Ownership of businesses through multiple economic cycles

An important aspect of the Growth Stock Theory of investment as envisioned by Mr. Thomas Rowe Price in the early 1930s is the concept of owning companies through the ups and downs of business and stock market cycles.

This approach distinguishes the genius of Mr. Price's discipline from almost everything else that you hear from Wall Street and the financial media.

Since at least the early 1860s, when Clement Juglar (1819 - 1905) began publishing his observations that economies pass through predictable up-and-down cycles every seven to eleven years, this so-called "business cycle" (sometimes called "Juglar cycle") has become a fixture in economic textbooks and the general consciousness, and investors have sought to make money (or avoid losing money) by timing their investments to various predictors of the next shift in the cycle.

Major financial services firms dole out analysis and advice on what the latest job report or retail sales number means in regards to where we are in the business cycle at any given moment, and what sectors or assets you should be switching to next. Do the business cycle indicators mean that you should switch from small-cap stocks to large-cap stocks now? From value to growth? From stocks in the Energy sector to those in Consumer Staples?

In contrast to all of this, Mr. Price wrote that by the early 1930s, after ten years experience in the investment business, he had learned that "most other people, including various stock market services, were unable to predict the market over an extended period of time." He made the important observation that "the various systems usually failed at crucial turning points in the market" ("A Successful Investment Philosophy based on the Growth Stock Theory of Investing," T. Rowe Price, 1973).

Price's response was to reject the endless attempts to time the various cycles. Instead, he sensibly observed (as we have discussed at length in several previous posts) that "most of the big fortunes of the country were made by men retaining ownership of successful business enterprises which continued to grow and prosper over a long period of years."

A vitally important point that he makes about the owners of such successful businesses is that "They did not attempt to sell out and buy back again their ownerships of the businesses through the ups and downs of the business and stock market cycles" (emphasis in the original).

The concept of holding a company based on the growth of the company, rather than its market value within the ups and downs of the business cycle, was a totally different approach. The very term "Growth Stock Investing" suggested a focus on criteria other than the business and market cycles followed by other investing methodologies.

In the same discussion of his theory, Mr. Price cautioned "That a stock is considered to be a growth stock is no assurance against a decline in earnings, dividends or market values during a downtrend in the business cycle when earnings and dividends of many companies decline." This fact no doubt creates a strong temptation to try to respond when such declines begin to hit, but Price's observation from the 1930s, that systems of cycle timing "usually failed at crucial turning points" continues to hold true today (recent failures of such systems at well-known hedge funds, by respected and experienced traders, provide additional proof, if any is needed).

However, as we have also discussed previously, this rejection of the timing of economic cycles does not translate into a blind or obstinate "buy and hold" mentality of never selling any business once purchased. The hallmark of the growth theory is that it recognizes that corporations themselves, "like people, pass through a life cycle of growth, maturity and decline," as Mr. Price put it.

Instead of trying to time the ups and downs of the business cycle, we recommend instead looking for companies that are in their growth cycle. In fact, as we have noted previously in last month's "Return of the 1970s?" posting, companies that are in their own growth cycle can provide exceptional returns, even during a time period which is atrocious in terms of the overall business cycle, such as took place in the 1970s.

This is a crucial concept. Unfortunately, it is little understood today, seven decades after Mr. Price first began to explain it to the public.

For later posts dealing with this same topic, see also:

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