Investing With Conviction
Investing returns tend to come in fits and starts. Some days your investments rise and you feel on top of the world. Other days the market falls and you feel poorer for it. It doesn’t matter what your favorite asset class is, returns are never smooth mathematical lines into financial infinity.
Mr. Market can act very irrational when he’s in the wrong mood. He can also maintain that irrationally for a very long time. How long is a long time? Potentially for decades…
Eventually though, Mr. Market does change his mind. One day he finally comes around and acts rationally again. Was your investing conviction strong enough to wait for him?
Oh Deere!
I recently had the opportunity to be on the winning side of Mr. Market’s mood swings — one that I want to share with you today.
Approximately 4 years ago, I purchased a few shares of Deere & Company in my IRA. I believed it to be a good investment.
Almost everyone knows Deere, — they’re the company that makes those iconic green tractors. But what you may not know is those green tractors are only part of the business. They actually make a huge array of different equipment — tractors, farm equipment, construction machinery, forestry equipment, lawn mowers, and so on.
Like most equipment manufacturers, they sell this machinery to customers around the globe — It’s a giant global business.
Unfortunately for Deere, Mr. Market has been quite negative about the company’s prospects … mainly because crop prices have been down. When crop prices are down, farmers make less money (and are less likely to buy new farm equipment). This was Mr. Market’s opinion of the business, and so the shares sat around doing nothing for 4 years.
Thankfully, I knew Mr. Market was being very short sighted. I purchased shares shares back in 2013 for about $90 a share.
Going into this investment, I knew several key facts that would allowed me to invest in Deere with conviction:
Fact #1: The global population is growing, but the amount of arable land isn’t growing. In fact, in some countries the land that can be used to grow food is actually declining. This means a growing global demand for food, and a fixed supply of land on which to grow it. Farms must eventually become more productive over time, or prices will rise. Improved farm productivity means lots of fertilizer, and very expensive machines. The robotic tractors from the movie Interstellar aren’t that far off from reality folks.
Fact #2: The number of farmers in the world continues to dwindle. In the 1800’s something like 98% of the population was farmers. Now, that percentage has shrunk to a mere 2% of the global population. It’s a number that’s been shrinking for decades, and yet we rely on those people to feed us. In the United States alone, farmers are about 1% of the population. To produce the same (or higher) level of farm output per person, a farmer must be more productive than ever. To do so, they rely on farming machinery.
Fact #3: Among farming equipment manufacturers, Deere has pricing power. They’re able to set prices higher than competitors, and hold them there. In some cases, a Deere tractor can cost almost double what competitors charge. Maybe it’s brand, or maybe it’s better product quality, but Deere definitely charges a premium for its products. Pricing power is very important for funding innovation, and the long-term rewarding of shareholders.
Armed with these facts, I made my investment in Deere knowing Mr. Market might disagree with me for a very long time — and he did. Deere shares remained essentially flat for 4 years, only paying dividends to shareholders.
Recently though, Mr. Market changed his mind about Deere in a big way. This year, shares skyrocketed to $125 per share, and much of that only in the last month. Better earnings had a lot to do with Mr. Market’s change of heart.
While I don’t consider this investment a massive success, I’ve done pretty well. Shares have appreciated almost 38% from my initial purchase price, along with 2.6% dividends annually. This is a 48% gain in 4 years, or roughly 12% per year.
That’s about what I expected going into the investment, but it took considerable conviction for those returns to be realized.
Investing With Conviction
I brought up my little Deere investment story, not to brag (it’s nothing to brag about), but to talk about investing conviction. How strong is your conviction when you invest?
The market could easily fall into a deep recession tomorrow, and your investments could hang-out in negative territory for decades. Or, like my Deere example, the market might just decide to stay flat for the next 10 years.
Are you prepared to hold investments without gains, until the fateful day when Mr. Market finally and very suddenly changes his mind? I got lucky, it only took my investment 4 years before Mr. Market woke up. One day it could take far longer.
