Churning is costly. On each side of the transaction brokers (or ‘croupiers’ as Charles Munger, Mr Buffett’s Vice-Chairman, has called them) extract a commission. Mr Buffett has estimated that the sum of all commissions, fees, etc. generated by churning is vast. In his words, “my estimate is that investors in American stocks pay out well over $100 billion a year-say, $130 billion-to move around on those chairs or to buy advice as to whether they should! Perhaps $100 billion of that relates to the FORTUNE 500. In other words, investors are dissipating almost a third of everything that the FORTUNE 500 is earning for them by handing it over to various types of chair-changing and chair-advisory ‘helpers’....In my view, that’s slim pickings.”

Churning is also costly in a more general sense. It is not sufficiently recognised-but is nonetheless fundamentally important to understand-that the more frequently one trades the poorer one’s results. This point applies as much to major institutions (whose portfolios’ annualised churn rates are often 50% and may exceed 100%) as it does to day traders. Clearly, the greater the frequency of trading the greater the amount paid in commissions. Accordingly, and as Charles Ellis has demonstrated, the more frequently one trades the more profitable one’s trades must be in order to counteract the ‘drag’ imposed by commissions and other charges. But trading, as demonstrated in Why Speculation Inevitably Ends in Tears and any number of other analyses, is virtually never a lucrative or socially-redeeming exercise. Hence a result demonstrated most convincingly in an article by Terrence Odean and Brad Barber entitled Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors.

Leithner & Co., in sharp contrast, attempts to locate, purchase and (wherever possible) retain indefinitely a manageable number of good businesses. This process-if it acquires good businesses at good prices, and if these businesses remain good businesses-can over time yield reasonable results. To see this, consider as a thought experiment that we have $100 to invest; that we invest it in a security whose intrinsic value compounds at a rate of 15% per year and whose market price, by some miracle, always corresponds to its intrinsic value. Assume for simplicity that capital gains tax (CGT) is levied at a rate of 15%; that (more miracles) there are no brokerage fees; and that the security’s initial purchase price is $1.00 per share. If we sold the security one year after we bought it then we would have an after-tax gain of $0.105 per share and total investment capital of $110.50. If we used this capital immediately to repurchase the security at $1.15 per share, held these shares for a year, sold them, paid CGT, and repurchased every year, then after 10 years we would accumulate 70 shares, pay CGT of $73, pocket $271 and earn a compound rate of return of 10.1% per annum. If we paid brokerage fees of just 0.5% per transaction then after 10 years we would accumulate fewer (64) shares, pocket a lesser amount, $245, and earn a lower compound return of 9.0% per annum. If, on the other hand, we purchase 100 shares at $1.00 per share, hold them for 10 years (thereby delaying CGT and brokerage fees) and sell them at the end of the tenth year, then we would pay more ($92) in taxes – but also pocket more cash ($313) and increase the compound rate of return to 11.9% per annum.

Leithner & Co. has neither the talent nor the disposition to churn securities in anticipation of favourable short-term movements of their market prices. Given the benefits of the buy-and-hold approach, it makes sense to devote considerable amounts of time and energy to the identification of sound securities. And given the costs of the ‘churn’ approach, it makes sense to regard market prices not as signals to trade but rather as opportunities to acquire part-ownership of sound businesses at reasonable prices. Accordingly, with respect to the frequency of buying and selling (as opposed to the intensity of research) lethargy bordering upon sloth forms a cornerstone of its approach to investment.