Once we became excited about the probable recovery in the housing market, we decided to invest about 20 percent of the funds we managed in stocks that should benefit from the recovery. Lowe’s was our number one pick. After researching a few dozen other companies, we purchased a medium-sized position in Whirlpool Corporation and small positions in The Home Depot, Lennox International (a manufacturer of air conditioners and furnaces), and Mohawk Industries (a manufacturer of carpets and other flooring materials). Why was Lowe’s our number one pick and our largest position? Simply, Lowe’s appeared to be materially more undervalued than Home Depot and the other larger capitalization stocks we researched. Home Depot had made a number of excellent merchandising decisions and was operating on eight cylinders. Lowe’s was sputtering some, and the price of its shares reflected the sputtering. In 2011, Lowe’s had revenues of $50 billion and a market value (the price of shares times the number of shares outstanding) of only about $24 billion. Therefore, an investor received about $2.08 of revenues for each $1 of market value. Home Depot had revenues of roughly $70 billion and a market value of $56 billion. Thus, an investor received only $1.25 of revenues for each $1 of market value. The comparison of revenues to market value was one of many comparisons we performed. All the comparisons clearly showed that, if Lowe’s engine revved up and purred, we could make far more money in Lowe’s than in Home Depot.

Liquidity was another consideration. Lowe’s had a market value of $24 billion. Lennox and Mohawk had market values of only $2 billion and $4 billion. Their shares did not trade in sufficient quantities to permit us to easily purchase or sell large quantities of the shares. Liquidity helps protect us from permanent losses. We do make mistakes, and when we make a mistake, we sometimes wish to exit the mistake quickly. We are victims of our own success. Because our strategies and disciplines have been successful over the years, we have earned high returns, and because we have earned high returns, we have materially more assets under management than if our results had been less favorable. The increased size of assets under management definitely reduces our flexibility and therefore our future returns. No good deed goes unpunished.

As it turned out, when housing-related stocks started to rebound in 2012, Home Depot, Lennox, and Mohawk initially outperformed Lowe’s. Investors generally had opted for the cleaner and clearer fundamentals. Lowe’s merchandising problems were an uncertainty—and many investors shy away from uncertainties. The price of Home Depot’s, Lennox’s, and Mohawk’s shares continued to climb sharply in early 2013, and we then sold the shares for roughly twice what we paid for them.

Of our five housing-related investments, Whirlpool was my second favorite. The company’s shares were selling at a depressed price because the company’s earnings had been under pressure from sharply increased costs for steel and other raw materials and from weak demand for appliances. We reasoned that there was a high probability that the cost of raw materials would stabilize or decline and that the demand for appliances would increase sharply as the housing market recovered. We projected that the company could earn roughly $20 per share five years hence and that the shares could then be worth $250 to $300. The shares were trading at about $80 at the time we performed our analysis. Thus, if all went well, the shares would be a superb investment.

Whirlpool was founded in 1911 by Lou Upton as the Upton Machine Company. Until that time, clothes washing machines were wooden tubs. Housewives filled the tubs with clothes, water, and soap and then scrubbed the clothes by hand. Upton added an electric motor to the tub. Almost immediately, Upton received an order for 100 of his newfangled washing machines from a company named Federal Electric. However, a problem soon arose when a cast-iron gear broke in many of the machines. Upton quickly replaced the defective part with a new gear made from steel. The problem was solved, and Federal Electric was so impressed by Upton’s speedy reaction and business ethics that it ordered an additional 100 machines. A company was born.

In 1929, Upton merged his company into the Nineteen Hundred Washer Company of New York, which evidently was an innovative company in spite of its totally uninnovative and awkward name. After producing airplane parts during World War II, the Nineteen Hundred Washer Company, anticipating a large postwar demand for home appliances, successfully introduced a broader line of appliances. In 1949, the company’s management demonstrated infinite wisdom by changing the name of the company to Whirlpool. At the time of the name change, Whirlpool’s revenues were $48 million. Over the next 50 years, Whirlpool continued to aggressively introduce new products and acquire other companies. By 1999, the company’s revenues had reached $10,511 million, a 219-fold increase versus 1949.

