Investor Ron Baron invests in cycles of entropy

Ron Baron, founder of Baron Capital

Anjali Sundaram | CNBC

I started my career as a securities analyst in 1970.

The Vietnam War, Watergate, the resignation of President Richard Nixon, the Iran hostage crisis, recession, inflation, interest rates in the double digits, gas prices tripled. The only crisis we didn’t deal with this decade was the pandemic. In addition, amid the chaos, the stock market crashed, resulting in a global bear market that lasted from 1973 to 1974. It was one of the worst recessions since the Great Depression. The only comparable was the financial crisis of 2007-2008.

My experience in the 1970s was key. The stocks I recommended were small companies. They were included Disney, McDonald’s, Federal Express, Nikeand Hyatt.

I recommended selling these stocks after they doubled or tripled. This was because I was earning brokerage commissions, not wages. A few years later, when I look back, almost all of these stocks continued to grow dramatically.

I have come to the conclusion that instead of trading stocks or predicting market fluctuations, a better strategy is to discover and invest in great companies at attractive prices and stay invested for the long term.

I believed then, and I still believe now, that you don’t make money trying to predict short-term market movements.

In my 52 years of investing, I have never seen anyone consistently and accurately predict what the economy or the stock market will do. So, when outliers occurred and stocks fell flat, I believed it represented a long-term opportunity.

Investment in “pro-entropic” businesses

I also learned how to invest in “entropic” businesses. Entropy—disorganized chaos—is where I’ve seen many of the best companies not only survive, but thrive. They took advantage of the opportunities created by the difficult times. They acquired weaker competitors at a lower price or gained market share as their competitors weakened. They positioned customers by building loyalty and goodwill, increasing lifetime value. They trimmed extra fat elsewhere in their budgets, creating long-term efficiencies while continuing to invest in key areas like R&D and sales. When conditions normalized, they were better positioned than ever to take advantage of their resilience.

After the bear market of 1973-1974, I saw this pattern play out over and over again. The stock market crash of 1987, the dot-com bubble burst of 2000-2001, the financial crisis of 2007-2008, and now. That’s why I like to say we invest in companies, not stocks.

We look for companies that will grow faster than average over full market cycles. We invest based on what we think the business will be worth five or 10 years from now, not what it’s worth now.

Our goal is to double our money every five to six years. We strive to achieve this by making long-term investments in companies that we believe have a competitive advantage and are run by exceptional people.

Tesla example

Tesla probably the most well-known company we own right now. But I would note that this is not an outlier. In fact, Tesla is a perfect example of how our long-term investment process works.

We first invested in 2014. I thought Elon Musk was one of the most visionary people I’ve ever met. What he proposed was so revolutionary, so disruptive, yet so meaningful.

We have owned shares of Tesla for years while it was building its business. Sales were up, but its share price was mostly flat, albeit extremely volatile. During that time, we remained an investment, and when the market finally caught up in 2019, Tesla’s stock price increased 20-fold. That’s why we try to invest in companies early – because you never know when the market will finally accept the value we perceive, and that drives the share price higher.

We only invest in one type of asset – growth stocks. Why? Because we think growth stocks are the best way to make money over time.

While the simple answer to fighting inflation is to invest for the long term, the concept of compounding tells us why. … Over time, this effect snowballs…

Historically, our economy has grown by an average of 6% to 7% annually in nominal terms, or twice every 10 to 12 years, and stock markets have closely mirrored this growth. In 1967, US GDP was $865 billion, but 55 years later it was $25.7 trillion, or 28 times what it was in 1967.

The S&P 500 Index In 1967 it was 91. Now it’s up to about 3,700.

We seek to invest in companies that are growing twice as fast as we believe stock prices do not reflect their favorable prospects.

Stocks are also a great hedge against inflation. Inflation is back in the headlines, but it has always been there. The dollar’s purchasing power has fallen by about 50% every 18 years on average over the past 50 years.

Although inflation causes currencies to lose value over time, it has a positive effect on tangible assets, business and economic growth. This means that stocks are the best hedge against devaluation of your money.

While the simple answer to fighting inflation is to invest for the long term, the concept of compounding tells us why. When your savings earn income, compounding allows that income to earn more income. Over time, this effect snowballs and profits grow exponentially.

So if you’re earning 7.2% on an investment, which is the historical annual growth rate of the stock market over the past 60 years (excluding dividends), the growth of your investment will be exponential. After 30 years, you will get almost seven times your original amount, 12 times in 40 years and more than 23 times in 50 years!

I would also like to note that the stock market is one of the most democratic investment vehicles — real estate, private equity, hedge funds, etc. unlike is accessible to everyone. My parents have a chance to increase their savings. Even today, 40 years later, that’s why I do it.

Ron Baron is the chairman and general director Baron CapitalThe company he founded in 1982. Baron has 52 years of research experience.

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