Owners vs. Investors
I recently stumbled upon an interview with Anthony Deden of Edelweiss Holdings. It’s a 2.5 hour tour de force from 2018, so I’m a bit late to the party. I’d never heard of Deden, and apparently that’s by design. This was his first, and only, interview.
Deden tells the story of meeting a date farmer. As they looked over his thousand tree orchard, the farmer explained that it takes a date tree twenty years to bear fruit. However, this fruit isn’t high enough quality to sell. Saleable dates require forty years of growth.
It struck Deden that this farmer couldn’t possibly have planted all of these trees. The farmer chuckled and said his great grandfather had begun planting the orchard over 100 years ago.
Why did these men plant trees knowing they’d reap none of their rewards? Planting and caring for trees requires money, labor, and land. It clearly was not in their best financial interests to front these resources. Economists might even call them irrational.
Deden concluded that they did it because they were owners rather than investors. This distinction was a common theme throughout the interview and forms the cornerstone of Deden’s investment philosophy.
Defining Terms
Plato wrote that “the definition of terms is the beginning of wisdom.” Ben Graham, a lifelong student of the classics, began chapter one of The Intelligent Investor by defining the term investment in contradiction to speculatation. He wrote: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” He elaborates that “investment is most intelligent when it is most business-like.”
Deden goes a step further by distinguishing an owner from an investor. An owner’s priorities are to make sure the company endures, has a great product, a happy workforce, stable suppliers and a delighted customer. Owners prize durability above all else. They would never trade balance sheet fragility for the stake of faster growth. That’s why owner-operated companies tend to have little to no leverage (e.g. Berkshire Hathaway, Facebook, Copart).
By contrast, investors try to anticipate the anticipations of others. An investor is someone who indulges in the pseudo-intellectual activity of analysing companies based on how the price of the stock will move the next quarter or the next year. Keynes compared this behavior to “a beauty contest where judges are rewarded for selecting the most popular faces among all judges, rather than those they may personally find the most attractive.” This devolves into circular logic and isn’t consistently winnable.
The key distinction is that owners focus on the durability and productivity of their assets while investors focus on how others may price their assets. The owner’s approach is superior because assets are more predictable than emotions. Sir Isaac Newton learned this the hard way when he lost a fortune speculating in the South Sea bubble. Afterwards he lamented, “I can calculate the movement of stars, but not the madness of men.”
This distinction between owners and investors has wide-ranging implications.
An owner views his or her capital as permanent and irreplaceable. An investor views capital as fluid. If an investor loses money, he raises more to replace it. An owner is naturally more defensive because he or his family earned their capital though labor that they’d rather not repeat. Deden’s priorities are (in order) to protect, preserve, and enhance his capital.
Similarly, we believe that what can go wrong is more important than what can go right. That’s why we look down before we look up. Charlie Munger’s first rule of compounding is “never interrupt it” because even a small amount of compound interest over a long time produces spectacular results.
An owner defines wealth as the compounding of earnings. An owner thinks about how much capital they can reinvest and what return that will yield. This is how earnings compound. When earnings compound, stock prices inevitably follow. This is why our analyses focus on reinvestment rate and incremental ROIC.
An investor quantifies wealth using market quotations. They look to others to tell them what they are worth. When prices rise, he feels wealthier, even if his business hasn’t grown. When prices fall, he feels poorer, even if his business is unimpaired.
Owners do not attempt to quantify risk. Deden, like Buffett, Munger, and ourselves, define risk as the probability of permanent loss. Permanent loss is related to the productivity of the assets owned. For example, the owner of an uninsured apartment building destroyed in a tornado experiences a permanent loss. An investor quantifies risk by measuring the standard deviation of the quoted price of his asset. The more quotations vary, the more risky they seem. To assess risk, an owner considers the competitive position of his businesses and the bargaining power of his suppliers, customers, employees, and regulators. Though these risks are not quantitative, they affect asset productivity. Price volatility is quantitative, but does not affect asset productivity.
Owners don’t attempt to precisely quantify the future. Investors love quarterly earnings estimates and forward guidance. Deden believes guidance turns the company’s stock into the company’s product. Why provide guidance if not to affect the stock price? When managers focus on the stock, they’re liable to lose focus on the business.