I find that the following data are both interesting and important. Whirlpool’s growth in revenues from $48 million in 1949 to $10,511 million in 1999 seems huge, but actually equates to a compound annual growth rate (CAGR) of only 11.4 percent. This means that if the company’s profit margins and price-to-earnings (PE) ratio remained flat during the 50-year period, an investor’s average annual return during the 50-year period would have been only 11.4 percent, plus dividends that were received. Since Greenhaven strives for annual returns of 15 to 20 percent, if we had owned Whirlpool for the 50-year interval, the investment would have been subpar, in spite of the 219-fold increase in revenues.

In the 1950s, the appliance industry was a growth industry, as many homeowners purchased dishwashers, freezers, and clothes dryers for the first time. During the 12-year period 1949 to 1961, Whirlpool’s revenues grew from $48 million to $437 million, which is equal to a CAGR of 20.2 percent. During the next 38 years, the appliance industry matured and slowed, and Whirlpool’s growth slowed to an 8.7 percent average annual rate. I believe that there is an important lesson in this. Over time, the growth rates of almost all technologies, products, and services slow because of saturation, obsolescence, or competition. Many investors tend to project high growth rates far into the future without fully considering forces that eventually will lead to slower growth. In the late 1960s and early 1970s, it became fashionable among many investors to purchase growth stocks with the intention of holding the stocks forever. These investors focused on about 50 stocks that appeared to have superior growth characteristics. Due to the popularity of the stocks, their prices rose substantially, and they sold at historically high PE ratios. The growth stock investors made the argument that the high PE ratios were neither a relevancy nor a risk, and therefore should be ignored. Their logic was that if a company was growing at a 20 percent rate and if the company’s stock was going to be held for many decades, the investor would earn a high return even if the PE ratio declined materially over the decades. For example, if shares of a company growing at a 20 percent annual rate were purchased at 30 times earnings and were sold 30 years later at 20 times earnings, an investor still would enjoy an average annual return of 18.4 percent (plus dividends). The 50 favored growth stocks became so popular with so many investors that they even were blessed with a nickname: the Nifty-Fifty. As a result of their popularity, the Nifty-Fifty eventually started selling at excessive PE ratios. According to Fortune magazine, in December 1972, the average PE ratio of the Nifty-Fifty growth stocks was 42 times. Coca-Cola sold at 46 times earnings, IBM at 35 times, Johnson & Johnson at 57 times, 3M at 39 times, Merck at 43 times, and Xerox at 46 times.

As it turned out, the Nifty-Fifty were not so nifty after all. The growth of most of the 50 slowed to normal or below-normal rates over the years. Worse, many of the companies developed serious problems. Two of the companies (Kodak and Polaroid) eventually filed for bankruptcy. A number of the other companies (including Digital Equipment and S. S. Kresge) ran into difficulties and were sold to larger companies at relatively low prices. It may be difficult to believe, but Citicorp (then named First National City Bank) was one of the Nifty-Fifty, as were J.C. Penney and Sears Roebuck.

At one time, the Nifty-Fifty were called one-decision stocks: a decision was made to purchase the stocks, and because the stocks would be held forever, no decision ever was required to sell them. Well, unfortunately for the advocates of the one-decision growth stocks, painful second decisions were required in 1973 when the prices of the Nifty-Fifty stocks started to tumble. From their 1973–1974 highs to their 1974 lows, the price of Xerox’s shares declined by 71 percent, Avon’s by 86 percent, and Polaroid’s by 91 percent. The leading proponents of one-decision growth stocks had led their followers over a cliff.

It seems to me that the boom-bust of growth stocks in 1968–1974 and the subsequent boom-bust of Internet technology stocks in 1998–2002 serve to disprove the efficient market hypothesis, which states that it is impossible for an investor to beat the stock market because stocks always are efficiently priced based on all the relevant and known information on the fundamentals of the stocks. I believe that the efficient market hypothesis fails because it ignores human nature, particularly the nature of most individuals to be followers, not leaders.¹ As followers, humans are prone to embrace that which already has been faring well and to shun that which recently has been faring poorly. Of course, the act of buying into what already is doing well and shunning what is doing poorly serves to perpetuate a trend. Other trend followers then uncritically join the trend, causing the trend to feed on itself and causing excesses.

