Category Archives: Investing

Contrarian Investing

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“The way to make money is to buy when blood is running in the streets.” ~ John D. Rockefeller

Contrarian investing believes that the worse things seem in the market, the better the investing opportunities are for profit.

Contrarians, as the name implies, try to do the opposite of the crowd. They get excited when an otherwise good company has a sharp but undeserved drop in share price. They swim against the current and assume the market is usually wrong at both its extreme lows and highs. The more prices swing, the more misguided they believe the rest of the market to be. (For more on this, read “Finding Profit In Troubled Stocks.”)

Bad Times Make for Good Buys

Contrarian investors have historically made their best investments during times of market turmoil. In the crash of 1987, the Dow dropped 22% in one day in the U.S. In the 1973-’74 bear market, the market lost 45% in about 22 months. The terrorist attacks of Sept. 11, 2001, also resulted in a major market drop. Those are times when contrarians found their best investments.

The 1973-’74 bear market gave Warren Buffett the opportunity to purchase a stake in the Washington Post Co. at a deep discount (the company could have “sold the [Post’s] assets for not less than $400 million.” Meanwhile, the Post had an $80 million market cap), an investment that has subsequently increased by more than 100 times the purchase price–that’s before dividends are included.

Sir John Templeton, founder of the Templeton Growth Fund, was also a serious contrarian investor, buying into countries and companies when, according to his principle, they hit the “point of maximum pessimism.”

As an example of this strategy, Templeton bought shares of every public European company at the outset of World War II in 1939, including many that were in bankruptcy. He did this with borrowed money. After four years, he sold the shares for a very large profit.

But there are risks to contrarian investing. While successful contrarian investors put big money on the line, swam against the current of common opinion and came out on top, they also did some serious research to ensure the investing herd was indeed wrong.

So, when a stock takes a nosedive, this doesn’t prompt a contrarian investor to put in an immediate buy order, but to find out what has driven the stock down and whether the drop in price is justified.

While successful contrarian investors have their own strategy for valuing potential investments, they all have the one strategy in common–they let the market bring the deals to them, rather than chasing after them.

References:

  1. https://www.forbes.com/2009/02/23/contrarian-markets-boeing-personal-finance_investopedia.html

Long-Term Investors vs Day Traders

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Billionaire “Old School” Investors:

1. Carl Icahn
2. Warren Buffett
3. Charlie Munger
4. Howard Marks
5. Nick Sleep

Billionaire Day Traders:

1.
2.
3.
4.
5.

The second list isn’t blank by accident.

For the purposes of this post:

  • Day trading is buying and selling on small price movements in stocks throughout a trading day, often in intervals of seconds or minutes.
  • Old School (Long-term) investing is buying or selling a company’s stock after long periods of holding an investment and being patient for the right price to intrinsic value proposition.

Return on Invested Capital (ROIC)

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Return on invested capital, or ROIC, is a valuable financial ratio. Understanding ROIC and using it to screen for high ROIC stocks is a good way to focus on the highest-quality businesses.

Put simply, return on invested capital (ROIC) is a financial ratio that shows a company’s ability to allocate capital.

A high return on invested capital (ROIC) means investors are realizing strong returns on their investment in a company.

The higher the ROIC, the better a company is investing it’s capital to generate future growth and shareholder value.

For example, let’s say a management team had $1 million dollars to invest, and they could either invest in a new product line, or enhancements to their existing product line. After thinking it over, the Company invests the $1 million in a new product line. One year later, the Company looks back at what they have earned on the new product line, only to find out that it’s a measly $100,000.

As it turns out, if they had invested in the enhancements to their existing product line, they would have earned $500,000 over the same period of time. What does this mean?

Well, there could be more factors at play, but based on this example, the Company’s management team made the wrong decision.

As an investor, you want your management teams making the right decisions and investing in the areas that will generate the highest returns for you as an investor.
The common formula to calculate ROIC is to divide a company’s after-tax net operating profit, by the sum of its debt and equity capital.

Once the ROIC is calculated, it is evaluated against a company’s weighted average cost of capital, commonly referred to as WACC. If a company’s WACC is not immediately available, it can be calculated by taking a weighted average of the cost of a company’s debt and equity.

Cost of debt is calculated by averaging the yield to maturity for a company’s outstanding debt. This is fairly easy to find, as a publicly-traded company must report its debt obligations.

Cost of equity is typically calculated by using the capital asset pricing model, otherwise known as CAPM.

Once the WACC is calculated, it can be compared with the ROIC.

Investors want to see a company’s ROIC exceed its WACC. This indicates the underlying business is successfully investing its capital to generate a profitable return. In this way, the company is creating economic value.

Generally, stocks generating the highest ROIC are doing the best job of allocating their investors’ capital.