Think this long-term market malaise won’t happen? It certainly can — just look at Japan.
At one point in the 80’s, corporate Japan was “king of the world”. People thought the Japanese would eventually own everything. Then, the Japanese asset bubble popped in the early 90’s. Stock prices tumbled, and investors suffered major losses. Nikkei prices still haven’t recovered to those levels in 20 years, and many people believe they never will.
Extended periods of non-performance have also happened in the United States too — From 1920 to 1942 and from 1965 to mid 1982. It’s something that can definitely happen, and it’s no fault of the investor.
So I ask the question — How strong is your investing conviction? Could you last a year? Two years? Five? Ten? Or, even twenty years without gains?
Twenty years is a long time to wait, I have to admit. If I have to wait 20 years to see returns, I probably screwed-up (investing when prices were way too high). There’s a reason why I consider this scenario my early retirement killer.
Final Thoughts
Over the years, I’ve noticed something — My largest returns tend to happen when I invest with the most conviction. I get all my facts and figures worked out ahead of time, and then I simply let Mr. Market take his time.
Eventually the planets come into alignment, and Mr. Market has his big “aha!” moment. That’s when the big returns come rolling in.
But investing this way isn’t easy. It takes patience. I always try to remember the famous quote by economist John Maynard Keynes, “The market can remain irrational longer than you can remain solvent.” I don’t get myself into situations where solvency is a problem.
Never bet your last dollar in Vegas, (or the stock market) thinking you’ll get lucky. You won’t.
Instead, find situations where markets are irrational, and then invest with the intention of being very very patient. It doesn’t matter if it’s stocks, ETFs, index funds, real estate, preferred shares, bonds, or even websites — irrational behavior provides opportunity for investors with deep conviction and real economic facts on their side.
If you believe the value of your assets will eventually rise, how long would you wait? How much conviction do you have?
Congrats on the increasing return on your Deere stocks! It’s great to know that the marketing has been treating Mr. Deere well. I’d be a bit depressed to see the flat returns over 4 years. But you’re right. We need to be committed to what we invest in in the stock market to see positive long-term returns.
I wonder, however, about the opportunity cost of parking your money with little or no interest for so long when you can invest in something else for a higher returns. It may be because you want to diversify our portfolio and don’t mind waiting. But it’d be great to hear your thoughts on that.
You can think of dividends as interest, but unfortunately the ‘true value’ of an asset is almost never fully reflected in accounting value. Market value always fluctuates around ‘true value’. Sometimes positively, and sometimes negatively.
Personally, I don’t need the market to validate me. As long as owner earnings exceed my no-risk rate of return, *eventually* that will be reflected in a higher value company.
This is what I mean by investing with conviction. You have to stand against the market’s tide, knowing you WILL be right… eventually.
That’s a very good question “Am I prepared to hold investments without gains for decades?”. My brain says yes, but I am not sure what my heart will say. It’s going to be hard to stay calm and keep investing, but I am preparing myself for this scenario.
Recently Mrs. FR and I had a “what if conversation”, about what if market crashes and our 401(k) will be more like 201(k), and our downpayment fund will become juts enough to buy nothing. It will be very sad moment for us, but we will keep investing and play long term game.
As I sad, my brain understands everything and has no issue with it, but I am not sure about my heart’s behavior
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Great job hanging in there. And patience is the key, when you’ve done your homework. You didn’t buy it in on a whim.
Absolutely, I never buy on a whim! I usually do lots of research beforehand.
What happened with Japan is the constant reminder for me of what “could” happen. The absolute worst case scenario. It’s also one of the reasons why I’m so big on global diversification. And why I’ve stopped diving into individual stocks. I’ve won some and lost some! It’s great to hear you did so well with Deere. It was one of the stocks I was looking at as well. The only thing that gives me pause about Deere (along with many other companies, so it’s not just Deere) is technology and advancements in methodology within industries. For example in agriculture, I’m hearing a lot about vertical farming coming down the pike. Might have an impact for Deere unless they are able to reinvent themselves to accommodate this switch. But fortunately for them, this isn’t like a Kodak type situation where agricultural equipment is the only thing they do. Since they do construction equipment, which can incorporate these technological changes.
