By Michael Brush, MarketWatch
With trading commissions approaching zero and cool mobile apps making the stock market look like just another video game, it’s more tempting than ever to “entertain” yourself with rapid-fire trading.
But that’s one of the worst things you can do. Time and again, the most successful investors from Warren Buffett on down preach the simplicity and importance of buy and hold as a way to beat the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.30% .
This may seem boring, and sometimes it is. But if you’re turning to the market for excitement — or any other kind of emotional fulfillment — you’re doing it all wrong. Your emotions can be your worst enemy in investing.
I recently checked in with Harding Loevner Global Equity Fund /zigman2/quotes/200067953/realtime HLMGX +0.26% to understand why it has the unusually good record of beating competing funds by 2.7 percentage points annualized over the past five years, according to Morningstar, and what investors might learn from its approach.
Once again, the buy-and-hold message comes through loud and clear. “We think our edge comes from having a longer-term orientation. We have a holding period of four or five years, if not longer,” says Chris Mack, who helps manage the fund.
To hold a stock for that long, you’d better do a lot of work and choose well at the outset. The trick for Harding Loevner is to identify sustainable growth and competitive advantages. Typically this means three things: the power of a protective moat; Energizer Bunny-type growth that lasts throughout the economic cycle; and knowing how to see through the quarterly earnings noise to avoid getting shaken out of positions.
To find companies with moats, a good trick is to look for stable growth in cash flow and return on investment, and then ask what explains this. Often you find out it is because of high switching costs, another way of saying it is tough for customers to migrate to competitors.
You’ll find this often in software businesses, says Mack, who specialized in tech-sector analysis at Harding Loevner. This is one reason he favors software companies.
Consider Microsoft /zigman2/quotes/207732364/composite MSFT +1.30% . Its cloud efforts grab the headlines because this is one of the sexy areas of tech right now. But good old Microsoft Office, now called Microsoft Office 365, is a core source of growth. “Everyone questioned that a few years ago,” says Mack. That’s because cheap knockoffs seemed attractive. When even free products like competing software from Alphabet /zigman2/quotes/205453964/composite GOOG +0.92% /zigman2/quotes/202490156/composite GOOGL +0.96% fail to lure customers away, “that’s switching costs,” says Mack.
Everyone has heard of Microsoft, but here’s a lesser-known example: Roper Technologies /zigman2/quotes/204270015/composite ROP +1.23% . This might be a better one to consider buying now because it is a higher conviction name in Mack’s portfolio. As of the end of last year, it was the fund’s second-largest holding, and a 3.2% position. That makes it an overweight name for Mack.
Roper is an industrial conglomerate that sells everything from pumps and water meters to laryngoscopes and stickers in highway tolling systems. It also sells software for medical and scientific imaging. There’s a learning curve to mastering the software, so there are switching costs. But you can find switching costs anywhere, even out on the highway. Roper’s TransCore division sells road tolling systems. Once they are in place, highway departments don’t likely change them.
Half of Roper’s revenue is recurring, such as the sales of consumables used in the equipment it offers. This, too, helps create a protective moat.
Mack is skeptical of one sector that has historically been a good place to hunt for the protective moat that comes from brand power: Consumer packaged goods. The brand power of companies like Nestlé /zigman2/quotes/210131093/delayed NSRGY -0.15% /zigman2/quotes/208115528/delayed CH:NESN +1.20% is getting leveled by e-commerce. In a world where sales are migrating to Amazon.com /zigman2/quotes/210331248/composite AMZN +0.66% , the power of big brands to wrangle scarce shelf space in supermarket chains is less important than it used to be.
For exposure to the consumer packaged goods group, Mack likes Symrise /zigman2/quotes/209121612/delayed SYIEY +0.28% /zigman2/quotes/207710023/delayed XE:SY1 -0.17% /zigman2/quotes/205788200/delayed DE:SY1 -0.17% , which sells flavorings used in food, drinks and toothpaste. Consumer goods companies have been pruning their lists of suppliers. That means survivors like Symrise are part of rarefied oligopolies. This is a source of moat protection for a company since oligopolies support pricing power and bring repeat business.