Crystal Cove Capital Management letter to investors for the first quarter ended December 31, 2015.
From inception to March 31, 2015 investors of Crystal Cove Capital experienced a 17.6% return compared to an 11.4% return from the S&P 500. Below, I share thoughts on why we present cumulative returns as well as thoughts on the predictability of short term vs. long term returns.
Crystal Cove Capital: Exponential Returns
In my experience, I have found that people tend to significantly underestimate the power of exponential returns over long periods of time. Over the last 50 years the S&P 500 has compounded at a rate of 9.9%. This would imply that $100,000 would turn into $11.3 million 50 years later. Over that same 50 year period, Berkshire Hathaway compounded at a rate of 21.6%. I would encourage you to take a guess as to what a $100,000 investment would turn into if it compounds at 21.6% over 50 years. I have asked a number of people this question and I’ve found that everyone I’ve asked tends to dramatically underestimate the result. The answer is that you would have $1.8 billion; essentially, 11.7% points of extra compounding annually over 50 years results in you having an additional $1.8bn in your pocket. I find it amazing how exponential returns can drive wealth over long periods of time.
This leads me back to why I think cumulative results should be the central focus in my quarterly letters. At the end of the day, the reason that you invest your money with me is so that you can have more purchasing power in the future. I think that showing cumulative results is more indicative of the additional purchasing power you are gaining through your investments as opposed to showing a quarterly return or even an annual compounded return.
Crystal Cove Capital: The Predictability of Short Term Returns vs. Long Term Returns
In the last quarterly letter I spoke about the difficulty of predicting short term results. I quoted Benjamin Graham when he said that: “In the short run the stock market is a voting machine, but in the long run it is a weighing machine.” I just wanted to expand on that thought. Short term returns are difficult to predict since they are primarily driven by investor sentiment. There are numerous unpredictable variables that drive investor sentiment leading to potentially high levels of volatility in publicly traded assets over short periods of time.
Investor sentiment can swing from exceedingly exuberant to very depressive. We can see symptoms of overly exuberant behavior during the technology bubble in 2000 in which technology companies attained massive valuations. In contrast, during the stock market crash in 2008 investors were overly depressive creating an environment of very low asset valuations.
In contrast to unpredictable short term returns, long term returns tend to be driven by more fundamental variables. For example, if we think about our investment in Liberty Global, our 5 year returns will be driven by the continued superiority of the cable bundle of services relative to competitors, increased penetration and pricing of services leading to growth, scale operations which will drive cost efficiency, as well as the prudent deployment of capital in a manner that is accretive to shareholder value. Our level of certainty is quite high over these factors and the resulting cash generative ability of the firm over the long term. In contrast, we don’t have a clue as to how investor sentiment and the stock price will fluctuate to the numerous news headlines that will be produced in the short term. Given the inherent unpredictability in short term returns over a quarter or even a period of a couple of years, we focus on maximizing long term returns. Given that this focus on long term results is relatively unique in the investment industry, it is one of our primary sources of competitive advantage and one that we seek to exploit to meaningfully increase the purchasing power of your money over the long term.
I want to thank you for your business and entrusting me with your capital. I welcome referrals to any potential investors you think may be interested in our product.