Vertical farming? That’s practically science fiction from a true business ROI level. Capital costs are just too high and returns are just too low.
Growing crops in dirt is going to be the most efficient way to grow for a very long time. I remain unconcerned.
Robotic tractors however, are a very real thing.
The problem is there is a small line between conviction and catching a falling knife. Ie buying low and then riding it down. This is why we stick to index funds because it decreases the liklihood. Still it’s possible, in the case of Japan if it lasts another twenty years it may surpass some people’s entire investing lifes. Then it wouldn’t matter if it recovered as they wouldn’t be here to see it.
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You’re kidding yourself if you think index funds don’t fall.
They can fall in value just like any stock, rental apartment, bond, private business, or preferred share. Don’t delude yourself into thinking you’ve somehow found the perfect asset class.
Any asset can fall or rise in value, but do you have the facts on your side to justify your investment? Most people don’t.
Yeah, what exactly happened to Japan? I’ve been wondering about that ever since I got back. Is it their low immigration number and low birthrate? Too much automation? I don’t get it. At one point, we thought Japan was going to be the future (remember the Blade Runner movie?) I don’t get why their economy ended up tanking.
It’s a good question. My view is that it’s a combination of a whole bunch of things — low birth rates, little immigration, culture, deflation, etc.
Deflation was a big problem. When prices tomorrow will be lower than prices today, people tend to put off purchasing… which of course really hurts the economy. A bad economy begets less money for R&D, and eventually corporate Japan just fell behind.
They’ve missed a couple of the last big technology waves, like smart phones and internet services…
That said, they do have some pretty amazing companies that might rise to prominence again. Fanuc Corp would be one example.
That sucks for Japan. When I travelled there, it did seems like they were falling behind in technology compared to South Korea, which is kicking ass with Samsung. I did hear recently that Japan is relaxing the immigration rules so hopefully that will help in the future.
The problem with Japan isn’t so much what happened since the bubble (stock market’s done okay recently) but the INSANE valuation people were putting on things in the late eighties/early nineties (fueled by the ‘Japan as number one’ meme).
Stock market P/E was over 60 and the Imperial Palace land was worth more than the whole of California 😉
Then someone noticed the emperor had no clothes…
What happened with Japan used to keep me up at night. I’ve come to live with the uncertainty. Life in and of itself is fraught with risk!
I think the biggest thing with Japan was that there was a huge real estate bubble. I’m talking astronomical proportions. For example, some of the prime property in Tokyo lost 99% of their value. I also remember reading somewhere that the land surrounding the imperial palace was greater than the value of all the land in California!
Hits to property prices can have huge repercussions for the economy as a whole because of how intertwined real estate is with both the business side and the consumer side.
Securitization of mortgages (not sure how much of this was going on in Japan at that time, if any, but this was one of the bigger reasons of the bubble popping here in the US in 2008-2009).
But I think the bigger thing is the use of property as collateral to secure credit, so I’m sure there was a massive loss of liquidity when the bubble popped in Japan.
And lastly, Japan’s been struggling with a low birth rate and an aging population for quite some time now, which creates deflation.
i’m thinking that if we get a 20-year bear market, i’ll keep my withdrawal rate to whatever my index funds’ dividends are paying. They will take long enough to falter that I can get a job as a Walmark greeter.
I used to also be worried that what happened in Japan could happen in the U.S. Their property values got so high it just pulled their stock market and everything along with it. Valuations were absurd and people hadn’t seen anything like it in generations. I don’t think they realized what was going on. Later after the bubble popped, deflation set in and took hold. I think our fed is very scared of deflation and has done a great job to fight it especially with what they had to deal with in 2008. I also bought some (small amount) of DE in 2015 because the valuation was good and it is a great company and has the highest reputation among most farmers. Their dividend yield wasn’t the greatest but it didn’t hurt that Buffet had some in his portfolio.
