The Merriam-Webster dictionary has the following definition of volatility, “a tendency to change quickly and unpredictably”. The stock market has plenty of it. Stock prices go up and down on a daily basis while nothing may have changed in the underlying business. Volatility invokes emotions and investors often act on these emotions.
Nothing like price to change sentiment
Many academics and some investors see volatility as risk. They postulate that a stock that is declining is riskier than a stock that is rising in price. In a badly chosen and low-quality stock, it is a risk. But, volatility in a high-quality company in the stewardship of a long-term oriented management team can be a gift!
Amazon is perhaps the most interesting case study. Everyone today wishes they bought and held Amazon stock since its inception. But it was very very difficult! A $10,000 investment in 1997 would be worth close to $22,580,645 today - 38% CAGR over 24 years. Here is the beautiful chart:
However, there were periods of time where one had to endure extreme volatility. In 2000:
Yes, you are reading it right. The stock fell from $105 per share to $6 per share - a 94.3% drawdown in 24 months. It was the same company with the same products with the same management. In 2008:
Very few people actually held the stock through this volatility. Even fewer investors added to their position when the stock price declined. In hindsight, were the price declines risky? Or were they times to buy even more stock. In Amazon’s case, it is definitely the latter.
In October 2009, after the great financial crises, Charlie Munger was interviewed by BBC and had the following to say on Berkshire Hathaway's stock price decline,
“This is the third time that Warren and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%...In fact, you can argue that if you're not willing to react with equanimity to a market price decline of 50% two or three times a century, you're not fit to be a common shareholder, and you deserve the mediocre result you're going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations."
To be fair, not all companies are Amazon or Berkshire Hathaway. In many cases, if the balance sheet is weak or if business risks are insurmountable, selling the stock is the right thing to do.
But the more interesting question is – what are the attributes needed to be able to hold on to the Amazon’s of the world in volatile times? We believe it comes down to temperament, conviction and aligned capital. Temperament to be able to control emotions when there is volatility in the portfolio. Conviction in the thesis based on research and analysis to be able to hold or add to the position. However, none of the above is possible if the portfolio manager is not given an opportunity by the partners to take advantage of volatility. Partners with long term time horizon are an invaluable asset to a portfolio manager.
There has been plenty of volatility in the markets over the last two weeks. It is unclear if it is over but we took advantage of this volatility and recently purchased shares in Amazon in our compounder bucket. White Falcon's compounder bucket has some well known companies with high quality base businesses where the management has ample opportunities to deploy free cash flow. While most investors think about Amazon as a retailer, it actually makes most of its money from Amazon Web Services (AWS) which is a toll booth on the innovation and data economy. Importantly for us, Amazon’s businesses have matured enough that one does not need to make outrageous adjustments to value the business.