Don’t Trust all the Adds
Every other investing website advertises how they use Warren Buffet’s techniques to pick winning stocks, whether it’s screens, or only buying obscure stocks about 99% of them are bad, as highlighted in this article by Bill Mann. If all of these sites can make all of this money off of Warren Buffet’s techniques why do they need to sell them on a website?
The Theory Behind the Quote
Small investors have tremendous advantages over bigger investors and institutions. It’s your money there are no limits to how many companies you own, what industry they're in, if they have unionized workers, if they're a “sin stock”, or if their market cap is below $100 million.
By combing the pink-sheets or a local stock exchange you can find tons of companies undervalued, simply because they're so small Wall St. doesn’t care enough about them to fully value them. Some of these small companies are truly gems, it’s not that hard to find one that goes up 1000% percent, but it’s easier to find one that will go bankrupt so don’t think I’m tooting penny stocks.
Warren Buffet says if he had less than a million dollars, he would take advantage of that and wouldn’t have to buy the whole company when he found an un-recognized one. Of course Warren Buffet can do it, but it’s a lot harder for every other mortal on the earth to do it.
Just to make sure you not going to go to the stock exchange fifty miles from your house tomorrow that trades companies with market caps less than one million lets clarify that getting 50% returns over a period longer than two months is near impossible. I’m sure some people can achieve those returns over two, maybe three, years, but after those two or three years their returns will suffer and their five-year average will probably be under 30%.
If you think you’re going to get these returns the first thing you have to do is go on Amazon and buy all of the value and financials statement analysis books and read them. After you do that comb the pink-sheets and local stock exchanges for companies with high returns on capital or low price/book or other metrics, it doesn’t really matter what you screen for it’ll probably be undervalued, than use your expertise to find only the best companies that are trading for less than 50% of their fair value and buy them. Even if you do all of this and become an expert, because of the size of the companies you’re working with, chances are probably good that your returns could go down 50% and not up 50%.
OK, I’m not going to get 50% returns, what’s reasonable and how do I get it?
It’s very possible for you to get 15% returns over five years and 12-15% over the long run, but even these take a lot of work. You may still want to buy all those books from Amazon. To do this you’ll have to diversify a little. By this I don’t mean go crazy own 217 companies from every size, industry and country, I mean don’t put all of your money into these micro-caps, that’s suicide. Put at least thirty percent into companies with extra-wide moats and multi billion dollar market caps – like Wal Mart and Bud – only buy these when they have suffered short falls and are temporarily undervalued. Current examples of this are:
· Pfizer (PFE)
· Wal Mart (WMT)
· Boston Scientific (BSX)
· Anheuser Busch (BUD)
· Microsoft, etc.
Put some into mid-cap companies with market caps between 1-10 billion, and finish it off with everything under one billion. Every now and then put some money into an arbitrage situation.
So if Buffet says these returns are easy why didn’t he get them?
He may have, nobody really knows what returns he had before the partnership, but while he had the partnership he got returns of 29% a year. You could say it was because he managed over a million dollars, but I think it’s for a different reason.
The first two companies he invested in for reason other than its trading below Net Net Working Capital were American Express – big salad oil scandal for a different time – and Disney – because he loved the brand – in other words he stopped with the blinders and looked into the intangibles and found value in brand names and competitive advantages. There are a lot of reason for this, but I bet Charlie Munger and Phillip Fisher are the two biggest ones.
If this is correct it means you need to look past how much cash per share a company has, or if its P/E is less than 5, it means that he’d rather “ buy a good company at a fair price than a fair company at a good price.” I’m betting that if he believed in this when he was only managing a few million, he would have gotten 50% returns, but by the time he figured it out he decided to stay out of the market because of its over valuation and he had too much money.
Conclusion
OK now you know not to believe ads that tell you they’ll teach you how to get 50% - or higher, maybe lower – returns, because it’s impossible. Now all you have to do is keep learning and next thing you know people will crowd around you at cocktail parties and ask you for your next big stock tip.
-Mike
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