Recently, my father-in-law hired a timber consultant to appraise the value of a large tract of timber he’s planning to harvest along the Mattaponi River in central Virginia. Before we went to meet this fellow, my father-in-law told me, “This guy’s been in the business for years – he knows his stuff.” But I wondered…
On a damp Saturday morning, as we walked through a stretch of towering beech trees, I asked the timber man which species he’d recommend we plant following the projected harvest. He didn’t hesitate for a second. “Loblolly pines.”
Now, I have no particular prejudice against pine trees. They just happen to be soft and cheap. They lack any real material quality other than providing an inexpensive source for framing brick-faced Dutch Colonials or serving as the Christmas centerpiece for millions come December.
So I asked: “Would you consider planting black walnuts?” I didn’t know the exact price difference, but I know black walnuts are worth considerably more than any species of soft Virginia pine.
“Black walnuts? You wouldn’t want to do that,” he said. I pressed him for a good reason. He rubbed his beard for a second. “Black walnuts take twice as long to grow. You’ll have to wait more than 30 years before you ever see any cash from that type of tree. You can harvest loblollies in half that time.”
I felt like the third-grader who truly believes his teacher when she assures her class that there’s never a “dumb question.” Nine out of 10 quickly comprehend the meaning. There’s never a “dumb question” – as long as that question does not challenge the teacher’s all-knowing authority on any and all matters. One student, bless his heart, always takes the bait. At that moment, I was that student.
Since timber investment contracts usually entail a great deal of money, I kept digging – much to my father-in-law’s chagrin.
“How much would a mature loblolly pine sell for?” I asked.
“And what about a mature black walnut?”
“Well, you could probably sell a good walnut for $1,000,” he presumed.
“But you’ll never see that money,” he chuckled. “Maybe your children will.”
Is that fact so easy to dismiss? First, let’s be clear that timber investments are no different from stock, bond or even housing investments. In each case, you expect the asset in question to produce an adequate return over some designated period of time.
In this particular case, the question whether to plant pine or black walnut pivots around the individual’s particular investment time horizon. Loblolly pines mature roughly twice as fast as black walnuts. So a timber investor who plants a pine receives twice as many cash flows as the man who plants walnut. But let’s consider the quality of those cash flows…
If a single walnut were worth exactly twice as much as a loblolly pine, the decision to opt for pine would be quite easy. But a single walnut generates approximately 10 times the cash flow of a single pine. Meaning over a 30-year period, a walnut harvest will generate five times the return as an investment in pine.
The 30-Year Timber Investment Race:
Pine: $100 per tree x 6 harvests = $600
Walnut: $1,000 per tree x 3 harvests = $3,000
For many, the decision to opt for walnut seems self-explanatory. Why then do most landowners opt to plant loblolly pines?
What happens when the majority of hardwood forests are being replaced with pine? The exponential supply growth of pine forests is bound to affect the price of a single tree 15 years down the road. And it won’t be to the upside, come harvest time.
Meanwhile, the dwindling supply of 30-40-year-old black walnuts will, assuredly, drive up the market price for the precious hardwood.
These are the long-term economic conditions my father-in-law must consider.
We tend to believe that the overwhelming, seemingly unquestioned conviction to plant pine demonstrates a growing trend among all investors today.
There’s a new investing generation. A generation weaned on the bottle of instant gratification. The stock market, for its part, has become the speculator’s lottery ticket. The evolution of complex financial instruments, cheap credit and a material-obsessed society formed this trend.
One of the more unique aspects of western culture, we believe, is class mobility. Westerners tend to believe in their capacity to rise above the class to which they were born. In fact, this concept has been infused into our society from the very beginning. Our political icons constantly remind us of becoming an “ownership society,” as if to say that when you do better and achieve more, you will find happiness.
Many believe in the interminable joys associated with great wealth. They think that the sooner they achieve fame and fortune, the sooner they will enter the exclusive club of perpetual nirvana.
But wealth creation takes time, while asset price inflation takes a loose central bank. Much of the Western world has chosen asset price inflation over true wealth creation. The speculator has replaced the investor. We day trade, flip condos and buy options.
Instead of picking up a copy of Benjamin Graham’s The Intelligent Investor, today’s investor shuns returns below double digits. Earning 9% won’t cut it if someone else is earning 10%. Stock markets have morphed to symbolize divine measures of prosperity in every form. And when Mr. Market doesn’t treat you well, you turn to Dr. Fed. And with the flip of a switch, he can quickly whip Mr. Market back into shape, or so we’ve come to believe.
The concept of wealth creation is Free Market Investor ‘s core theme. Our friend Marc Faber wisely points out, “It is important to distinguish between wealth creation arising from increased market valuation (asset inflation) and wealth creation through saving and investments.”
As my former colleague the late Dr. Kurt Richebächer opined:
“American economists have never been as strict as European economists in making this distinction in wealth creation between rising market valuations and rising capital stock through saving and investment. Yet what has happened lately in this respect puts economic reason on its head. Protracted house price inflation, deliberately engineered by the Fed, is presented to the public as a virtually wondrous new policy stance in creating wealth and economic growth. It is hard to believe that such a grotesque perception is possible.”
Focus for one moment on the premise that societies accumulate wealth slowly over generations. A true return on invested capital, like a tree growing in a forest, takes time to bring to fruition. Some investments, naturally, produce better returns than others. The key: Find the investments that have the potential to produce the greatest returns with an acceptable level of risk. When those investments trade for less than their intrinsic value, the potential for above-average returns can be fully realized.
In the case for cultivating the black walnut, the asset most timber investors lack is the patience to sit quietly and let their superior investments develop.
If market timers and the financial media followed this advice, many people would find themselves searching for other work. Instead, many investment professionals make a handsome living opining the ebbs and flow of quarterly earnings guidance, despite the fact that 59% of Wall Street’s “consensus” earnings forecasts miss the mark by a mortifyingly wide margin. In such a world, a good timber investment can easily go unnoticed.
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