‘You have to want to ‘learn to trust yourself more.’ It is way easier to stay in our comfort zone.” ~ Jamie Kern Lima
Category Archives: Building Wealth
Warren Buffett’s Investment Strategy
An initial investment of $10,000 in Berkshire Hathaway when Warren Buffett took over in 1964 would now be worth more than $438 million!
Despite his reputation for picking winning stocks, Berkshire chairman and CEO Warren Buffett wrote to investors in his 2022 Berkshire Hathaway letter: “Charlie [Munger] and I are not stock-pickers; we are business-pickers.”
Over the decades, Buffett has refined a holistic approach to assessing a business—looking not just at earnings but also at its overall health, deficiencies, and strengths. He focuses more on a company’s characteristics and less on its stock price, waiting to buy only when the cost seems reasonable.
In short, Warren Buffett’s investing strategy is not complicated:
- Buy businesses, not stocks. In other words, think like a business owner, not someone who owns a piece of paper (or, these days, a digital trade confirmation).
- Look for companies with competitive advantages that can be maintained or economic moats. Firms fending off competitors have a better chance of increasing intrinsic value over time.
- Focus on long-term intrinsic value, not short-term earnings. What matters is how much cash a company can generate for its owners in the future. Therefore, value companies use a discounted cash flow analysis.
- Demand a margin of safety. Future cash flows are, by their nature, uncertain. Always buy companies for less than their intrinsic values to compensate for that uncertainty.
- Be patient. Investing isn’t about instant gratification; it’s about long-term success.
Other investing virtues prized by Buffett include candid communication with shareholders, patience in letting an investment bear fruit and emphasizing practical vehicles over investing fads.
Patience Pays: An initial Investment of $10,000 in Berkshire Hathaway when Warren Buffett took over in 1964 would have purchased approximately 808 company shares at a stock price of just $12.37 per share.
As of the end of 2023, Berkshire Hathaway’s Class A shares (which have existed since 1964) traded for just over $542,625 per share. The stock has produced an overall gain of 4,386,621% from 1964 to 2023. Your initial $10,000 investment would now be worth more than $438 million!
While Berkshire Hathaway’s past 60 years have been an impressive growth story, Buffett cautions that the company’s size has become too large to sustain the same 20% growth rates over the long term. He believes future gains will not be as dramatic as those of the past 60 years.
Nevertheless, Buffett’s core investment strategy prioritizes thinking like a business owner and viewing investments as actual companies, not just as stocks.
He has long advocated for “boring” investing and the notion that real moneymaking happens when you sit back and trust in a long-term plan instead of strapping in for a wild ride seeking short-term profit. He continues to focus on lifelong learning, whether that means unpacking what a new product is all about or reading up on interdisciplinary subjects.
And he intends to give away 99% of his wealth to philanthropy.
Source: Susan Dziubinski, How to Invest Like Warren Buffett, Morningstar, March 13, 2024.
Investing and Building Wealth
“Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.” – Warren Buffett, 1992 Berkshire Hathaway Shareholder Letter.
Investing is putting money into different securities or investment vehicles, hoping these securities will increase in price and payout profits.
In particular, investing in the stock market involves buying shares of companies that then rise in price. Some companies also pay dividends on their shares at regular intervals.
The end goal of investing is to spread your wealth in different vehicles that grow your money over time.
“Don’t be afraid to overpay for a stock with a history of rewarding shareholders. Winning stocks tend to keep winning if you have a long-term outlook.” Charlie Munger convinced Warren Buffett that sometimes it’s worth paying a premium for a great business.
A company’s intrinsic value is the present value of all of its future free cash flows (meaning from now until the end of time- all the free cash flows that it will ever generate).
Free cash flow (FCF) is the amount of cash the firm generates from its operations minus the amount of money it reinvested into its operations. Cash flows are “free” because they can be used to pay off debt, buy back shares, pay dividends, or leave in the firm’s bank account.
If you own a private company, this is what you would think of as “real earnings” that you can pay yourself with, given that you don’t have to reinvest those funds into the operation.
”Good things happen to cheap stocks of out-of-favor, industry-leading companies.” ~ Nancy Tengler
The most crucial quantitative evidence of an economic moat is a high return on invested capital (ROIC).
Return on invested capital, or ROIC, is a financial metric that helps understand how efficiently a company generates profits. The less capital it requires to produce earnings, the better.