Often, investors invent a thesis to justify a trend: “Outsized returns can be realized by purchasing growth stocks regardless of their PE ratios because their PE ratios are not relevant over the longer term.” Or “New Economy Internet stocks will continue to grow exponentially—and Old Economy stocks are dead and should be sold.” In my opinion, booms become particularly dangerous when the theses that justify the booms generally become uncritically accepted by investors. Then, investors are prone to become complacent and to accept the excesses as new norms. History books are full of booms and busts, and booms and busts likely will continue to occur because of the proclivity of humans to become uncritical participants in trends and fads.

I have a thesis about why so many human beings are uncritical followers of trends. I cannot prove the thesis, but it makes sense to me. My experience and observations are that many intelligent investment professionals who are followers fully recognize that they are followers. Yet, try as they may, they do not have the innate ability to change and become leaders and buckers of the conventional wisdom. Thus, I conclude that their proclivity to be followers is at least partially, if not largely, hardwired and genetic. I further conclude that only a small percentage of humans are leaders. There is logic to this. Human beings have been civilized for only about 10,000 years. For the prior approximately 200,000 years, they were hunter-gatherers who traveled in bands in search of food and shelter. To be successful, bands normally could have only one leader. If there were more than one leader in a band, dissension likely would develop over decision making, and the stronger leader eventually would eliminate the weaker ones. Leaders tend to seek absolute power and sometimes will murder rivals or potential rivals in order to protect their position. History books tell of kings who murdered their siblings, or even their children, in order to eliminate the threat of competition. Thus, over tens of thousands of years, many humans with leadership genes were eliminated by survival of the fittest, leaving the vast majority of hunter-gatherers as followers. Scientists say that the genetic composition of present humans is almost identical to the genetic composition of hunter-gatherers. Therefore, only a minority of present humans have the leadership gene, and most humans tend to be followers.

A corollary thesis explains why so many investors are too focused on short-term fundamentals and investment returns at the expense of longer-term fundamentals and returns. Hunter-gatherers needed to be greatly concerned about their immediate survival—about a pride of lions that might be lurking behind the next rock or about the vicinity of a neighboring enemy tribe that might attack and kill. They did not have the luxury of thinking about longer-term planning. Through the selection process, many of those that did not possess the ability to react to immediate dangers did not survive. Then and today, humans often flinch when they come upon a sudden apparent danger—and, by definition, a flinch is instinctive as opposed to cognitive. Thus, over years, the selection process resulted in a subconscious proclivity for humans to be more concerned about the short term than the longer term.

I note that others also have come to the conclusion that much of human economic behavior is genetic. Notably, Daniel Kahneman won a Nobel Prize in 2002 for his work on prospect theory, which concludes that people often are prone to make irrational decisions that are based on inherited intuitions as opposed to logical conclusions. Kahneman and others invented a new branch of science called behavioral economics that studies the influence of human behavior on economic decision making.

Late in the 1998–2000 Internet boom, I received telephone calls from two clients who tended to be followers and who were overly focused on the short term. The first call was from Dick Albright, an intelligent older man who had sold his business and who now passionately collected antique Chinese furniture, especially furniture made from huanghuali wood. At the time Dick called, our stocks were doing fine, but not nearly as fine as Internet-related stocks. Dick mentioned that his son, who most unfortunately had lost his regular job and now was day-trading Internet stocks from a computer in his apartment, was materially outperforming Greenhaven. Dick strongly suggested that I test the waters by purchasing a few Internet stocks: “Just buy two or three to broaden your knowledge, because if you don’t learn something about the New Economy, you may lose your relevance as an investment manager. Maybe my son can give you some ideas; maybe you can learn something from him about investing in the New Economy. Here is his telephone number. You really should call him; he is in his 20s and he really understands digital technology.” I did not call him, and I did not purchase any of the overpriced Internet stocks.

The second call was from Frank Heat, a retired Goldman Sachs investment banking partner. Frank simply could not understand how Greenhaven managed to completely miss the Internet boom. “Where were you? Were you asleep?” I carefully explained what I normally explain to clients: that we are value investors who seek margins of safety in value stocks—and that there are risks of obsolescence in high-technology stocks that do not give us the margin of safety that we cherish.