By calculating  a company’s return on invested capital, investors can get a better gauge of companies that do the best job investing their capital. Yet, ROIC is by no means the only metric that investors should use to buy stocks.

References:

  1. https://www.suredividend.com/high-roic-stocks/#top
  2. https://www.discoverci.com/stock-scanner/roic-screener

Top Investing Rules

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The number one rule of investing is: Don’t lose money. In other words, preservation of capital and management of risk are most important for investors than maximizing returns and income.

What follows are 10 proven rules of investing to make you a more successful — and hopefully to build wealth — investor.

Rule No. 1 – Never lose money

Legendary investor Warren Buffett stated that “Rule No. 1 is never lose money. Rule No. 2 is never forget Rule No. 1.” The Oracle of Omaha’s advice stresses the importance of avoiding loss in your portfolio. When you have more money in your portfolio, you can make more money on it. So, a loss hurts your future earning power.

What Buffett’s rule essentially means is don’t become enchanted with an investment’s potential gains. Instead, focus on downside investment risks and preservation of capital. If you don’t get enough upside for the risks you’re taking, the investment may not be worth it. Focus on the downside risk first, counsels Buffett.

Rule No. 2 – Think like an owner

Think like an owner. Remember that you are buying fractional ownership of companies, not just stocks.

While many investors treat stocks like gambling, real businesses stand behind those stocks. Stocks are a fractional ownership interest in a business, and as the business performs well or poorly over time, the company’s stock is likely to follow the direction of its profitability.

Investing involves an analysis of fundamentals, valuation, and an opinion about how the business will perform and produce cash in the future.

Rule No. 3 – Stick to your process

The best investors develop a process that is consistent and successful over many market cycles. Be discipline and don’t deviate from your process because of short-term challenges and market volatility.

One of the best strategies for investors: a long-term buy-and-hold approach. You can buy stock funds regularly in a 401(k), for example, and then hold on for decades. But it can be easy when the market gets volatile to deviate from your plan because you’re temporarily losing money. Don’t do it.

Rule No. 4 – Buy when everyone is fearful

When the market is down, investors often sell or simply quit paying attention to it. But that’s when the bargains are out in droves. It’s true: the stock market is the only market where the goods go on sale and everyone is too afraid to buy. As Buffett has famously said, “Be fearful when others are greedy, and greedy when others are fearful.”

The good news if you’re a 401(k) investor is that once you set up your account you don’t have to do anything else to continue buying in. This structure keeps your emotions out of the game.

Rule No. 5 – Keep your investing discipline

It’s important that investors continue to save over time, in rough climates and good, even if they can put away only a little. By continuing to invest regularly, you’ll get in the habit of living below your means even as you build up a nest egg of assets in your portfolio over time.

The 401(k) is an ideal vehicle for this discipline, because it takes money from your paycheck automatically without you having to decide to do so. It’s also important to pick your investments skillfully – here’s how to select your 401(k) investments.

Rule No. 6 – Stay diversified

Keeping your portfolio diversified is important for reducing risk. Having your portfolio in only one or two stocks is unsafe, no matter how well they’ve performed for you. So experts advise spreading your investments around in a diversified portfolio.

“If I had to choose one strategy to keep in mind when investing, it would be diversification,” says Mindy Yu, former director of investments at Stash. “Diversification can help you better weather the stock market’s ups and downs.”

The good news: diversification can be easy to achieve. An investment in a Standard & Poor’s 500 Index fund, which holds hundreds of investments in America’s top companies, provides immediate diversification for a portfolio. If you want to diversify more, you can add a bond fund or other choices such as a real estate fund that may perform differently in various economic climates.

Rule No. 7 – Avoid timing the market

Experts routinely advise clients to avoid trying to time the market, that is, trying to buy or sell at the right time. “Time in the market is more important than timing the market.” The idea here is that you need to stay invested to get compounding returns and avoid jumping in and out of the market.

And that’s what Veronica Willis, an investment strategy analyst at Wells Fargo Investment Institute recommends: “The best and worst days are typically close together and occur when markets are at their most volatile, during a bear market or economic recession. An investor would need expert precision to be in the market one day, out of the market the next day and back in again the following day.”

Experts typically advise buying regularly to take advantage of dollar-cost averaging.

Rule No. 8 – Understand everything you invest in

“Don’t invest in a product you don’t understand and ensure the risks have been clearly disclosed to you before investing,” says Chris Rawley, founder and CEO at Harvest Returns, a fintech marketplace for investing in agriculture.

Whatever you’re investing in, you need to understand how it works. If you’re buying a stock, you need to know why it makes sense to do so and when the stock is likely to profit. If you’re buying a fund, you want to understand its track record and costs, among other things. If you’re buying an annuity, it’s vital to understand how the annuity works and what your rights are.

