Christopher M. Begg, CFA – CEO and Chief Investment Officer East Coast Asset Management’s letter to investors for the third quarter 2014.
In our third quarter letter you will find our portfolio update and general market observations. Each quarter we highlight one component of East Coast Asset Management’s investment process. This quarter, in the section titled Grove of Titans, I will discuss the attributes of what we think constitutes an enduring business. As is our standard practice, client reporting, including performance and positioning, has been sent under separate cover.
East Coast Asset Management: Market Summary
Over the past two months, volatility has returned to the equity markets. A six-year recovery of equity prices has many investors questioning the viability of an appreciating stock market. Projecting market expectations through a rearview mirror is a limiting strategy. Instead, we think harnessing business specific valuation and margin of safety tools are the only forward looking methods that deserve merit. In these terms, we believe our portfolio of quality businesses at today’s valuations is an attractive and intelligent place to allocate capital.
Loss aversion is a deeply embedded human trait; thus it’s only normal to feel uncomfortable when market prices move lower. While volatility can cause uneasiness, we feel that it often creates the possibility for improved expected returns by increasing per share ownership through direct purchases and company share buybacks. We think short-term volatility should often be viewed as an opportunity to the long-term investor who seeks enduring businesses at reasonable prices.
Price and value are two contrasting sides of the same coin. The value of any investment is simply the present value of all future cash flows. News and related media spawn noise that create an environment where price overshoots value and they become disconnected, crisscrossing each other along a trajectory. The increasingly short-term nature of investors only serves to bolster our belief that employing a long-term business approach is a winning strategy through time.
East Coast Asset Management: Dialectical Materialism – The Unified Theory of Reasoning:
The quest for a theory explaining how the universe works has captured the imaginations of some the world’s most enlightened thinkers. Einstein spent the final thirty years of his life attempting to find a grand unifying principle that would explain the universe both theoretically and mathematically.
In absence of a mathematical principle that unifies the laws of the universe, I do believe there exists a theoretical unifying principle that – when applied to certain questions – can produce an answer that aligns with how things work. This principle is called Dialectical Materialism or Dialectics for short. Dialectics is a method of reasoning that I interpret to have three foundational insights:
1. Cycle of Life: Everything is either coming into existence or fading out of existence. As early as 99BC, Lucretius captured this idea in these words, “Nature repairs one thing from another and allows nothing to be born without the aid of another’s death.” In the forest ecosystem, the forest floor recycles the fallen organic matter of trees to produce new growth. In business, lack of continuous evolution in light of the reality of change, bureaucracy, size and misaligned interests create an environment where disruptive entrants recycle the fallen business’s organic matter to produce new, emerging businesses. Dialectics reveals the transitory character of everything and the uninterrupted process of becoming and of passing away. Human nature causes us to see things in their static form versus the reality of all things being in motion.
Thus, the sum of things is ever being reviewed, and mortals live dependent one upon another. Some nations increase, others diminish, and in a short space the generations of living creatures are changed and like runners pass on the torch of life. – Lucretius – (99BC – 55BC)
2. Form versus Essence: Dialectics employs understanding something via its essence, not just a fixed definition, or form. For ordinary understanding there is no difference between the appearance of a thing and its essence, but for dialectics the form and essence of something can be quite contradictory. I believe this to be one of the most important competitive advantages of reason. In investing for example, most market participants are keenly focused on the form of price and are too often ignorant of the essence of intrinsic value.
See full PDF here.