Both clients called me several additional times with the same complaints. Finally, I successfully convinced Dick that he should seek another investment manager (maybe his otherwise unemployed son), and Frank left on his own accord. Of course, soon after the two clients departed (presumably for investment managers who were heavily invested in excessively priced New Economy Internet stocks), the bubble abruptly burst, with many technology stocks losing more than three-quarters of their market value.

During the 1997–2000 boom period for technology stocks, a typical Greenhaven account’s average annual return was 18.5 percent. The Standard & Poor’s (S&P) 500 Index’s average annual return during the period was 22.4 percent (the Index was heavily weighted with technology stocks). We lagged. Near the end of the boom, I was happy to lag. I told my associates that if the S&P 500 Index continued to increase sharply due to the further appreciation of materially overvalued Internet-related stocks, I wanted to lag the Index. The only way we could outperform an already overvalued index was to take risks that would be unwise, unsound, and irresponsible.

Then, during the sharp market decline of 2001 and 2002, Greenhaven’s average annual return was a positive 3.4 percent, while the S&P 500’s was a negative 18.2 percent. Internet and many other New Economy technology stocks were dumped by investors. Our stocks generally held their own, in spite of the strong headwind of a declining stock market.

Every once in a while, the stars align for an investment manager. Such was the case in 2003 to 2005. In early 2003, the “Old Economy” stocks we owned were selling at undeservedly depressed prices. They had been underowned during the Internet boom. Furthermore, we had an exciting opportunity to purchase shares of companies that produce commodities. In the early 2000s, China and a number of other emerging countries markedly increased the quantities of crude oil, steel, copper, and other commodities they were purchasing to meet the needs of their growing economies. Demand started to exceed supply for many commodities, and their prices started to rise sharply. Greenhaven noticed this and purchased shares of companies that produce oil, fertilizer, and paper. We were in the right place at the right time, and during the three-year period 2003 through 2005, our average annual return was 34 percent, far above the S&P 500’s 12.8 percent.

I sometimes wonder how Dick Albright’s and Frank Heat’s portfolios fared during the 2000–2005 period. Probably quite poorly. Patience, steady emotions, and common sense all are important attributes when investing in common stocks.

The sharp increase in commodity prices between 2003 and 2008 helped create an opportunity for us to purchase Whirlpool’s shares in 2011 at a particularly and undeservedly depressed price. The years 2003 through 2011 were an absolutely hellish period for Whirlpool. From 2003 to 2011 the price of steel, copper, and plastics (the key raw materials used to manufacture appliances) increased sharply. The price of copper increased from an average of $0.81 per pound in 2003 to about $4 per pound in 2011. During the same eight-year period, the typical domestic price of hot rolled steel increased from about $270 per ton to about $650 per ton. Between 2003 and 2011, Whirlpool’s annual raw materials costs increased by about $3.5 billion, or by about 18 percent of revenues. What a headwind! Actually, what a storm! Moreover, after the housing market started to weaken in 2007, the demand for large appliances fell sharply. According to the Association of Home Appliance Manufactures, U.S. industry sales of the “big 6” appliances (washers, dryers, refrigerators, freezers, dishwashers, and ranges) declined from about 47 million units in 2006 to about 36 million in 2011. In an environment of weak demand, Whirlpool had difficulties increasing prices sufficiently to offset its increased costs for raw materials. Thus, Whirlpool simultaneously suffered from increased raw material costs, reduced sales, and pressured pricing. Not a happy situation.

Amazingly, Whirlpool remained profitable during the entire 2003–2011 period in spite of the hurricane-force headwinds. To the credit of management (especially Jeff Fettig, who had become CEO in 2004), the company aggressively and continually reduced its costs during the period. Products were redesigned to reduce the use of raw materials and to increase the commonality of parts, plants were consolidated and relocated to low-cost geographies, employee benefits were reduced, and advertising and other overhead expenditures were curtailed. In Whirlpool’s 2008 annual report, management listed three strategic priorities. The first priority on the list was to “reduce our global cost structure”:

We are taking aggressive action to redesign our products with global standards for parts and components. This proven global approach lowers costs, improves quality, and speeds our time from design to market. The difficult decision to close five manufacturing facilities and reduce approximately 5,000 positions globally will allow us to further reduce costs and operate more efficiently in 2009. We are aggressively managing all costs in every part of our business to rapidly adjust our cost structure to current and expected global demand levels. … The decisive and thoughtful actions we are taking today will significantly lower our overall cost structure.