Rule No. 9 – Review your investing plan and goals regularly

While it can be a good idea to set up a solid investing plan and then only tinker with it, it’s advisable to review your plan regularly to see if it still fits your needs. You could do this whenever you check your accounts for tax purposes.

“Remember, though, your first financial plan won’t be your last,” says Kevin Driscoll, vice president of advisory services at Navy Federal Financial Group in the Pensacola area. “You can take a look at your plan and should review it at least annually – particularly when you reach milestones like starting a family, moving, or changing jobs.”

Rule No. 10 – Stay in the game, have an emergency fund

It’s absolutely vital that you have an emergency fund, not only to tide you over during tough times, but also so that you can stay invested long term.

“Keep 5 percent of your assets in cash, because challenges happen in life,” says Craig Kirsner, president of retirement planning services at Stuart Estate Planning Wealth Advisors in Pompano Beach, Florida. He adds: “It makes sense to have at least six months of expenses in your savings account.”

If you must sell some of your investments during a rough spot, it’s often likely to be when they are down. An emergency fund can help you stay in the investing game longer. Money that you might need in the short term (less than three years) needs to stay in cash.

Investing is effectively about doing the right things and about avoiding the wrong things. And, it’s important to manage your temperament (emotions) so that you’re focused and disciplined to do the right things even as they may feel risky, scary or unsafe.

References:

https://www.bankrate.com/investing/golden-rules-of-investing/

Lessons of Warren Buffett

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An understanding of the investing lessons of Warren Buffett.

1. Value investing works. Buy bargains which involve buying assets at a price below the asset’s intrinsic value. Value investing takes time, focus, discipline and patient, and is a hard process to implement and follow. It requires a lot of work to determine the fair value of a particular business. If investors could predict the future directions of the stock market, they would certainly not choose to be value investors. But no one can accurately forecast future prices. Value investing is a safe and successful strategy in all investing environments. The biggest obstacle for a value investor is to remain disciplined and patient in every circumstance the market and life might throw at him. Most people quit value investing and long- term investing for this exact reason: because they lack the discipline and cannot sit through periods of poor performance.

2. Quality matters, in businesses and in people. Better quality businesses are more likely to grow and compound cash flow; low quality businesses often erode and even superior managers, who are difficult to identify, attract, and retain, may not be enough to save them. Always partner with highly capable managers whose interests are aligned with yours.

3. There is no need to overly diversify. Invest like you have a single, lifetime “punch card” with only 20 punches, so make each one count. Look broadly for opportunity, which can be found globally and in unexpected industries and structures.

4. Consistency, discipline and patience are crucial. Most investors are their own worst enemies. Endurance and long-term perspective enables compounding.

5. Risk is not the same as volatility; risk results from overpaying or overestimating a company’s prospects. Prices fluctuate more than value; price volatility can drive opportunity. Sacrifice some upside as necessary to protect on the downside.

6. Unprecedented events (or Black Swan events) occur with some regularity, so be prepared.

7. You can make some investment mistakes and still thrive.

8. Holding cash in the absence of opportunity makes sense.

9. Favor substance over form. It doesn’t matter if an investment is public or private, fractional or full ownership, or in debt, preferred shares, or common equity.

10. Candor is essential. It’s important to acknowledge mistakes, act decisively, and learn from them. Good writing clarifies your own thinking and that of your fellow shareholders.

11. To the extent possible, find and retain like-minded shareholders (and for investment managers, investors) to liberate yourself from short-term performance pressures.

12. Do what you love, and you’ll never work a day in your life.

13. “The first rule of investing is to not lose money, the second rule is to never forget the first one,” states Warren Buffett. Loss avoidance must be the cornerstone of your investment philosophy. Investors should not stick to bonds or avoid risks at all, but rather that “an investment portfolio should not be exposed to losses of principal capital over five to ten years”, according to Klarman. This, concentrating on avoiding big losses is the safest way to ensure a profitable investing outcome.

14. Ignore Market Price Fluctuations which are completely unrelated to the value of the investment or asset. When the stock’s market price goes down, the investment may be seen as riskier regardless of its fundamentals. But that’s not risk. Investors should expect prices to fluctuate and should not invest in securities if they cannot tolerate market volatility.

15. Avoid Leverage At All Costs.

References:

  1. https://hollandadvisors.co.uk/wp-content/uploads/2021/03/what-ive-learned-from-warren-buffett-seth-klarman.pdf
  2. https://medium.datadriveninvestor.com/how-seth-klarman-achieved-a-20-annual-return-for-30-years-8cd0f39da208

Margin of Safety

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“A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world.” ~ Seth Klarman

Berkshire Hathaway CEO and Chairman, Warren Buffett, is known for his value investing approach, which involves finding companies that are undervalued by the market and investing in them for the long term. To invest like Warren Buffett, there are a few things you need to know.

