Successful investing is easy, but it’s hard to do!
Making money as an investor has very little to do with intelligence or luck. Patience, independent thought and thinking like an owner are the keys to successful investing. It really is that simple.
In his 1996 annual letter to Berkshire Hathaway investors, Warren Buffett summed it up well. “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.”
So why do so many find it hard to follow this seemingly simple guidance? Well, let’s unpick the key strands of Mr. Buffett’s advice to see if we can learn why investment success eludes so many.
Purchase at a rational price. This doesn’t mean an investor has to buy stock on the cheap. After all, many so-called cheap stocks are inexpensive for good reason: they are poor companies. Great companies, those whose earnings “are virtually certain to be materially higher in five, ten and twenty years from now” are rarely cheap, but there are periods—during downturns, or perhaps when the company slipped up—when a patient investor can acquire the stock at a modest entry multiple. To achieve this, however, means the investor will sometimes be sitting on cash, watching from the sidelines—not always easy when, like now, the markets continue to rise from high to exorbitant levels. For a fund manager, measured against this or that benchmark index, sitting on cash can be harder still. Many would rather be judged on their performance relative to peers than strive to achieve higher absolute returns by being out of the market from time to time. For that, independence of thought is required, something tricky to pull off when such managers are measured on a quarterly basis against the market.
Easily-understandable business. Investing involves thinking like an owner, knowing more about the company than its current stock price. It means having to research what the company does and how it sits in its market relative to the competition. It is time consuming and laborious work, but only with that understanding can an investor make a judgment as to how sustainable the profits will be. One thing that separates a trader from an investor is the level of insight into the underlying company and its operations. I have met many traders, particularly those who buy and sell technology and bio-tech stocks, who don’t have a clue what the company actually does. Traders are driven only by the momentum of the stock price on the market, an activity closer to gambling than investing.
Own a stock for ten years. Investing success can involve long periods of inactivity. Compounding of returns takes time. Sure, there are some stocks that double in price in months, but these are for traders, not investors. Doing nothing is not easy, particularly when stock prices are visible on a daily basis, thus highlighting paper profits and losses. Once again, acting like an owner helps maintain the right posture. Owners of private companies, such as those I used to invest in when I ran a private equity fund, don’t have the “luxury” of a daily stock price to monitor. That way, they can focus on what the company is doing to increase long term value and not be affected by the distractions of today’s stock quote.
Buy well, be patient and act like an owner. Sounds easy, doesn’t it?
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