Invest with Certainty
“You are neither right nor wrong because the crowd (agrees or) disagrees with you.
You are right because your data and reasoning are right.” – Benjamin Graham
Like to know what really works with investing?
A proven investment method that works – regardless of economic conditions.
WHY are you investing?
Is it for income?
Is it to make your capital grow?
TIP: Always invest either for growth or income and growth. Never invest for just income only.
If you are looking to invest for income and growth or just want to make your money grow for now, read on…
Why do our clients like their investment portfolios? Take a look at The WISEplanning investing philosophy…
The value method
This methodology made famous by Warren Buffett and his less well-known colleague Charlie Munger, was founded by Benjamin Graham about the same time that Harry Markowitz began developing what is now known as modern portfolio theory.
What we have here are two very different investment methodologies.
Modern portfolio theory is by far the more widely used around the investment world, although value investing developed by Benjamin Graham and further advanced by Warren Buffett and Charlie Munger, is arguably a better way to invest.
Most people do not understand the difference between the two methods.
Modern Portfolio Theory
In simple terms, modern portfolio theory is based on the idea that diversification helps to manage risk.
“Risk” is seen as the variability in the cash up value of an investment portfolio – otherwise known as volatility.
The big idea here is to diversify as widely as possible in the hope that volatility is minimised and that in the event an investment within the portfolio defaults, that its weighting will be minimal and therefore it will have minimal impact on the overall investment portfolio.
Without a doubt, this method is valid. The real question though is whether or not this investment methodology is right?
Value Investing = investing success
Initially, this was about investing in shares whose price had declined significantly to the point where those businesses could be purchased at a price that was below the value of cash sitting in those businesses’ bank accounts.
This meant that those shares were “cheap” or good value.
Warren Buffett and Charlie Munger progressed value investing further.
They figured that cheap investments whilst a good idea on the surface, however, takes no account of the underlying quality of the investment (the business).
This became known as “the cigar butt” theory. Basically, you could pick up a used cigar butt that was still burning out of the gutter and you might get a couple of free puffs. Of course, the quality of the experience of a soggy, used “pre loved” cigar butt is altogether a different issue!
First there was price, then there was value
Over time, Warren Buffett and Charlie Munger, working together, realised that they could invest using a simple methodology that protected their capital and gave them real growth over the long term. Eventually this method generated billions of dollars for them and their shareholders.
It was obvious to them but few could understand how they did it!
Intriguingly, as Warren Buffett has commented occasionally, he has seen no swing toward value investing as a methodology, even after all these years of continuing success.
Anyway, the methodology is straightforward enough and whilst few investors have Warren Buffett’s or Charlie Munger’s skill, their ideas and methods are transferable. WISEplanning has adapted their core methodology, for many years, with success.
By the way, we are not suggesting that Warren Buffett’s skill is transferable nor that his success in the past somehow guarantees that we can emulate his results in the future. Even he is struggling to keep up with his past results although this we believe is about market conditions rather than a method that is fraught.
For example, whenever markets are in a strong bull run and very happy, Value Investing usually looks a bit slow. That is when the chorus of “Value Investing nay sayers” sing their loudest. Eventually, it passes. The fundamentals always matter – eventually.
As an aside, the Value Investing method meant it became difficult for us to locate investments that matched the methodology (i.e lack of quality options).
Therefore, we began looking elsewhere in the world and found that whilst still not easy, those quality investments including Berkshire Hathaway (Warren Buffett and Charlie Munger’s business) began to stand out as obvious investments.
WISEplanning now brings this methodology to New Zealand investors (and other investors around the world who are now clients of WISEplanning).
The Business Accumulator
Although still not well understood, what is obvious to value investors is the relevance and the importance of buying the business rather than speculating on the stock.
Value investors know that the real value of an investment is driven by the performance of the business, not the trading price moving up and down.
“Price is what you pay, value is what you get”. – Ben Graham
This is an outline of the method that WISEplanning use to locate profitable investments:
- Compare price and value
Understanding that price and intrinsic value are not the same thing provides a significant advantage for investors. The price of course is the trading price of an asset. For businesses listed on the share market, this is the trading price as per the stock exchange listing. The intrinsic value, on the other hand, is the fundamental underlying value of the actual business – as distinct from the trading price of the stock or the share. The trading price is easy to find on the internet. The intrinsic value, on the other hand, much more difficult to locate. That is because share brokers and other analysts apply a valuation methodology based more on the trading financials than the underlying fundamentals of the business.
Anyway, once we have an idea of the underlying intrinsic value, we can compare that with the price per share and have an indication as to whether this business is worth buying now or possibly at some other point in the future when the price is right.
- Earnings growth
Earnings growth simply refers to the earnings or the profit of the business and whether or not the growth is rising over time. More specifically, we prefer to avoid businesses whose profit is erratic or either growing very slowly or not at all. Steady earnings growth over the long term may indicate a business that has a strong position in its market niche.
