Sunday, July 12, 2009 2 comments ++[ CLICK TO COMMENT ]++

Long-term investors vs Short-term ones

It's widely known that the Street is very short-term-oriented. In fact, the crisis has shown that even some institutional funds, which are supposed to be investing for the long-term, engaged in short-term strategies and had to sell heavily into the market crash due to liquidity problems (recall the story of Harvard's endowment fund.)

It is generally suggested—I certainly believe strongly in this—that small investors can only beat the pros by investing for the long term. The thinking relies on the fact that professionals are unable to enter into certain transactions because they are short-term-oriented, so small investors may have better outcome by thinking of the long run. Some investors, such as Warren Buffett and Charlie Munger, have suggested that even professionals should invest for the long run if they hope to beat the market; in contrast, others such as Marc Faber and Dennis Gartman have suggested that investing for the long-term is not advisable (Late last year Faber said the "Warren Buffett way of investing" will be dead for 10 years and Gartman recently said that "Buffett is an idiot". It's probably not a coincidence that both of these guys are trading-oriented and use technicals a lot.) Whether you invest for the short-term or the long-term is up to you. Just stick with what works for you.

In any case, I thought I would point out the short-term nature of the Street. It's very subtle but important. Consider the following quote in a Marketwatch story about Intel:

"However, we believe upside potential is constrained by a tightly managed supply chain that is limiting inventory beyond what is required to satisfy real demand," Orji said in a report Wednesday.


Orji is a UBS analyst and the thinking is typical of nearly all analysts (I'm not picking on him by any means; I don't know anything about him and he may be a good semiconductor analyst.) He is basically saying that the upside for Intel's shares is capped because customers will only be purchasing enough inventory to meet real demand. What he is saying is true but let's think about the implication of that for a minute.

If you were a short-term investor, hoping for the stock to rally sooner rather than later, this is actually an important piece of information. I'm sure a short-term investor would spend a lot of time and resources trying to pin down this issue. After all, if sales are lower because customers only order enough to meet real demand, then the short-term results will be worse than if sales were higher. Hence, the shares won't perform as well in the near term if sales were less.

But, if you were a long-term investor, this is almost silly. In the long run, sales will always equal real demand. If sales were higher now, it doesn't really create any additional shareholder wealth in the long run. After all, if customers order more than needed, they will either return it back to you later (in some businesses, retailers can return the product); or they will order less in a future period. The long-term net effect is very similar whether you have sales equal to demand now, or if sales were higher than real demand. Having higher sales than real demand accomplishes nothing. In fact, it may be ideal for long-term investors if companies only produced enough (with some small cushion) to satisfy real demand.

Thus, if you were a short-term investor, you actually may not invest in Intel because near-term upside is limited due to customer purchases equalling real demand. In contrast, if you are a long-term investor, this issue is completely irrelevant. If I, who is long-term-oriented (except for special situations and some contrarian situations), were considering Intel, I wouldn't consider it as a negative if Intel only supplies what the real demand happens to be. I also wouldn't consider it as a serious negative if near-term demand is low but long-term normal demand will rise. But a short-term investor would definitely consider issues like these as a negative.

Short-term investors are completely different from long-term ones. The mindset is so different. At times, I read some of the free analyst resports I get through my discount brokerage, and a lot of what they use to justify share price targets are completely useless for long-term investors.

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2 Response to Long-term investors vs Short-term ones

Daniel M. Ryan
July 13, 2009 at 1:26 AM

Actually, it is relevant if you're a long-term investor who likes taking the opposite side of the trade to the short-term investors. If sales and real demand get out of whack...

hpmst3
July 13, 2009 at 2:49 AM

This is a little off topic Sivaram, but do you know Faber's long term track record?  His Barron's picks overall seem to beat the S&P 500 every year, but I am not sure.  I think that he manages individual accounts, so he is not publicly measured like U.S. mutual fund managers.  Do you by any chance know?  I read his Tomorrow's gold, and it was all about long term historical economic cycles/macro.  But I notice that aside from commodities, and currency picks, he usually buys asian companies that are trading at single digit pe's with nice yields.  Do you find this to be the case from what you know about him.  I have to admit that I am not very macro focused, so this may influence my perspective.

On another topic, I read that over the past 40 years, gold has returned 8.4% annualized versus the S&P 500's 9.1% annualized.  This was in the wsj, and the author was quoting a money manager from Cincinnati.  I was shocked.  I thought that Gold's return was a lot lower like around 2 or 3% annualized.  I don't know what they were using as a benchmark since ETF's were not around.  I am guessing that they used the commodity itself.  I have seen you write about gold before.  Do you by any chance know if this is correct Sivaram?

Finally, I also wanted to write about how I really liked your posts on individual securities which you bought, and the posts about companies on your watchlist.  There was a lot of info on things which I have never seen before.

Sorry about bunching these thoughts all on one comment box.

hpm

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