Broyhill Letter Highlights VI: Capitalizing on Human Nature

This is the sixth piece in our Broyhill Letter Highlight series, highlighting our thoughts on human nature over the years.  You can access other posts in the series here.

For those who would like to revisit our letters in full, we will also be gradually sharing them to our Research Studio throughout the series.

VI: Capitalizing on Human Nature

A value-oriented approach can leave one feeling quite lonely at times as it often demands a good bit of distance from the crowd. As such, the biggest risk inherent in such an approach is that it is guaranteed to result in a much different portfolio than your peers. Said differently, one must be willing to trade short-term underperformance for long-term success. It is impossible to produce superior results without doing something materially different than consensus.

Our goal is to construct portfolios capable of generating as high a return as possible, without subjecting your wealth to significant loss. Our priority at Broyhill is protecting your capital. In any given year, you should assume that someone or some index will do better. This can be torturous. Nothing clouds judgment more than watching your neighbor get rich. But you don’t get rich by taking risk at the end of the cycle. You get rich by buying cheap assets. You stay rich by being patient. Our goal is to keep you rich. It is far more important than outperforming the herd in the short term.

Our portfolios look different than the market and as a result, our returns do too. Over the long term, we believe our approach will compound capital at a higher-than-average rate with lower-than-average risk, but from time to time, it is sure to produce results below our high expectations.

Value investing requires patience and a thick skin to withstand occasional periods of underperformance. For value investors, one variable wall always ensure long-term success – human nature. Investors will make the same mistakes they have been making forever because they simply can’t help themselves. Those mistakes will always offer patient value investors an endless pool of opportunity. Returns from value investing will be lumpy, as they’ve always been, but they will come in time.

A big gap between perception and reality can create a big opportunity for profit. In the short term, perception is sometimes more important than reality. So, we must look past short-term fluctuations and think independently about long-term business value. Stock prices fluctuate as underlying fundamentals change or are perceived to change. Since business operations don’t fluctuate nearly as much as shares or as perceptions, prices often change not because reality has changed, but because our perception of reality has changed.

Our ears perk up when we hear someone describe an investment as uninvestable. Low expectations and low valuations are a powerful formula for future performance.

There is nothing easy about this game. And gambling with the house’s money is most dangerous when it looks easiest. Rolling the dice with boundless optimism is not a sustainable investment strategy. Gamblers from shuttered casinos should know better. The house always wins. Thinking otherwise is what prevents the long-term growth of capital – speculative, short-term gains are eventually wiped out by occasional and unpredictable tidal waves. This is why compounding at even low rates of return can turn a small pool of capital into a very large one over the long term.