea, which is a kind of crutch to help you hold on to your stocks longer.
What’s a Coffee Can Portfolio?
The idea began with Robert Kirby, then a portfolio manager at Capital Group. He first wrote about the coffee can idea in The Journal of Portfolio Management (Fall, 1984). You can find the original paper here:
It’s still a good read and I recommend it. Here’s Kirby:
“The coffee can portfolio concept harkens back to the Old West, when people put their valuable possessions in a coffee can and kept it under the mattress. The success of the program depended entirely on the wisdom and foresight used to select the objects to be placed in the coffee can to begin with.”
The idea is simple enough: You put a together a portfolio of your favorite stocks for the long haul. Then you let them sit for 10 years. You incur practically no costs with such a portfolio. And it is certainly easy to manage. The biggest benefit, though, is that it keeps your worst instincts from hurting you.
In his paper, Kirby told a funny story about how his idea came about:
“The potential impact of this process was brought home to me dramatically as the result of an experience with one woman client. Her husband, a lawyer, handled her financial affairs and was our primary contact. I had worked with the client for about ten years, when her husband suddenly died. She inherited his estate and called us to say that she would be adding his securities to the portfolio under our management.
"When we received the list of assets, I was amused to find that he had secretly been piggybacking our recommendations for his wife‘s portfolio. Then, when I looked at the total value of the estate, I was also shocked.
"The husband had applied a small twist of his own to our advice: He paid no attention whatsoever to the sale recommendations. He simply put about $5,000 in every purchase recommendation. Then he would toss the certificate in his safe-deposit box and forget it.
"Needless to say, he had an odd-looking portfolio. He owned a number of small holdings with values of less than $2,000. He had several large holdings with values in excess of $100,000. There was one jumbo holding worth over $800,000 that exceeded the total value of his wife’s portfolio…”
Holding on to a stock for ten years is hard. So much can change. The rides up and down can be gut wrenching.
But to nab really big returns, you need time. And to get that time, you need to suffer some big drops along the way.
100-Baggers: Roller Coaster Rides + Boredom
In researching and writing my book 100-Baggers, I learned all kinds of fascinating things about stocks that turned every $1 invested into $100. I included several case studies in the book. And one of them was Monster Beverage.
Monster was a 100-bagger inside a decade. Of the 365 stocks in my study, only 20 did it inside of ten years. More typical is the 20-25 year range. During that ten-year run you had to suffer some big drawdowns. Multiple times the stock lost more than 20% of its value in just one quarter, including a 31% decline in a single quarter in 2006.
Yet, it returned 100x in a decade – and kept going. I think ultimately investors were up more than 700x at the peak.
Sometimes it’s not the drawdowns that get you. It’s the boredom. Some random examples: Bank of NY Mellon went sideways from 1976 to 1981, amidst a 100x run. Texas Industries: sideways from 80 to 85 in its 100x run. AMEX: flat from 85 to 92 amidst its 100x run. Berkshire at its peak in 1998 was no higher seven years later. And on and on…
Five to seven years of holding a stock that goes nowhere can be… excruciating. Just think of all the other stocks you see during that time that are moving while you’re holding one that goes nowhere. Tough.
Athey had at least a couple of 100-Baggers. (He promised to tell me these stories next time we meet). But I’m guessing one of them was T. Rowe Price (TROW). It took decades. Athey sent me a note after our lunch:
“As far as a 100 bagger, TROW did its IPO in April, 1986 at $24. Five 2 for 1 splits later, the split adjusted price is 75 cents. Today the stock is $91, but the high earlier this year was $127. Oh yes, you could have bought all the stock you wanted between 60 cents and a buck in the two years after the IPO, thanks to the crash of 1987, so no need to get in on the IPO to make that 100 times. It's a beautiful thing!”
It is.
Back to the Coffee Can
In that October 2012 piece I wrote after Athey’s talk, I mentioned 5 stocks for readers to put in their coffee can. We’re little more than 6 years in. If we pull that coffee can out from under the mattress and take a peek inside, what would we find?
