Investing isn’t all that difficult-at least, it doesn’t have to be. With the universe of investment opportunities available at the click of a mouse, why bother to try and invest in companies or in ways that you do not easily understand?
Warren Buffett:
I have three boxes on my desk: In, Out, and Too Hard.
The point is simple: Don’t invest in things (or in ways) that you do not easily understand. Sounds simple enough. What’s the catch?
The Hard Part
The catch is…you have to do it. You have to be able to say, “No.” You have to say it a thousand times before you say, “Yes.” You have to be bored-practically to tears-at the lack of truly wonderful investment opportunities that are (or aren’t) available.
On top of it all, you have to have a solid, rational reason for buying a stock. You have to buy it as if you were buying the entire company. Then, you have to hold onto it regardless of what the professional gamblers do to the price. You have to believe that you are right-not because the price is changing, but because your rationale and reasoning is right.
When Is It Too Hard?
There is a simple test to determine whether an investment opportunity is a Yes, No, or Too Hard: If you do not understand it in five minutes…it’s Too Hard. If you do not love it ten minutes after that, it is a No.
Will that eliminate 99.9% of your investment options? Yes-and that’s the point! There are more than 5,000 businesses with stock trading on a daily basis…in the U.S. alone. If 99.9% of them are Too Hard or an automatic No, then there are five or so out there that are truly wonderful, easily understandable businesses selling at a discount to their true value.
But I Need To Diversify!
If you only invest in wonderful, easy-to-understand businesses, and you buy them on sale to their true value, you do not need to run out and diversify for the sake of diversifying. Your portfolio will eventually become diversified.
Think about it: We all know the story of Microsoft. Selling for pennies in the 1980s. Anyone who bought it became a millionaire many times over. If you had the chance to go back in time, wouldn’t you put everything you owned into Microsoft back then?
Patience Is THE Virtue
Assuming you had purchased Microsoft, how long would you have held it? Would you have dealt with the daily, weekly, monthly, and annual fluctuations of 30% or more at any given time? How long before you would be “shook out” of your position?
Patience isn’t a virtue in investing-it is the virtue. You know who held on to Microsoft the entire time? People who understood its business and saw value in the company-regardless of the stock price that the gamblers set on a particular day.
Invest Like Warren Buffett
At any given time, in any given market condition and economy, some gambling guru will make a killing-in the stock market, in real estate, whatever-and everyone will take that gamblers word as gold, try to replicate the gamblers success, and usually lose money. Why do they lose money? A gambler can only make money for so long-a few months, a few years-before the market conditions change and the gambler’s system is no longer good.
On the other hand, for some 70 years, Warren Buffett has been successfully buying wonderful, easy-to-understand businesses when they are at a discount. And he has made billions from it.
When will you finally decide to stock worshiping gamblers and follow in the footsteps of the billionaire who made his money the easy way?
Filed under: How to Think About Investing
I don’t want to leave you out there, so I’ll give you the quick answer below. Look for a more detailed response (with more Plain English) in this coming Thursday’s post.
To figure out when a company is on sale, you must first figure out its intrinsic value. Intrinsic value is the value of company as an ongoing business, and is equal to that company’s net worth (Shareholder Equity) and the future cash that can be taken out of the business (Free Cash Flow), discounted by your desired rate of return.
Three examples of this calculation are on the Johnson & Johnson valuation, the Coca-Cola analysis, and American Eagle Outstanding.
Once you know the value of the company, you should figure out how comfortable you are with that company’s future and decide what your Margin Of Safety (or discount) should be. Large, stable, industry leaders can be bought with a 25% MOS. Smaller or hyper-growth companies should be purchased with no less than a 50% MOS.
Once you know the value, and you have factored in your desired discount, you can quickly check the stock price to see if the gamblers are willing to sell you a piece of the company (stock) at or below your discounted price.
Check out the above posts and look for a more detailed explanation on Thursday. Hope that helps!
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Here’s an interesting analysis on why KFT and GSK were selected by Buffett. Short answer – they were the best-in-class among their peers http://seekingalpha.com/a... (see article titled ‘Why did Buffett buy Glaxo Smithkline and Kraft’)
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Joe,
Thanks for the insights. I was wondering what to do with the money I have lying around waiting to be invested! I was thinking it might be a good idea to put it in a bond ETF until I find an opportunity to purchase. Vanguard has a really good total market bond fund (BND). I was wondering what you thought about this type of strategy. Should I just hold on to my cash?
Thanks!
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How can I tell when a stock is on sale? How can I tell when a stock is being sold at a discount? How can I tell if a company is selling at a discount to their true value?
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