Every year at the Berkshire Hathaway annual meeting, Warren Buffett gives shareholders insights into his investment thinking and keys to long-term success. At the May meeting, Buffett observed that over the past 58 years he has made only a dozen or so truly great decisions. This works out to about one every five years. You don’t need to get every
decision right, just your highest conviction ones.
How do you do this? There is no easy formula here. Buffett focuses on Value versus Price. He looks for businesses with great Value, businesses that he can understand, businesses where it is difficult for competitors to enter (a wide “moat” – think Coca-Cola and American Express) – and also good management, high profitability, products with staying power. Then you wait and wait and wait some more until the price drops to a low enough level relative to Value that you get a sufficient “margin of safety” just in case things don’t work out as expected.
It is not easy to be this patient and this disciplined. A Virginia-based insurance executive recently funded two college investment programs where students each year pick stocks that will be left in place for 25 years. No trading, no selling. Nothing. Two lessons will hopefully be learned here. The first is that you must focus only on companies you really think can stay competitive for 25 years and second, you get to see the power of compounding, allowing your winners to grow exponentially even as other selections drop to as low as zero.
Why is patience and focusing on the really long term so difficult? First, we are faced with a waterfall of information every day in the market and as professionals paid to be “experts”, we feel pressure to have an opinion on everything. Will the Fed raise interest rates? When will the next recession begin? What about hot stocks like Nvidia? It is easy to get caught up in the moment and end up making far too many short-term decisions.
Buffett Partnership, Ltd.
It is also difficult to stay committed to the long term. Even the most successful long-term investments underperform for significant periods. Amazon fell to below $5 a share in the early 2000s before soaring to today’s level. Would you have had the stomach to stay the course? Barton Biggs of Morgan Stanley once said, you really find out who your friends are when you underperform for two quarters in a row.
The reward for long-term investing is seeing the results of compounding. Look at the results of Buffett’s investment partnership (which closed in 1969). The annual returns are incredible (we mortals will never duplicate these), but even more impressive are the compound numbers where each year’s performance is magnified by the next year’s increase. You can only lose 100% in a bad investment, but your good investments can grow infinitely through compounding.
Where do you find long-term winners? Sometimes right in front of your nose. Warren Buffett bought the Burlington Northern Railroad in 2009. This is my interpretation of his reasoning: America needs to transport goods across the country; rail is the cheapest way of doing this; and no one is going to build another transcontinental railroad. Buffett’s assessment of Value and Price was spot on. He was paid back his entire investment within five years and is still left with a productive asset for the long term.
We need to learn to go sit quietly in our room. Focus on the important. Tune out the rest.
Source: The Intelligent Investor, by Benjamin Graham, HarperCollins Publishers, Revised February 21, 2006
