How many billionaires are there in the United States? There is no definitive count. Most estimates put the number well below 1,000–with 927 being by far the highest estimate we have seen. Whatever the precise number, given the power of compounding, there should be many times the number of billionaires in this country than there are today. Assuming a 10% annualized rate of return in the stock market over the last 100 years, a family needed to invest $72,000 in 1922 and then simply leave it alone to have around $1 billion in 2022. We have no idea how many families had that kind of money to invest in the stock market back in 1922, but whatever the number, we believe it was much larger than the number of present-day billionaires.
What happened to all those could-have-been billionaires? Why do more investors not reap the benefits of compounding? We believe the reason has surprisingly little to do with recessions, depressions, wars, financial crises, political crises, rising interest rates, inflation, stagflation, a global pandemic, or most adverse macroeconomic events. The stock market’s return over the past 100 years includes all of these terrible things. Yet, the stock market still compounded wealth to the point where every $1 invested in the S&P in 1922 and left untouched would have become nearly $13,800 in 2022! Our conclusion: it is not adverse macro events that derail compounding; it is investors’ reactions to them. In short, investor behavior derails compounding.
Examples of such counterproductive behavior are well known to all of us: trying to sell before the next recession, trying to buy just before the next bull market, “repositioning” portfolios based on what is supposed to do better in the new paradigm, dumping stocks during a downturn, which deprives oneself of the means to eventually recover. People do these things because they are intuitive, because these actions appear rational in the face of heightened concern and uncertainty. This is precisely why compounding over the long term is so challenging and rare: it demands counter-intuitive and seemingly irrational behavior.
One of our favorite Buffett maxims is that the stock market exists to serve investors, not instruct them. We think it speaks to the importance of distinguishing between the fundamental performance of a business and the price movement of its stock. Investors minding both can periodically be served by the stock market when business fundamentals and share price diverge. Too often, however, investors are informed only by share price movements from which business fundamentals are then inferred. These investors are not served by the stock market. Rather, they are instructed by it and typically to their detriment when it comes to compounding.
I would like to provide a couple of examples of divergence between fundamentals and share price for the year-to-date period through May 13, 2022.
The first example is CarMax. In the fiscal year completed February 28, 2022, CarMax, the business, did the following:
• Increased retail units sold by 23%.
• Increased wholesale units sold by 66%.
• Increased free cash flow per share by 47%.
• Increased its market share of 0-10 year-old vehicles sold from 3.5% to 4%, a 13% increase in market share over the past year.
CarMax achieved these record results while rebuilding its business to be able to offer the best in-store experience, the best online experience, and everything in between, all while maintaining CarMax’s unmatched transparency and fairness to the consumer.
If that sounds impressive, we agree. So how has CarMax, the stock, done so far this year? Down nearly 30% YTD through May 13, 2022.
The second example is private equity powerhouse KKR. In 2021, KKR, the business, did the following:
• Increased assets under management organically by 48%.
• Increased fee-related earnings by 54%.
• Increased distributable earnings by more than 100%.
• Raised $121 billion of new capital, nearly half of that for strategies KKR didn’t have just 5 years ago.
• Finished the year with $112 billion of investable “dry powder.”
• Grew book value by 25%.
Again, spectacular fundamental performance. So how has KKR, the stock, done so far this year? Down nearly 31% YTD through May 13, 2022.
Now, we understand that stock prices take their cue from the future, not the past, and that share price declines in 2022 have to do with concerns over worsening conditions in the near term. But that does not obviate the point, which is that we believe our businesses continue to become more valuable as earnings power continues to grow. It is ironic that if CarMax was not publicly traded, if it was a private business held in a private equity fund, its valuation might justifiably be marked higher after the year it just had. But, this irony is also the source of great opportunities in public equities thanks to the behavior induced by ever-changing stock prices.
Hopefully, these illustrations for CarMax and KKR demonstrate why we remain steadfast believers in the businesses in which we invest. Our focus is on the fundamentals. We do not infer those fundamentals from share price movements. Rather, we endeavor to let the market serve us when fundamentals and share prices diverge. This is the best way we know to avoid the behavior that history proves so detrimental to compounding.