Well, here are those 5 stocks and the annualized total return since:
First Citizens Bancshares, 18%
Brookfield Asset Management, 16%
Howard Hughes Corp, 13%
Beneficial Bancorp, 10%
Kennedy Wilson, 6%
An equal-weighted portfolio of these names would’ve produced an average total return of 12.6%. That easily tops the S&P500’s return of 10% since that time. And you didn’t even have to do anything. No worrying about the Fed, or China, or recessions or whatever…
As Athey would say, “it’s a beautiful thing!”
Coffee Can Stocks for Today?
What about starting a fresh coffee can today?
I’d still put Howard Hughes in it. Under $100 seems a very good price. But what new things would I add?
One might be Fairfax Financial Holdings. Prem Watsa’s firm goes for just under book value as I write. Seems a no-brainer, given the long-track record of success. Today, Fairfax has a collection of businesses that seem good enough to deliver market-beating returns for years.
Another candidate would be Interactive Brokers. The downside is that Thomas Peterffy, the CEO and large shareholder, is 74. But the business he created is so good and still has so much room to grow. Hard to imagine Interactive Brokers isn’t worth a whole lot more money in ten years.
St. Joe is another candidate. It owns vast real estate holdings in Northwest Florida. In ten years time, it will have worked through a good chunk of its development pipeline. And it will likely have retired a lot of stock via buybacks. St. Joe got hit hard of late and trades for around $13 per share. It could be a multi-bagger in ten years.
Anyway, that’s four. All of these stocks are well financed and self-funding. And the people in command have a lot of skin in game. Usually a winning combination in my experience.
What stocks would you put in your coffee can? It’s a great exercise to think about in any case. And perhaps, given all the recent volatility in the market, a good aid to getting through the rough patches.
Here’s to wishing you many happy returns for 2019 and beyond!
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Published: January 3, 2019
Please see our disclaimers.
Write me at: info [at] woodlockhousefamilycapital.com
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Appendix – Notes on Athey’s Speech: Three “Secrets” to His Success
The Baltimore CFA Society hosted a lunch at the Center Club in Baltimore in 2012. Athey was the speaker. He gave his talk a modest title: “Some Thoughts on Investing.”
My three key takeaways from Athey’s talk are below. It is a slightly edited version of what I published in my newsletter in October 2012. The message is timeless.
No. 1 — The Power of Share Buybacks
Athey asked this question: “What happens to stocks if companies actually reduce their share counts?”
An in-house study at T. Rowe Price took a look at the 3,200 largest U.S. stocks from January 1985 – September 2012. The study measured the change in shares outstanding over a 12-month period. Then it looked at the price change in subsequent 12-month periods.
The results? The 10% of companies that had the greatest decrease in shares outstanding enjoyed the best stock price performance, about a 15% return. The 10% of companies with the largest increase in shares outstanding on average showed the worst stock price performance, about a 2% return.
The difference in performance continued to expand in the second year. It also occurred in both up and down markets, and you could see the effect in 90% of the observed periods.
An immediate conclusion: Reducing your shares outstanding is good for shareholders. But there are more layers to consider.
In the study, only about 56% of firms in the lowest decile (meaning, their share counts decreased the most) outperformed the median firm in the study universe. Put another way, 44% lagged.
“You might think,” Athey continued, “why doesn’t it work that 44% of the time? Well, it depends on what the companies pay for their shares.”
How to measure this? Athey chose free cash flow yield. If a $10 stock earned $1 per share in free cash flow — then the free cash flow yield was 10%. (That is, $1 in free cash flow over the $10 stock price. Remember, free cash flow is cash after all expenses and capital spending. It is, essentially, the cash left over that a business can use to pay dividends, buy stock, retire debt or pile in a bank account.)
“If you combine share repurchase with a high free flow yield, the results are even better,” Athey said. To put it another way, companies with high free cash flow yields that bought back their stock did even better than their buyback peers with low free cash flow yields.