For example, what does an ROIC of nearly 920% mean? It basically says that a company like Apple can generate massive profits with little investment.
The formula for ROIC is highlighted below. To reinforce, the larger the numerator (NOPAT is the after-tax operating profit) relative to the denominator (which can be defined as fixed assets plus net working capital), the more efficient the company is.
ROIC = NOPAT/Average Invested Capital
Investors— both shareholders and creditors— require a certain level of return in exchange for providing a company with the funds it needs to run its business. This is called the weighted average of capital (WACC). A company generates excess returns if its ROIC consistently exceeds its WACC.
For example, imagine little Joey wants to open a lemonade stand. He needs $100 upfront to buy a table, a pitcher, lemons, sugar, ice, and cups. This is invested capital. Joey borrows $50 from Mom and promises to pay her 5% interest ($2.50). Dad has a higher risk tolerance, so he buys $50 of common stock in Joey’s lemonade stand. Dad equity return (this is called the cost of equity).
Buffett created a concept called owner earnings. It is a measure of the firm’s potential free cash flows if it weren’t reinvesting them:
Owner Earnings = Earnings + Depreciation & Amortization + Other Non-Cash Charges – Maintenance Capital Expenditures
Attaining prosperity and financial freedom and building wealth through investing in the stock market for the long term is fundamental.
References:
Spending More Than You Have Never Ends Well
Spending more than you have never ends well.
Spending more than you have is indeed a precarious path. It’s like diving into a stormy sea without a life jacket, or standing on a brick wall while simultaneously removing one brick at a time. It can lead to financial stress, debt, and instability. Whether you’re young or mature, wise financial choices are essential.
Remember, financial stability and planning are like a well-anchored ship. They can provide you with financial peace of mind, lead you to financial independence, and help build wealth.
Keep in mind: In the ocean of expenses, sail with care,
Overspending waves can lead to despair.
Budget your voyage, trim the excess sail,
And watch your financial ship weather the gale.
So, set sail wisely, and may your financial compass always point toward prosperity and abundance!
Here are some prudent tips to avoid falling into the overspending trap:
- Budgeting: Create a realistic budget that outlines your income, expenses, and savings goals. Please be sure to stick to it diligently.
- Emergency Fund: Build an emergency fund to cover unexpected expenses. Having a safety net helps prevent overspending during crises.
- Track Expenses: Keep a record of your spending. Use apps or spreadsheets to monitor where your money goes. Awareness is key.
- Prioritize Needs Over Wants: Distinguish between essential needs (like rent, groceries, and utilities) and discretionary wants (like dining out or shopping). Prioritize needs first.
- Avoid Impulse Purchases: Pause before making a purchase. Ask yourself if it’s necessary or if it’s an impulsive desire.
- Limit Credit Card Usage: Credit cards can encourage overspending. Use them wisely and pay off balances promptly.
- Set Financial Goals: Establish short-term and long-term financial goals. Having a purpose for your money helps curb unnecessary spending.
Remember, financial well-being is a journey. By practicing mindful spending and making informed choices, you can avoid the precarious path of overspending.
Superior Investors are Lonely
“Large amounts of money [or wealth] aren’t made by buying what everybody likes. They’re made by buying what everybody underestimates.” ~ Investment Books
If everyone likes a stock or company, it’s likely the asset has been mined too thoroughly, and has seen too much capital from investors flow in.
“Large sums of money or wealth are not made by investing in what everybody likes. They are made by investing in what everybody underestimates. This implies that if everyone is investing in a stock or company, it has probably already been thoroughly researched and too much capital has already been invested in it, leaving little room for any bargains to exist.
Furthermore, if everyone likes a stock or company, it is highly probable that its price is overvalued and inflated, which means it is at risk of falling if the crowd changes its collective mind and decides to sell.
Successful investors, therefore, tend to identify and purchase assets when their price is lower than their intrinsic value or when they are mis-priced and undervalued by the crowd or market. This means that superior investors often spend a lot of time being lonely since they buy assets that others do not recognize or appreciate.
In essence, superior investing involves two primary elements: identifying a quality or economic moat in a company or stock that other investors do not recognize, and having it turn out to be true (and accepted by the crowd and market).
It is essential to note that macroeconomics may influence a stock price in the short term, while microeconomics dominate in the long term. Therefore, investors should look for situations where macroeconomic factors depress prices.
Ultimately, if a company delivers consistently quarter after quarter, year after year, the price will eventually follow.”
nto it for any bargains to still exist.
