Warren Buffett and Charlie Munger have a reputation for being some of the most successful investors of all time, and it’s pretty clear why. Over the past 20 years, shares of Berkshire Hathaway grew by 590%, handily beating the market’s return of 533%.
But you don’t need to spend years studying their techniques to improve your own investing process. In fact, a lot of their folksy chestnuts of investing wisdom are quite digestible — so let’s learn three of their quick tips that’ll help you to power returns for decades to come.
Image source: The Motley Fool.
1. You make money by holding, not buying and selling
Buffett and Munger are famously patient, and their perspective can be summed up in Buffett’s advice that “if you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” In short, you make money by holding quality companies for long periods. Transitioning your mindset from buying and selling stocks in quick succession is difficult, but your most important skill is often simply to do nothing.
That’s right, once you make a purchase, simply do nothing else with the shares you bought — for years. You can and should still keep up with the company’s happenings in that time. And you might even consider adding to your position if you find some extra cash to invest. Most of all, the plan is to simply leave your shares alone, quietly (hopefully) gaining in value.
Buffett’s investment in medical supply distributor McKesson is just one of many examples that support the value of patience. If you bought its shares five years ago, you’d be up by 186%. But to attain that result, you had to be patient as your shares were underwater for a while, and then for a bit longer as the stock underperformed the market.
2. Over time, a stock’s valuation today is less likely to matter
Buffett and Munger are famous for their style of value investing, in which they compare the intrinsic value of a company to its current share price in hopes of finding a mismatch. But, for their super-long-term approach, a stock’s valuation today is far less important than its value in the distant future. Valuations can expand and contract with the market and the economy, but a company’s actual value is something that accrues and compounds over time, hopefully to the benefit of shareholders.
From that point of view, today’s valuation is a temporary phenomenon. Ideally, it wouldn’t get too far beyond the company’s financial fundamentals and its realistic prospects for growth, even as the investment increases in value. But think about it: If you overpay by 30% for a stock today relative to other investments, and 20 years from now its price has risen by 3,000%, the fact that you paid too much at the start absolutely doesn’t matter.
Take Apple for example, a current Buffett favorite. If you purchased its shares three years ago, when its price-to-earnings (P/E) ratio was on the high side, above 24, you’d now have a total return of nearly 129%. The high valuation was justified.
The only trouble arises early on in the investment’s lifecycle, when overly high valuations can lead to major tumbles that are liable to shake the investor’s confidence in their decision, even if in the long run they would turn out to be correct. None of this is to say that you should ignore a stock’s valuation, especially if it’s quite inflated.
Just remember another Buffett chestnut that’s derived from his mentor, Benjamin Graham: The market is a weighing machine in the long term. The longer you’re willing to hold your shares, the less a somewhat pricey valuation matters when you’re making your decision about whether to invest today.
3. Wide profit margins belie competitive advantages
Buffett is all about competitive advantages, because they’re part of the special sauce that enables certain companies to grow for years on end without fail.
Some competitive advantages, like brand power, are obvious; people like to keep buying from brands that they’re loyal to, which helps businesses to retain their market share. Others, like cost-cutting methods or technologies, are far more slippery, and management won’t necessarily mention them in communications to investors. That can make it hard to figure out which potential investments have the competitive advantages that will sustain them for the long haul.
One sign that Buffett and Munger use to sniff out those harder-to-appreciate competitive advantages is the stability and breadth of a company’s profit margin. A rule of thumb is that if a company perpetually has a profit margin that’s wider than 30% for years and years despite the presence of empowered competitors in their industry, there’s a very good chance that there’s a competitive advantage lurking. So even if you can’t identify exactly what the secret sauce is, be sure to note that there could be one in play.
And for the record, it’s also entirely possible for competitive advantages to exist in businesses that have narrow margins. The tell-tale sign is that the margin doesn’t budge even under the conditions that are squishing a competitor’s.