Athey offered up a real example of a bad buyback done at low free cash flow yields: Carly Fiorina in 2000, as the CEO of Hewlett-Packard, bought back $800 million of HP stock at 33 times earnings. “Those of you who know your math,” Athey said, “know that if you buy back something at 33 times earnings, you’re getting a 3% return on your capital.” HP’s stock subsequently fell by some 75%. The buyback was a terrible waste.
In conclusion, Athey summed up his comprehensive in-house study: “Absent other factors, stock buybacks are demonstrably good for shareholders.”
Look for companies who reduce their shares outstanding over the years at favorable prices.
No. 2 — The Power of Low Turnover
“One of my favorites,” Athey began.
“We live in a hedge fund world, where many emulate hedge funds even if they don’t run money for a hedge fund. Constant trading is going on and turnover is very high. Now, one of the questions is this: Is this turnover doing a good job for us?”
Athey looked at Morningstar’s mutual fund database. This, too, is another study he has updated over time. He looked at all nine style boxes — value and growth, large cap and small cap, etc. He compared the top funds with the worst ranked funds and with the average funds.
What did he find?
“In all nine cases,” Athey said, “the higher-rated funds have lower turnover than the lower-rated funds. In essentially every study we’ve done, this holds.” Said another way, funds that held onto their stocks did better than those that traded them.
Then Athey asked an interesting question: “Does anybody believe there is a cause-and-effect relationship here? If you simply trade less, will you do better?”
Various folks in attendance offered up their ideas. Athey, though, had his ready answer. No, there is no cause and effect. Low turnover is a residual or a reflection of something else: conviction.
“Lower turnovers imply higher conviction,” he said. “If you know what you own and why you bought it in the first place, then if it falls in price, are you likely to panic out?” The answer is no. You only panic when you don’t really understand what you own and have no conviction in the idea.
Athey’s career shows incredible conviction. In the last 10 years, his fund had a turnover of just 10%. This implies an average holding period of 10 years! And half of that turnover, Athey told us, comes from takeovers in which he had no choice. The stock was taken away from him.
In short, spend time knowing what you buy before you buy. And buy only those ideas in which you have a strong conviction. Ask yourself, “If the stock fell by 25%, are you a buyer?” If you can’t answer yes, then you don’t have conviction in the name. Resist the urge to trade in and out of stocks. Aim to lengthen your holding periods.
No. 3 — Riding Winners
Related to this idea of low turnover is another important secret, almost a sub-secret, you might say. “People tend to sell their winners too soon,” Athey says. “If a stock goes up 30%, people are quick to want to take a profit.”
Athey continued:
“I’d like to credit my colleague Jack Laporte, who is a great investor any way you want to measure it. Jack and I used to talk about this, and he felt that one of his secrets was riding his winners. If you own a small-cap growth company and you get the right idea, it can continue to do well for a long period of time and you can make a lot of money.”
Here, Athey told an unforgettable story:
“We had a client that we started managing money for in 1977. One of the first stocks we put in that portfolio was Wal-Mart. Our cost basis in that Wal-Mart stock is 5 cents per share today. [Editor’s note: Wal-Mart was $77 at the time of Athey’s talk.] It is one of many examples where you get a winner and ride it...”
As Athey points out, it is really hard to find a great company. “When you get it right and make 40% and sell it, remember you then have to go find another one,” he said. “So when you get one right, don’t let it go so easily.”
It is tough to know when to sell, but trimming can be prudent. T. Rowe has sold off pieces of that Wal-Mart position along the way to prevent the portfolio from being too reliant on one just stock. There is always a risk that things can go horribly wrong.
Riding your winners is excellent advice. Instead of watching the charts and trading in and out, Athey suggests “reading and thinking more about the companies you own.”
This will be where you make a lot of money. In my own investing career and in running my newsletter portfolios, what really make the overall returns stand out are the contributions from those stocks that doubled and tripled or more.