In the spring of 2011, Greenhaven studied Whirlpool’s fundamentals. We immediately were impressed by management’s ability and willingness to slash costs. In spite of a materially subnormal demand for appliances in 2010, the company was able to earn operating margins of 5.9 percent. Often, when a company is suffering from particularly adverse industry conditions, it is unable to earn any profit at all. But Whirlpool remained moderately profitable. If the company could earn 5.9 percent margins under adverse circumstances, what could the company earn once the U.S. housing market and the appliance market returned to normal?

We made an Excel model that guesstimated what Whirlpool might earn in 2016. The model assumed that the housing industry had recovered by then. About 53 percent of Whirlpool’s revenues came from the United States. The remaining revenues came from Latin America (mostly Brazil), Europe, and Asia (mostly India). We made conservative guesses about future non-U.S. revenues and profit margins, but focused most of our efforts trying to project future U.S. earnings. Our best guess was that if the housing industry recovered, U.S. revenues would grow at a 7 to 8 percent CAGR between 2010 and 2016. We then tried to analyze Whirlpool’s operating leverage. After looking at past data and after speaking to management, we estimated that for each $1 increase in revenues, Whirlpool’s pretax profits should increase by about $0.20 before future cost reductions (and the company was in the midst of several programs to further reduce costs). Our conclusion was that the company’s revenues and operating margins in 2016 could be roughly $25 billion and 10 percent, and thus its operating profits could be about $2,500 million. We estimated that the company’s 2016 interest costs, effective tax rate, and diluted share count would be $275 million, 28 percent, and 80 million, respectively. Given these educated guesses and projections, Whirlpool would earn about $20 per share in 2016.

The $20 earnings per share (EPS) estimate assumed that raw material costs stabilized but did not decline. My analysis was that there was a high probability that the prices of steel and copper actually would decline between 2011 and 2016, thereby providing Whirlpool with an additional tailwind. The price of copper, for example, started spiking sharply in 2003. The apparent primary cause of its fivefold increase in price by 2011 was China. The numbers are telling. Between 2003 and 2011, China’s consumption of copper increased at a 12.4 percent annual rate from 3,056,000 tons to 7,815,000 tons. In 2011, China consumed 4 out of every 10 pounds of copper consumed in the world.

My experience and logic is that when the price of a commodity increases sharply, countervailing forces come into play. Specifically, high prices incentivize producers to increase their capacity and incentivize users to reduce their consumption through conservation or substitution (aluminum can replace copper in many electrical applications). There is elasticity of supply and elasticity of demand. The usual result is that supplies start exceeding demands—and, consistent with the laws of supply and demand, prices fall.

Over the years, when an industry’s condition turns tight, I have often heard management say “it is different this time; the industry has become disciplined and will not add excess capacity.” However, except for commodities whose supplies and prices are controlled by cartels, I have yet to witness a commodity that has remained in tight supply for a prolonged period. It takes only one or two managements who desire to add capacity in order to take advantage of existing highly profitable conditions. Then, other managements, fearful of losing market share, also start planning capacity additions. The result is large additions to capacity and a resulting softer (or soft) market. Unless pricing is controlled by a cartel, commodities tend to be cyclical—very cyclical.

The proclivity of managements to develop herd instincts when deciding to add to capacity is an example of the “fallacy of composition,” which states that a decision or action that is rational for one or a few individuals or companies becomes irrational if a whole group of individuals or companies follow the decision or action, and the outcome of the irrationality is adverse for all. An example of the fallacy of composition would be the tendency of hundreds of theatergoers to simultaneously rush for the single exit when there is a cry of “fire” in a crowded theater. If only a few had rushed for an exit, they likely would have made a quick, unharmed escape. But the simultaneous rush of hundreds likely would result in trampling and injuries, or worse.

