Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you advice on specific investment advice. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.
Today’s tip: “Value investing’s good reputation owes a great deal to Warren Buffett, but he and other successful investors owe their success to much more than just one relatively narrow approach to the market.”
In last week’s Investor Toolkit, I pointed out that learning what not to do can be the hardest and costliest part of an investor’s education (see the Toolkit here). I focused on how this applies to technical analysis—the practice of trying to base investment decisions on past trading and market history. This week I want to expand on what I said, since the idea applies to a wide range of narrow approaches to investing.
To succeed as an investor, you have to take a broad view in making investment decisions. Technical analysis and other narrow views do sometimes seem to “work” for lengthy periods, of course. But they only work for a minority of the time, and they never work consistently. Instead, they run hot and cold. As with all random events, their successes occur in bunches.
These bunches of successes come in random lengths, with random beginning and end points. It’s easy to see how this applies with technical analysis, which has an arcane air about it. But the same principle works for something as straightforward and commonsensical as, say, value investing.
Value investing fans zero in on financial statistics and ratios as an indicator of what to buy. They like to buy stocks with low ratios of stock price to per-share earnings, cash flow, sales and book value. They assume that if you get enough value in your stock buys, indicated by low numbers in these ratios, your profit is virtually assured, in the long run if not in the short. The problem is that while a 9.0 p/e is attractive, the price can still drop enough to cut the p/e down to, say, 7.0. Then too, a low p/e is no guarantee that the “e” or earnings won’t drop. (When the ‘e’ drops, the p/e automatically shoots back up again.)
In fact, a low p/e and other low readings in value-investor ratios may simply mean that well-informed investors are selling the stock and pushing down the “p” or stock price. If so, it probably means they see flaws in the company’s situation or outlook that investors generally are missing.
Exiting the market at the right time paved the way for Warren Buffett’s success
Value investing gained a great deal of name recognition and respect because of its association with investing legend Warren Buffett. But Mr. Buffett’s investing success rests on far more than a mastery of financial ratios.
Buffett’s first great investing achievement was to sell all his holdings in 1969, just prior to the early 1970s market downturn. He felt that 1969 stock prices were simply too high, from a value investing point of view. He re-entered the stock market in 1974, after prices had collapsed by 40% or more. This alone established his investing-legend status. Since then, he has achieved a better-than-average investing record by buying large stakes in a handful of well-established companies.
Mr. Buffett mainly invests through Berkshire Hathaway, a New York Exchange-listed holding company that he controls. In the spring of 2014, the $105 billion Berkshire portfolio included 45 stocks. The portfolio’s biggest holding is in Wells Fargo, which makes up 21.79% of the entire portfolio. Next is Coca-Cola at 15%; American Express, 12.9%; IBM at 12.4%; Wal-Mart, 4.1% and Procter & Gamble, 4.0 %.
These six stocks make up almost 70% of the Berkshire portfolio. (Five of the six—the exception is Coca-Cola—are among our Wall Street Stock Forecaster recommendations.)
The next seven stock holdings range from 3.8% (Exxon Mobil) to 1.15% (Graham Holdings). These seven make up around 17% of the portfolio. The remaining 29 stocks each represent 0.98% or less of the portfolio. Altogether, the 29 smallest holdings make up around 13% of the portfolio’s total value.
This is an odd portfolio, if only because of the wide disparity of the weights of its holdings. But you can’t argue with success that lasts for decades.
Value investing played a role in Buffett’s investment success, of course. But he owes a great deal to his one-time, 5-year departure from the market in 1969. However, the main contributor to his success is his history of excellent stock-picking, and his practice of holding his top picks for a long, long time.
One thing you won’t find in the making of Buffett’s stock-market fortune is a history of relying on any single investment theme or gimmick.
Virtually all successful investors have some understanding of value investing, many have some knowledge of technical analysis, and most have some knowledge of a variety of other tools and shortcuts. But virtually all successful investors take a broad view, and apply everything they know to their investing decisions.
As the saying goes, if you’re going to play the game, you might as well look at all your cards.
COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members
Is there one thing—or more than one—you had to learn not to do in order to become a more successful investor?
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