- The dividend pay-out ratio
As obvious as it sounds, companies that pay out all of their dividends eventually struggle to grow, or at some point, come back to shareholders with a rights issue. This effectively means asking the shareholders to put money into the business. Many New Zealand investors hold a simplistic view about investing in the share market and like businesses that pay a healthy dividend. This is generally considered to be a sign of a good business. The reality is that businesses who consistently pay out all of their profits or a high percentage of their profits struggle to grow long term. A business that maintains its profits, reinvests the profits at a useful rate of return, can make investors rich.
- Focus on profitability, not profit
Profit is the money that a company makes each quarter or each year in dollar terms. Profitability, on the other hand, is the ability of the business to use its capital and can be measured by return on shareholders’ funds and/or return on capital. In short, rising profits do not necessarily mean business improvement. How well businesses use their capital over the long term is a useful indicator for us as investors as to whether or not we might have a good investment. Again, consistent high levels of profitability can indicate a strong position for that business in its market niche. That is good for us as investors, particularly in the long run.
- Growth mandate. Buy the business, not the stock or the shares
Most investors, analysts and share brokers adopt what value investors regard as a reasonably speculative approach to investing. That is because their methodology is more based on financial analysis, trading and the shares as opposed to the underlying business fundamentals. For example, the price earnings ratio (P/E ratio) is a common methodology for assessing the value of a share or stock. However, whilst the “E” or earnings component of the ratio may be accurate, the “P” or price is really a function of market sentiment. As many a value investor has commented in the past, “How can you possibly value a business based on its popularity (or unpopularity?).” Price movement rises and falls on the back of market sentiment and often has little to do with the underlying intrinsic value of a business.
To be clear, there is no judgment here on other methodologies. We just prefer our value investing method and are happy to rely on it. The point is that we are investing in the underlying business fundamentals and not playing the markets or investing in price movement or the share market financials that are subject to fickle sentiment driven influences. This is a different methodology.
- Conviction and Discipline
Whilst financial analysis is useful if not essential, it is not the sole basis upon which value investors invest their money. As value investors, we are interested in the underlying business performance. We know that the money we will make long term will be based on the underlying business fundamentals rather than many of the other financial analysis that are widely available.
The intrinsic value of the business comes from underlying business performance – not a rising or declining share price. Indeed, the trading price for value investors is simply an entry or an exit point. By the way, value investors invest with conviction and discipline around the method. The methodology allows us to invest with high conviction and confidence because of its fundamental nature (we are not playing the markets) and helps us to avoid the usual trading activity that goes on with many portfolios. Buying and selling for value investors is minimised because we invest in the underlying business and are keen to participate in the future growth – difficult to do that if we well out.
We are not interested in trying to play the markets and therefore, the cost of running the portfolio is significantly reduced. Whilst this is not a buy and hold long term approach, we are happy buying good businesses and keeping longer term if possible. As Warren Buffett has often quipped, “My favorite holding period is forever.” This does not mean that we never sell. It does mean that we buy the business with conviction and keep it until such time as the underlying fundamentals of the business deteriorate. The point here is that a sharply declining trading price is not a reason for us to sell and certainly no reason for us to become uncomfortable, let alone panic. Whilst most investors in this area treat it as a form of high risk speculating, value investors are happy quietly selecting good businesses, sitting on them and allowing them to grow and compound over time – regardless of short term share price movement.
“In the early years, the money we make investing is determined by the voting machine (market sentiment and a rising or falling share price). Longer term though, the weighing machine (the underlying fundamentals of the business) determine how much money we make.”
Although this methodology is quite rare and not widely followed, it is fundamental and for those who invest with conviction and remain disciplined, this approach provides a methodology for investment success with a high degree of certainty.
What to do?
Sometimes it is difficult to know who to trust or what to believe. Avoid risky investments or investments that you don’t understand that can be dangerous, as well as those cunning “low cost” approaches that are shrouded in self interest that may not help you to achieve your goals. Invest using The Business Accumulator Model available at WISEplanning. That way you can invest in productive assets that will grow and keep your money safe. This means minimal or no investing anxiety – no stress around investments, regardless of market conditions. That is difficult to achieve when other methods that play the markets are used.
How to do it?
You can read the variety of books that are available that have been written about Warren Buffett and his method.
That might take a while.
You can surf the internet.
The challenge here is that the information about value investing is of varying degrees of quality and accuracy. If you don’t really understand Value Investing, you could head down the wrong path.
The easy way is to contact WISEplanning and discuss how this method can help you to protect your capital, make it grow and to minimise any investing anxiety and stress – permanently.
What are you looking for?
Whether you are looking for income, growth, or both, you might like to check out how hundreds of New Zealanders and thousands of Americans over several market cycles have come to rely on Value Investing.
To be clear, this is not their preferred way to invest – it is the only way they will ever invest.
Do you understand why yet?
Click here if you would like to talk more.