Ever shortening horizons
In the beginning of the 20th century most investors believed bonds were a superior and safer investment compared to shares. As the first stock market boom took off in the US many Americans began buying stocks. As the economy continued to grow during the decade more investors started believing that owning shares could be more profitable than owning bonds. This was fuelled by the growing realisation that the returns generated by shares extended beyond any dividends paid to include the retained earnings of the business. These were reinvested by the business in order to generate greater earnings in the future.
It is well known that the stock market crash of 1929 and subsequent economic depression, had a great impact on the average person in America. It is less widely known that at the time only 2.5% of Americans owned stocks. The memory of this crash ensured that owning stocks remained a minority investing activity until the late 1970s. In the following decades investment firms such as mutual funds and hedge funds became popular and by 1999 more than 60% of US households were invested in the share market, either directly or via such funds. The stock market today in Australia is of course a commonplace investment destination. Every worker who has paid superannuation is likely to own shares (even if indirectly).
As ownership of shares became more widespread an interesting change occurred. The average holding period of shares has steadily decreased as ownership level increased. The graph below shows how investors have switched from owning shares for the long-term to trading in and out of shares on a short-term basis during the last 50 years. The average holding period of shares in US was 8 years in 1960, 4 years in 1980, 1 year in 2000 and down to 4 months today.The transition from long-term oriented shareholders and short term had a dramatic impact on public companies. Every quarter, analysts wait for the announcement of the company’s earnings results on which they base their buy-and-sell recommendations. Earnings announcements can move the stock price substantially. For this reason CEOs of public companies are constantly under pressure to deliver short-term performance.
By constantly focusing on achieving good performance in the short term, public companies are often struggling to plan for the long term to the detriment of long term investor. Furthermore, remuneration of management often incentivises short term results. Employment contracts of CEOs rarely last longer than 3 years with compensation heavily weighted towards short term stock options. Similarly investment managers are typically evaluated based on their quarterly performance. Due to the intense level of competition between investment firms, managers need to perform well in the short term or they may be fired by clients.
Fearful of the impact of such short-term consideration a growing number of fantastic private companies have elected to delay becoming publicly traded during their best growth periods. This has been particularly evident in the technology space where many excellent businesses have decided to stay private for as long as possible. With companies like Microsoft, IBM and Apple, investors had the opportunity to invest at an early stage in the development of these businesses. Investors who did so were rewarded with incredible returns. As the next crop of technology giants, such as Airwatch, Uber and Airbnb, have delayed listing, public market investors will only be able to invest when these companies are at a more mature stage. The downside is that with maturity comes higher valuation and slowing levels of growth. Accordingly, public market investors will have missed the best opportunity to have been involved in these companies.
The above progression towards the short term brings with it some good news. Price fluctuations caused by too much of a fixation on achieving short-term results open up exciting opportunities for long term oriented investors such as our firm.