I was a witness to one decision to add to capacity. In 1981, I received a telephone call from Bob Hellendale, the chairman and president of Great Northern Nekoosa Corporation, a manufacturer of newsprint, pulp, and other “paper” products. Great Northern was considering constructing a large new pulp mill on the Leaf River in Mississippi. Bob Hellendale planned to present the plans to Great Northern’s board of directors for approval, and he asked me to listen to and critique his presentation prior to the board meeting. The economics of the proposed mill largely were a function of the cost of the mill, investment tax credits that Great Northern would receive from the U.S. government, the assumed price of pulp, and the assumed production and overhead costs. Bob Hellendale’s projections assumed that prices would increase at a rate near the top end of their historical range and that costs would increase near the bottom end. It seemed to me that Great Northern’s management wanted to build the mill and had adopted assumptions that would justify the construction. When Greenhaven is weighing whether or not to purchase a security, we usually make assumptions that hopefully will prove conservative. Great Northern did just the opposite. So much for discipline within an industry that produces commodities!

A securities analyst or portfolio manager must be careful when basing decisions on statistical information, such as historical price or cost trends. Statistics can be misleading if they are incomplete or are slanted to justify a predetermined decision, such as the decision to build the pulp mill. An example of a misleading statistic is the statistician who relied on his conclusion that a stream was three feet deep on average—and drowned trying to cross it.

Now that we had concluded that Whirlpool could earn as much as $20 per share in 2016 if the housing industry fully recovered by then, we had to value the shares. This proved to be difficult. While I have spent most of my working life valuing companies, sometimes I am stumped because of uncertainties. In the case of Whirlpool, I had difficulty assessing the company’s competitive position. It appeared that the company was the low-cost producer in its industry and that most of its competitors were unprofitable. There were several other positives: Whirlpool had eliminated a major competitor when it purchased Maytag; Sears Roebuck appeared to be losing market share (and in trouble as a company); and GE seemed to have lost some of its competitiveness due to insufficient investments in productivity and design. But there also was a large negative. Two Korean competitors (LG and Samsung) seemed bent on gaining market share, even if they needed to slash prices to do so. Whirlpool had filed antidumping charges against the Korean companies, but the outcomes of the charges were uncertain. On balance, my best guess was that Whirlpool was not worth more than 15 times its normalized earnings, but likely was worth more than 12 times its earnings, and therefore that the shares might be worth $250 to $300 in 2016. However, I finally decided that my current valuation made little difference. If Whirlpool came close to earning $20 per share in 2016, the shares (which were selling at about $80 in the spring of 2011) would be an exciting investment regardless of whether they were worth 15 times earnings or 12 times earnings or even 10 times earnings. My plan was to aggressively purchase the shares and then have plenty of time over the next few years to refine both my earnings estimate and my valuation. When you think you are hitting a home run, you need not dwell on whether the ball is likely to end up in the lower deck, the upper deck, or out of the ball park—and I did not have to dwell over valuing Whirlpool’s shares to know that they were an exciting investment opportunity. After a moderate amount of further due diligence and after reading a few Wall Street reports on Whirlpool, I started purchasing the company’s shares.

I should note that, in 2011, Wall Street analysts generally were not positive about Whirlpool’s shares. The analysts were focused largely on the company’s short-term problems to the exclusion of the company’s longer-term potential. A report by J. P. Morgan dated April 27, 2011, stated that Whirlpool’s current share price properly reflected the company’s increased costs for raw materials, the company’s inability to increase its prices, and the current soft demand for appliances. J. P. Morgan maintained its “neutral” rating on the shares.

The J. P. Morgan report might have been correct about the near-term outlook for Whirlpool and its shares. But Greenhaven invests with a two- to four-year time horizon and cares little about the near-term outlook for its holdings. We knew that Whirlpool’s shares might remain flat or even decline before they appreciated, but any temporary flatness or decline in the price of the shares would not affect the final return on our investment. I viewed Whirlpool’s shares as an abnormally fat pitch. Should a batter let an abnormally fat pitch go by with hopes that a future pitch will be even fatter? I think not. In fact, I believed there was a high probability that the short-term problems detailed by J. P. Morgan and others likely were already largely or fully discounted into the price of the share, and therefore were the opportunity.