If everyone likes the stock or company, there exist significant risks that the stock’s price has become too inflated and overvalued, and will fall if the crowd changes it collective mind and moves to the exit.
Superior investors know—and buy assets—when the price of a company’s stock is below its intrinsic value or is lower than it should be. And the price of an investment can be lower than it should be when the crowd does not recognize its merit.
Large amounts of wealth are not made by buying what everybody likes or following the proverbial crowd. Wealth is made by buying what everybody or the crowd underestimates or mis-prices.
In short, there are two primary elements in superior investing:
- Seeing some quality or economic moat in a company or stock that other investors don’t recognize or appreciate (and it’s not reflected in the stock’s price)
- Having it turn out to be true (and accepted by the crowd and market)
That is why it is said that successful investors spend a lot of time being lonely.
Source: https://x.com/investmentbook1/status/1759534213752102957
Macroeconomics determine a stock price in the short term. In the long term, microeconomics dominate.
If a company delivers quarter after quarter, year after year, eventually, the price will follow.
Look for situations where macro depresses prices.
Dividend Kings
The highest yield is only part of it when finding the best dividend stocks. Income investors know there’s no substitute for regular dividend increases over the long haul.
Dividend Kings are a unique class of stock that offers investors a phenomenal track record of annual dividend increases.
These elite members of the Dividend Aristocrats, which are companies in the Standard & Poor’s 500-stock index that have raised payouts once a year for 25 years running, have far more extensive track records. Specifically, Dividend Kings must have at least 50 consecutive years of uninterrupted annual dividend hikes.
Dividend Kings’ appeal should be evident after 2020’s COVID-19 outbreak. Many dividend stocks cut or even suspended their payouts amid uncertainty and disruptions. Income investors who had hoped these companies were lower risk simply because they paid dividends received a rude awakening, as the payout cuts often came along with deep share price declines.
With half a century of increasing distributions, however, Dividend Kings have an excellent track record that adds a layer of stability in an otherwise uncertain market environment. Nothing is ever certain on Wall Street, but these are 15 of the best stocks for dividend growth. The names featured here are all longtime leaders who exhibit more than 55 years of increases – including one pick with a track record of 69 straight dividend hikes – making them a bit more trustworthy than your typical income investment.
Warren Buffett and Berkshire-Hathaway’s Annual Letter
“For whatever reasons, markets now exhibit far more casino-like behavior than they did when I was young. The casino now resides in many homes and daily tempts the occupants.” ~ Warren Buffett
Berkshire’s goal is simple: “To own either all or a portion of businesses that enjoy good economics that are fundamental and enduring. Within capitalism, some businesses will flourish for a very long time while others will prove to be sinkholes. It’s harder than you would think to predict which will be the winners and losers. And those who tell you they know the answer are usually either self-delusional or snake-oil salesmen,” writes Warren Buffett, legendary Chairman and CEO of Berkshire-Hathaway.
At Berkshire, they “particularly favor the rare enterprise that can deploy additional capital at high returns in the future. Owning only one of these companies – and simply sitting tight – can deliver wealth almost beyond measure,” writes Buffett.
Be patient when you find a wonderful business
“When you find a truly wonderful business, stick with it,” Buffett writes. “Patience pays, and one wonderful business can offset the many mediocre decisions that are inevitable.”
Never risk permanent loss of capital
The stock market is becoming more and more like a casino, offering daily temptations to ignore a long-term investment strategy and quickly turn over holdings when “feverish activity” brings all number of uninformed or ill-intentioned actors out of the woodwork.
He writes: “At such times, whatever foolishness can be marketed will be vigorously marketed — not by everyone but always by someone.”
The late Charlie Munger, Buffett’s long-time friend and business partner, argued that there were two types of individuals who buy shares in the stock market: investors and speculators. The investors tend to be disciplined, hard-working, and thoughtful when buying assets. But the speculators are those who seek nothing more than a quick buck without care for the intrinsic value of the underlying business they’re buying.
He notes do not fall for the marketing of the foolishness, or the scene could turn ugly, and the average investor may walk away “bewildered, poorer, and sometimes vengeful.”
Number One Rule
“One investment rule at Berkshire has not and will not change: Never risk permanent loss of capital. Thanks to the American tailwind and the power of compound interest, the arena in which we operate has been — and will be — rewarding if you make a couple of good decisions during a lifetime and avoid serious mistakes,” states Buffett.
