Gold as an investment

An Investment Lifetime, Distilled

Sep 24, 2022

Success concept

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On January 1, 2022, I retired after exactly 20 years as portfolio manager of the Fort Pitt Capital Total Return Fund (FPCGX). From inception on January 1, 2002 through December 31, 2021, the fund outperformed the SP 500 by 7 basis points annualized - 9.53% to 9.46%. As with all public funds, the net asset value and performance of FPCGX are immutable and transparent to all. Less than 1 in 5 portfolio managers outperform popular indexes over the long term, so I consider myself in good company. With this in mind, I want to provide some perspective on topics of interest to long term investors. Consider it a distillation of some of what I’ve learned in 38 years of managing money. It won’t take long. Here goes:

The Equity Premium Is Real

My first boss taught me this, and it is the foundational and preeminent concept of investing. In aggregate, in our capitalist economy, the people who take equity (ownership) risk receive a premium (greater) return over time relative to lenders. It’s another way of saying: “stocks outperform bonds”. Not every company and not every year, but if investors aren’t getting “extra” returns from non-guaranteed investments, why bother? Just lend your money instead. Another way of looking at it: Own stock and corporate management works FOR you rather than AGAINST you. Management is trying to maximize the value of their stock, while paying the minimum required on outstanding debt. Which piece of paper do you want? Fully understanding (and applying) this concept over your investment lifetime – particularly when the world is going haywire – will set you apart from other investors. Some of our most successful clients at Fort Pitt Capital are business owners who know this “in their bones.”

Diversify, But Don’t Overdiversify

Yes, owning just two or three investments in a couple industries is foolish. It will make you either a giant winner or giant loser, when there’s no need for either. That’s the whole point of the equity premium. Owning 2 or 3 decent quality businesses in each of a dozen different industries allows you to capture that premium, but in a fashion that allows you to sleep at night. If stocks in aggregate earn higher returns, just go with the flow and own them in aggregate. This technique reduces the volatility in your portfolio, especially in times of market tumult. If you’re more likely to do something dumb and sell your entire portfolio after a 40 percent decline, then by all means diversify to the max. You may still be tempted to sell, but it won’t be for lack of diversification. Finally, be aware that volatility is not the only (or even the most important) risk. A greater risk is loss of purchasing power over time. If you can stomach the volatility that comes from a less diverse portfolio, and you own decent quality companies, you will make more money (and stay further ahead of inflation) over time by being slightly less diversified. 25 to 30 names in your portfolio are all you need.

The Risk Is Always In The Price

If you think about it, there is no risk inherent to a business that can’t be offset by paying a low enough price for that business. Even a business on the doorstep of bankruptcy has value to its secured creditors, who likely will become its next owners. Conversely, businesses perceived as perpetually growing and (therefore) bulletproof often sell at irrationally large premiums. Perhaps the single best historical example of this latter phenomenon was Cisco Systems circa 2000. It sold for over 100 times earnings in March of that year, a price at which no amount of blue sky or tortured math could make the numbers work. This is really just another way of framing the “growth vs. value” continuum. There’s a price at which even the best business is a bad investment, and one at which dross becomes gold. Investment success often comes from both knowing – and acting on – the differences. The single greatest mistake I see from retail investors is blindly overpaying for businesses “everybody knows” are winners.

Lastly, I'll mention the profound drop in trading costs over the last 40 years – and revisit the equity premium in the context of this decline. Before trading commissions were deregulated in 1975, stock trading was expensive – 3% to 5% of the value of a trade. A million-dollar trade might cost $30K – more like what it costs to sell your house today. Thus, the “friction” involved in trading stocks was considerable – so people considered it. Today, this same trade costs nothing – ZERO. This should be unadulterated good news for investors, particularly young ones with small sums to invest. Yet, multibillion dollar businesses have arisen that “gamify” stock trading – making investing more like frequenting a low-end casino or sports book than steadily and deliberately putting money to work in a diverse set of businesses. This is not good.

In 1999 columnist Jim Glassman and economist Kevin Hassett wrote a book entitled “Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market”. They published it on October 1, just as fears of the Millennium Bug reached a crescendo. The Dow closed that day just above 10,000, and market pundits scoffed at the book’s outlandish projections, particularly given the market’s meteoric rise over the previous 5 years. Fast-forward 22 years. On Tuesday, November 2nd, 2021, the Dow Jones Industrial Average closed at 36,052.63.

My point in mentioning “Dow 36,000” is not to credit the authors with supernatural prescience. In fact, a rise from 10,000 to 36,000 over 22 years equates to just a 6% annual compounded return – hardly heroic. No, my point is instead to emphasize both the inexorable nature of the advance and the need to stay invested, rather than trying to play the “game” of Wall Street via frequent trading. Like rust, the Dow Jones never sleeps. Yes, it wanders off trend for extended periods (see the 1970s), and benefits from intermittent committee substitutions of smartphone makers for tired conglomerates. But over time it’s a numeric reflection of tens of millions of people around the world going to work each day to add value to their businesses – to create the equity premium – so that we as investors can benefit.

A well-worn placard on my desk reads: “Don’t Just Do Something – Stand There!” It’s perhaps the single greatest bit of stock market wisdom ever uttered.

Happy Investing!

This article was written by

Charles A. Smith profile picture

Charlie Smith – Retired Principal and Chief Investment Officer of Fort Pitt Capital Group. Charlie is a graduate of Penn State University and lives in Marshall Township, PA.

Disclosure: I/we have a beneficial long position in the shares of FPCGX either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.


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