I was particularly excited about Whirlpool’s shares because they had the potential to increase several-fold over the next few years if the wind happened to blow in the right direction. For example, if the housing industry started to improve sharply in the near future and if the prices of steel and copper started to decline, it would not have been unreasonable to estimate that Whirlpool could earn about $15 per share in 2014 and that its shares could then roughly triple in price (to roughly $240, or 16 times earnings) between 2011 and 2014. I have noticed that, over the years, a disproportionately large percentage of Greenhaven’s returns have come from relatively few of its holdings. In fact, I would make an even stronger statement: a relatively modest percentage of our holdings have been responsible for the bulk of our success since our founding in 1987. Greenhaven’s stretch goal is to achieve average annual returns of 20 percent for its clients (because 20 percent is a stretch, we generally say that our goal is 15 to 20 percent). If one in five of our holdings triples in value over a three-year period, then the other four holdings only have to achieve 12 percent average annual returns in order for our entire portfolio to achieve its stretch goal of 20 percent. For this reason, Greenhaven works extra hard trying to identify potential multibaggers. Whirlpool had the potential to be a multibagger because it was selling at a particularly low multiple of its potential earnings power. Of course, most of our potential multibaggers do not turn out to be multibaggers. But one cannot hit a multibagger unless one tries, and sometimes our holdings that initially appear to be less exciting eventually benefit from positive unforeseen events (handsome black swans) and unexpectedly turn out to be a complete winner. For this reason, we like to remain fully invested as long as our holdings remain reasonably priced and free from large risks of permanent loss. I am continually reminded of a favorite saying of Mr. Arthur Ross (my old boss who liked to say everything twice): “stay in the game, Ed, stay in the game.”

We purchased a sizable position in Whirlpool in the first half of 2011 at a time when the shares were selling at about $80. In the second half of 2011, the appliance market and Whirlpool’s earnings were disappointing, and the shares traded down to as low as about $50. When shares of one of our holdings are weak, we ask ourselves a question: are the reasons we purchased the shares still valid (and thus the weakness attributable to a temporary problem), or was our original analysis and judgment flawed? If we believe that our original analysis and judgment was correct, then we often will take advantage of the weakness and purchase additional shares. If, however, we come to the conclusion that our original analysis and judgment was faulty, we usually will admit to our error and sell our holding in the shares, hopefully before the loss becomes large. We realize that from time to time we will make mistakes. If we never made a mistake, we should be properly criticized for being too conservative. To make money, one must take some risks. The question is where one should draw the line on risks. There is no single correct answer to this question because different investors have different investment objectives, different balance sheets, and different emotional tolerances to risk.

We gradually added to our holding in Whirlpool in the second half of 2011 and into 2012. During 2012, I continued to monitor the opinions of Wall Street analysts, particularly those at J. P. Morgan and Goldman Sachs. Neither firm had adopted our thesis on Whirlpool’s attractiveness. J. P. Morgan remained “neutral” on the stock during 2011 and 2012. On February 1, 2012, a Goldman Sachs report estimated that Whirlpool would earn only $4.56 in 2012 and $5.97 in 2014. The report recommended that the shares be sold, even though they were selling at only $62 at the time, or at only 10.4 times the firm’s estimate of 2014 earnings. On October 23, 2012, Whirlpool announced favorable earnings for the September quarter, increased its EPS guidance for 2012 to $6.90 to $7.10, and publicly stated: “We have delivered three consecutive quarters of year-over-year operating margin improvement this year. … Our ongoing business performance should continue to improve due to our strong cadence of new product innovations, the benefit of our cost savings programs, and positive trends in U.S. housing.” The following day, Goldman Sachs increased its 2012 EPS estimate to $7.09 and changed its opinion of the shares from a “sell” to a “buy.” On the day the Goldman report was issued, the shares sold at $94, up more than 50 percent from nine months earlier when Goldman recommended selling the shares.

The year 2013 was a breakout year for Whirlpool. Housing starts in the United States increased by 18 percent to 925,000, domestic sales of the “big 6” appliances grew by 9.5 percent, and Whirlpool’s EPS increased by 42 percent to $10.02. Reacting to the good news, the price of the shares increased by 54 percent, from $101.76 at the start of the year to $156.86 at year-end. One robin does not make a spring, but now there were several robins on Whirlpool’s lawn. I was excited that we had doubled our money in the shares, and I was excited that our thesis on housing-related stocks appeared to be working.

