When I was a kid, my Mom taught me that she would be the most important woman in my life, until I married, at which point my wife would become the most important woman in my life. This guidance, beyond reinforcing the all-star status of my mother and her support as a mother-in-law, reminds us that some things are more important than others, and these can change over time.
This thinking applies to investing, especially as asset classes mature and cycle. While my research and advisory work centers on timberland markets and the forest industry, the investment lessons apply generally.
Specify the thesis. Why invest in this asset? Why accumulate shares of stock in this company in this industry? Why is this a good investment for you or your client? In my experience, robust justifications are one or two sentences in length and well-supported by available data. Yesterday, I had two phone calls with clients related to capital investments, one in timberland and another in manufacturing. In both cases, the clients had clear, specific theses that aligned with our knowledge of the local markets and physical facts on the ground.
Long stories and justifications, like a long chain, erode confidence and magnify risks. In forestry, few investors flock to timberlands to secure outsized absolute returns. Rather, mature forestry and timberland investments support portfolio diversification and preserve wealth and generate consistent cash flow.
Understand value drivers. While all firms have financial statements, the importance of individual line items varies. Sensitivity analysis helps clarify the two or three things that drive investment performance, and the inability to point these out indicates lack of preparation, knowledge or transparency. To me, one of the most impressive and energizing aspects of spending time with people who really understand their fields or businesses is their ability to clarify what matters in their operation.
For example, forest investments can endure large swings in management costs and volumes or prices of lower grade products; however, returns on investment in forestry are highly sensitive to discount rates, realized sawtimber volumes, and sawtimber prices. And for timberland investments, the “cost of the dirt,” the dollars allocated to the land influence investment returns for shorter holding periods. This type of analysis highlights the dependence of timberland returns on the local markets for wood, assumptions related to future prices, and the ability to implement site-appropriate forest management plans. For timberland investors, do we really need to manage forests to make money? Is it worth the extra effort? Analysis of value drivers tells us yes.
Manage costs. While a short list drives value creation, we erode the compounding benefits of these returns if we fail to manage costs. In 2019, the two words “costs” and “control” came up more than any other when talking with investors about the performance and management of their timber-related assets.
For timberland, your returns depend largely on three things. One, what you pay for the forestland. Two, how long you stay invested. And three, how much you pay in fees to manage the forest. The need to understand fees motivates our research into forest management and silviculture costs in the South and Pacific Northwest for timberland owners.
As with any asset, the actual investing in and managing of timberland requires discipline, patience and a sharp pencil. A framework or checklist can offer a working set of priorities for minimizing errors, mitigating risks and maximizing potential returns. In the end, while priorities can change over time, know what matters today.
P.S. Happy Birthday, Mom.