Last night, I really enjoyed watching the CNBC interview with Warren Buffett. The real beauty of the interview is how the world’s second richest man revealed his key ingredients to investment success, and I'll bet you only a handful of investors understood what he said. Why do I say this?
Buffett laid out his investment strategy, and this strategy does not jive with the investment psyche of today's investor. Simply put, investors who have a mindset of instant gratification cannot, and will not, achieve Buffett like returns because they are not patient enough to wait for "the perfect pitch."
In my 35 years as an investor, and 18 years as an investment advisor, I have seen it over and over again. People will not change, and as long as financial publications and TV programs constantly appeal to investor’s greed, they will continue doing what they're doing. The recent real esate debachle is a prime example of what greed and following the crowd can do to your pocketbook.
While most investors run around like dogs chasing their tails, Warren Buffett invests in companies that have a “durable competitive advantage”, and then he waits for the market to mis-price the stock so badly that his odds of winning are huge.
Here are some key points to Buffett’s stock picking;
1) He makes a list of companies that are easy to understand, and that have a “durable competitive advantage”. This is his wide moat strategy. A wide moat is a company like Coca-Cola or Budweiser who have a “durable competitive advantage” as well as a dominate brand identity. These powerful brands are what Buffett describes as a wide moat. While there will be competition, both Coca-Cola and Budweiser basically have consumer monopolies. Companies with these characteristics have a powerful advantage to grow their earnings with a loyal consumer base.
2) After identifying the companies that have a “durable competitive advantage”, or “wide moat”, he looks at the 10 year history of each company to see if they have had a consistent return on equity of 15% or more.
Instead of dividends, Buffett prefers companies with stock repurchase programs because lower dividends reduces his tax burden. So much for Wall Street’s latest theory of buying large cap dividend paying stocks.
Now this was the easy part. Here is the hard part, and the one that most people cannot bring themselves to do.
3) “Wait for the perfect pitch.” The license number on Warren Buffett’s last car spelled out the word “Thrifty”. Here is a guy worth over $40 billion dollars with a license plate that basically said he was a miser. He has lived in the same house for 48 years, and he only buys bargains.
This being said, most investors do not have the patience to wait for the perfect pitch. During the 2000-2003 market debacle (the last perfect pitch timeframe), Home Depot fell into the low 20’s. At this price, the stock had a P/E ratio of around 13, and looked to be a screaming buy. I bought the stock around $22-23, and when the market began to rally, the stock jumped up to $32-33 in less than 6 months.
This is a classic example of waiting for the perfect pitch, and the result were a 45% gain in a very short amount of time.
One of the reasons many investors cannot do this is because they always have a majority of their assets tied up in the market. When a big decline eventually occurs, they are panicking to sell rather than patiently waiting to buy.
The current market environment is giving off classic signs of panic buying. Panic buying, the “I’m afraid I missed the boat” mentality, has always lead to serious mistakes in the past.
Go back and read the article I wrote on October 18, 2006- “Taking a Clue from Henry Clews”, I think it will be well worth your time.