My Investing Style
I’m glad there’s discussion of the Japan thing here. I hear about it so much. Every time someone gets too confident in the market, another person will chirp in “hey, remember Japan’s bubble?”
Congratulations of Deere, 12% return per year is a sweet return! Should I hold conviction for my forlorn VRX shares…*cry*
Conviction for VRX? No, probably not.
Good job on hanging in there and waiting it out! It takes much discipline to do so. I have had to learn the hard way after buying stocks in the past, selling, and then seeing the price go up a year or two later. 🙁
Mr. Market can do all kinds of crazy things. It’s better to focus on the earnings and let your decisions be driven from there.
Congrats with DE. I have a few shares too! Probably should have purchased more when they were cheap.
Truthfully, I’m not strong with my convictions. I’ll need to work on that more. For now, I just don’t pay a ton of attention to the market. Invest in good companies and leave them alone is the way to go.
That’s actually a pretty solid investment thesis for Deere. I struggle with conviction sometimes, if the stock moves down after a purchase I start re-crunching figures and thinking about whether I’ve missed something. I suppose one either waits or sells out (for the best or not), but without conviction then buying the index seems like the only rational option! You’re right though, sometimes it takes years for the market to wake up (in either direction).
Good points, I had the same for my MCD buy back in 2012. I bought at 86. Then all the headlines about the downfall of McDonald’s did not sway me. Now MCD is up around 50% since 2012 after staying flat until last year. Meanwhile for the 4 years I just collected dividends and waited.
Nice article. I bought a nice chunk of DE back in 2014 at $84 per share or so. Earlier this year I sold out at $105 and reinvested this in other securities. DE continued to run up another $20 since then to where it is now, but in my model and analysis I put the fair value at below $100- their dividend has not gone up and are being valued more than in 2011 when the profits were much higher. DE is a cyclical play, that also has a long term tailwind, as you mentioned. I wouldn’t be buying here as there is little margin of safety. Holding or lightening up is fine, as long as you can find something else that is undervalued that you can invest in with conviction (XOM and CVS fit that bill for me).
-Mike
I don’t disagree! Mr. Market is very enthusiastic about most stock prospects right now.
Where would you draw the line between holding onto flat/non-performing stocks like Deere over those few years versus holding onto loser stocks that over a few years afraid to sell it and realize the loss?
Jordan @ New Retirement
Hi Mr Tako,
Many investors find it hard to just have an investment that “is not working”, so they grow impatient, wear themselves out and sell out. Personally, I find it helpful to get paid that dividend to hold on to the company. I also avoid comparing to a benchmark on a quarterly/annual basis, because that is short-term noise that would influence me to do something silly.
I researched and invested in DE about 3 years ago in July 2014, and it seems to have done better than S&P 500. Looking at my analysis, it looks like I had a low conviction in the company as a long-term B&H one.
I am quite opposite to you in convictions. My best convictions have turned out to be not as great as incidental companies where I have had enough courage to buy, but not enough to call it “best idea”.
As far as stock markets being flat for 20 years, I say bring it on. As long as I get those dividends, and I avoid overpaying in the first place, I can afford to be the smart-ass I think I am. For example, in the 1966 – 1982 period, the amount of dividends on S&P 500 easily matched inflation. The issue in Japan was severe overvaluation in the 1980s – the dividend yield on Nikkei was half a percent and P/E was 60 – 80. I have read somewhere that most Japanese invest predominantly in fixed income type investments, which is why I do not think the effect was as bad on investors..
Great comment DGI!
Great blogs and blog posts inspire great comments. Keep up the good work!
This seems to be a great argument for holding forever once you’ve done the research to buy well. Dividends coming in are more important than the size of the portfolio to your daily living.