Guidance and earnings calls are a standard practice on Wall Street, but a number of our investments have opted out of the circus — Berkshire Hathaway, NVR, and Schmitt Industries. Other companies without quarterly calls are: T. Rowe Price, Constellation Software, Daily Journal, White Mountains Insurance, and Graham Holdings. We consider this a signal that management thinks and acts like an owner.
An owner buys without an expectation of a sale. This doesn’t mean owners never sell, just that selling is not plan A. When we invest, we’re prepared to hold for at least five years even though we may opportunistically sell sooner. Investors buy knowing they will soon sell. They want to flip the business, profiting from a rising valuation rather than rising earnings power.
An owner understands that a P/E ratio is not a substitute for comprehensive valuation. Business profitability is often influenced by temporary factors (like a pandemic) that valuation ratios don’t account for. There’s no single formula for valuing all businesses in all scenarios. Judgement is always necessary. While a P/E ratio can be meaningful, it lacks sufficient nuance. Owners think about normalized earnings power and free cash flow, not EBITDA, trailing earnings, or forward estimates.
Owners think in decades and generations, not quarters or years. A generational time preference is the only explanation for planting trees that won’t be productive for 40 years. Jeff Bezo has pointed out that if you are willing to take on projects that won’t pay off for 7+ years, you’ll face little competition. If your projects must pay off in 3 to 5 years, you’ll face a lot of competition.
Investors are eager not just to get rich, but to get rich quick. They forget that even a modest compounding rate of 10% per year (the S&P 500’s long-term average) will multiply capital 100 times in 48 years. That’s enough to turn $10,000 into $1 million well inside of the average lifespan.
Why Don’t More Investors Think Like Owners?
The world’s wealthiest individuals almost all share a common trait: they own meaningful stakes in wonderful businesses and hold them for long periods of time. In other words, they think and act like owners. It’s proven to be a winning strategy, if not for becoming wealthy then at least for protecting savings.
Yet few seem to use it. Apple’s shareholder base turns over every 105 days. Tesla’s, every 13 days. Imagine if your business partners or your employer changed that often!
Deep liquid markets and minimal frictional costs should be a blessing. Often they end up as a curse. The ease of dancing in and out of a stock encourages a focus on price. Liquidity allows investors to buy without understanding what they’re buying. As a result, investors know the price of everything but the value of nothing.
Warren Bufett says “liquidity is a very mild plus for us. It's not a minus, it's a mild plus... But if it's going to be a huge plus to Berkshire holders, we have the wrong shareholders." Liquidity is like sugar: it’s good to have on hand, but shouldn’t be consumed every day.
How To Think and Act Like An Owner
Investors can become owners with a shift in perspective.
Deden does this by changing his vocabulary. He buys “participations” instead of “stocks” and refers to himself as an “owner” rather than “investor.” Li Lu similarly encourages investors to think in gross, not per share, earnings. We think of our portfolio as our conglomerate.
Before investing, Deden analyzes the situation as if he were buying the entire business in a privately negotiated sale. He asks:
Would I want to own this entire company? Is this something I want in my personal collection of assets?
If I owned the entire business, would I hire the current management team to run it?
Is this business likely to be around in twenty years?
A single “no” disqualifies the investment. If he doesn’t want to own the entire company or partner with management, he doesn’t want to own a single share. His focus on durability means that he only wants to invest in companies virtually certain to endure for several decades.
Deden also avoids checking the market price of his investments too frequently. We all make it through Saturday and Sunday just fine without quotes, afterall. The more frequently you look at prices, the more likely you are to second guess yourself. A study at Fidelity found that its best performing accounts were owned by people who had either died or forgotten about the account. Buffett describes his investment style as “lethargy bordering on sloth.”
Last but not least, Deden focuses on the business’s economic value rather than its financial value. It’s easy to say ‘this company trades for X dollars.’ It is more difficult to explain, from first principles, what the business is worth and why. How does the business create value for owners, customers, suppliers, and employees?
Deden’s owner mindset and philosophy of investing are remarkably similar to ours. We think of our self first and foremost and long-term business owners and view our portfolio as a conglomerate with subsidiaries. An owner’s mindset is perhaps the single most powerful tool in our toolbox.
If you’d like to watch the interview, it’s on YouTube. There’s also a transcript here.
Disclosure: The author, Eagle Point Capital, or their affiliates may own the securities discussed. This blog is for informational purposes only. Nothing should be construed as investment advice. Please read our Terms and Conditions for further details.