During the spring of 2014, I heard rumors that Whirlpool might be interested in acquiring Indesit, a European manufacturer of appliances that had put itself up for sale. I immediately wrote a letter to Jeff Fettig (Whirlpool’s chairman and CEO) suggesting that Whirlpool not acquire Indesit. Whirlpool had a bright future. It did not need to make an acquisition. An acquisition would leverage the balance sheet and distract management. Europe was a tough place to do business. Many acquisitions do not turn out as planned. The sellers know more than the buyers and may know of problems or uncertainties that are not apparent to the buyers. Jeff answered me with a “form” letter that stated that Whirlpool would acquire Indesit only if the acquisition made sense for the shareholders. What else could he say?

In July, Whirlpool announced an agreement to acquire Indesit for $2 billion. Chris, Josh, and I immediately telephoned Jeff. He calmed us. Indesit had revenues of $3.5 billion, so the company was being acquired for only 0.57 times revenues. There would be about $350 million of synergies (equal to more than $3 per share after taxes) when Whirlpool’s European operations were combined with Indesit’s. Two head offices would be combined into one. Plants would be consolidated. Increased purchasing power should lead to lower prices for purchased parts. Efficiencies would be gained through best practices. Research and design would be consolidated. Furthermore, about $1.4 billion of the revenues were from Russia and Eastern Europe, where long-term growth prospects were strong. In 2013, Whirlpool’s European operations only broke even. Jeff’s best guess was that when the synergies were fully realized in about 2017, the European operations should have 7 to 8 percent operating margins on well over $7 billion of revenues. We thanked Jeff for his time and put a pencil to his estimates, realizing that he had a vested interest in making the acquisition appear attractive. Seven to 8 percent margins on $7 to $8 billion of revenues would result in $490 to $640 million of operating earnings. A 4 percent interest rate on $2 billion of additional borrowings to pay for the acquisition would increase annual interest expense by $80 million. Thus, if Jeff’s projections happened to be correct, Whirlpool’s European operations would contribute $410 to $560 million to pretax profits in 2017, or $3.70 to $5 per share after taxes at a 28 percent effective rate and based on 80 million shares outstanding. Whirlpool was taking a risk, but the risk appeared worth taking. I regretted having written the negative letter to Jeff. I had jumped the gun.

Whirlpool also made a smaller acquisition in 2014: a 51 percent interest in Hefei Sanyo, a Chinese manufacturer and distributor of appliances. Hefei sold $862 million of appliances in 2013 through about 30,000 distributors. Whirlpool had only 3,000 distributors in China. By acquiring the 51 percent controlling interest, Whirlpool could market its line of appliances through Hefei’s thousands of distributors, thus hopefully materially expanding its revenues in China from a very small base. Jeff Fettig believed that Hefei’s revenues could grow at a 15 to 25 percent rate and that its operating margins could be 8 to 10 percent. Assuming growth at a 20 percent rate and margins at 9 percent, Hefei would contribute about $0.60 per share to Whirlpool’s 2016 EPS—not a game changer, but a material addition to earnings in a large and rapidly growing country.

At the time we originally purchased our shares in Whirlpool, we had one concept: the company and its shares would benefit from the recovery of the housing market. Now, we had an additional concept: Whirlpool had a smart and ambitious management that was finding ways to grow the company. This was an important concept because if the company could grow over the longer term at a rate materially faster than the appliance industry, it was worth a higher multiple of earnings. I had originally valued Whirlpool at 12 to 15 times earnings. Now, I was beginning to believe that the company might be worth materially more than 15 times. Thus, it increasingly appeared to us that our investment in Whirlpool’s shares could appreciate several fold versus our cost basis—and thus make a lot of money for our clients and us. And, equally important, we would enjoy the psychological satisfaction of knowing that our theses on the company and on the housing market had proven correct. In the end, the psychological rewards of being right can be as important as—or more important than the monetary rewards. And they are interrelated. When you feel good, you are more likely to do well.