The final statement from Warren Buffett as stated in Berkshire Hathaway’s Annual letter to shareholders:
“Berkshire can handle financial disasters of a magnitude beyond any heretofore experienced. This ability is one we will not relinquish. When economic upsets occur, as they will, Berkshire’s goal will be to function as an asset to the country – just as it was in a very minor way in 2008-9 – and to help extinguish the financial fire rather than to be among the many companies that, inadvertently or otherwise, ignited the conflagration,” commented Buffett.
Source: https://www.berkshirehathaway.com/letters/2023ltr.pdf
Backdoor Roth IRA
A Backdoor Roth IRA is a clever strategy used by high-income earners who find themselves ineligible to directly contribute to a Roth IRA due to income limits. Let’s break it down:
- Traditional IRA: First, you contribute to a traditional IRA. This contribution is made with pre-tax dollars, meaning you get an immediate tax deduction for the amount you put in. Essentially, you’re reducing your taxable income for the year.
- Conversion to Roth: Next comes the “backdoor” part. You convert the funds from your traditional IRA into a Roth IRA. This conversion is done after the initial contribution. Keep in mind that when you convert, you’ll owe taxes on the amount you’re moving over. So, it’s not a tax-free maneuver.
- Why Do It?: The backdoor Roth IRA strategy allows high earners to bypass the income limits that typically prevent them from directly owning a Roth IRA. While it may result in higher taxes initially, the long-term benefit lies in the future tax savings of having a Roth account.
- Passing It On: Another advantage is that if you anticipate having funds left in your traditional IRA, you can pass that money on to your heirs in a Roth IRA. Roth IRAs have no required minimum distributions during your lifetime, making them a useful estate planning tool.
Remember, this strategy is entirely legal and not a tax evasion scheme. It’s a way for high earners to access the benefits of a Roth IRA despite income restrictions. 🌟
Eight Lessons from Think and Grow Rich
Napoleon Hill in his landmark book “Think and Grow Rich” provided a guide to personal development and wealth creation.
Here are eight practical lessons from the book:
1. The Power of Positive Thinking: Positive thinking can shape your actions and reactions, and ultimately lead to better outcomes.
2. Definiteness of Purpose: Having a clear, defined purpose can act as a guiding light in your journey to success. It provides a framework for your actions and decisions.
3. Value of Self-Discipline: Self-discipline is a fundamental trait for success. It enables you to stay focused on your goals and resist distractions or setbacks.
4. Mastermind Principle: Surrounding yourself with people who inspire, challenge, and motivate you can provide a support system and collective intelligence that propels you toward success.
5. Learning from Failure: Failure is not a setback, but a stepping stone for growth. It provides valuable lessons that can guide future actions.
6. Continuous Learning: Lifelong learning is vital in personal and professional development. It keeps your skills and knowledge updated, making you more valuable in your field.
7. Taking Initiative: Taking the initiative, instead of waiting for opportunities to come to you, sets you apart and can lead to increased responsibilities and, consequently, a higher salary.
8. The Art of Selling: Learning how to sell – be it a product, a service, or your own skills and abilities – is a crucial skill that can lead to financial success. It’s not just about persuasion, but also about understanding the needs and wants of others and providing valuable solutions.
Think and Grow Rich (An Official Publication of the Napoleon Hill Foundation)
Invest for the Long Term
“If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” – Warren Buffett
“Historically, the stock market has doubled on average every 10 to 12 years,” according to Ron Baron. Thus, staying invested in equities over longer periods increases the likelihood of positive returns.
Never forget, when you sell a stock, the taxman will be at the head of the line for their cut of the profit
Historically, the U.S. economy has grown on average 6%-7% nominally per year, or doubling every 10 or 12 years, and the stock markets have closely reflected that growth.
As GDP Has Grown, So Has the Stock Market
U.S. GDP in 1968 was $968 billion, 55 years later it is $27.9 trillion. That’s over 28 times greater than it was in 1968.
The Dow Jones Industrial Average was around 944 and the S&P 500 was 104 in 1968. They are now 37,690 and 4,770, respectively.
Not taking risk is the greatest risk!
Belief before ability! Self belief is immensely powerful, the most successful people believe in themselves almost to the point of delusion!
References:
https://www.baronfunds.com/sites/default/files/baron-investor-baron-growth-fund-12.31.23.pdf