  • First, you need to have a clear understanding of what value investing is and how it works.
  • Second, you need to be patient and be willing to hold onto your investments for the long term.
  • Third, you need to have the discipline to stick to your investing strategy even when the market is going against you.

When deciding on how to invest in a company, the first step is to determine its worth or intrinsic value. According to Warren Buffett, the best companies to buy are those that are inexpensive to buy. His investment strategy is based on a few simple principles:

  • Buy quality companies that have a competitive advantage (moat),
  • Buy them at a reasonable price with a margin of safety, and
  • Hold them for the long term.

These principles of margin of safety have helped Buffett generate incredible returns over his career. Margin of safety is a strategy that involves investing only in securities at a significantly lower intrinsic value than their market price.

The margin of safety (MOS) allows investors to avoid overpaying for an investment or asset, and it protects investors from the potential of loss if the market price of the asset falls. Buffett has said that the margin of safety is the key to his investing success.

The margin of safety is a measure of how much room there is between the price of the stock and its inherent value. The wider your margin of safety, the less likely it is that overly optimistic valuation inputs will harm your investment.

Value investing is the process of making investment decisions using margin of safety. It is critical for value investors to find a high-quality, easy-to-understand company with good management priced below its intrinsic value.

The purpose of using a margin of safety in buying is twofold.

  • If your investment does not grow as quickly as you originally anticipated, you may be forced to make more conservative investments in your portfolio. If your estimates are correct, you will be able to achieve a better rate of return over time due.
  • If you purchased the investment at an extremely low price.

Discounted cash flow (DCF) is a method of valuing a company or asset using the principles of time value of money.

The objective of DCF is to find the value of an investment today, given its expected cash flows in the future. One popular way to value a company is using the discounted cash flow (DCF) method. This approach discounts a company’s future expected cash flows back to the present day, using a required rate of return or “hurdle rate” as the discount rate. The idea is that a company is worth the sum of all its future cash flows, discounted back to the present.

The DCF formula is: Value of Investment = Sum of (Cash Flow in Year / (1 + Discount Rate)^Year)

The “discount rate” is the required rate of return that an investor demands for investing in a company. This rate is also known as the “hurdle rate.” There are two ways to calculate the discount rate.

There are two ways to calculate the discount rate.

The first is the weighted average cost of capital (WACC). This approach considers the cost of all the different types of capital that a company has, including debt and equity.

The second way to calculate the discount rate is the discount rate for equity. This approach only considers the cost of equity, which is the return that investors demand for investing in a company.

Once the discount rate is determined, the next step is to estimate the cash flows that a company is expected to generate in the future. These cash flows can come from a variety of sources, including operating income, investments, and financing activities. After the cash flows have been estimated, they need to be discounted back to the present using the discount rate.

The present value of the cash flows is then the sum of all the future cash flows, discounted back to the present.

“If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it’s over the Grand Canyon, you may want a little larger margin of safety.” ~ Warren Buffett

References:

  1. https://www.merchantshares.com/margin-of-safety-the-key-to-warren-buffetts-investing-success/
  2. https://www.merchantshares.com/the-dcf-method-of-valuing-a-company/
  3. https://www.merchantshares.com/how-to-win-warren-buffett-39/

Warren Buffett’s Investing Top Four

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“Don’t look at a stock like it is a ticker symbol with a price that goes up and down on a chart. It’s a slice of a company’s profits far into the future, and that’s how they need to be evaluated.” ~ Warren Buffett, Chairman and CEO, Berkshire Hathaway

Warren Buffett’s philosophy is simple. Buy with a “margin of safety” undervalued companies with strong fundamentals and balance sheet, and then wait. It’s possibly the most boring way to invest in the world. But it’s effective.

For Warren Buffett, deciding what stocks to buy is “simple but not necessarily easy,” according to CNBC Warren Buffett Guide to Investing.

In his Berkshire Hathaway 1977 annual letter to shareholders, he listed four attributes he wanted to see when investing, whether he’s buying the entire company for Berkshire, or just a slice of it as a stock.

1. “One that we can understand…”

When Buffett talks about “understanding” a company, he means he understands how that company will be able to make money far into the future.

He’s often said he didn’t buy shares of what turned out to be very successful tech companies like Google and Microsoft because he didn’t understand them. At the 2000 annual meeting, a skeptical shareholder told Buffett he couldn’t imagine him not understanding something. Buffett responded, “Oh, we understand the product. We understand what it does for people. We just don’t know the economics of it 10 years from now.”

2. “With favorable long-term prospects …”

Buffett often refers to a company’s sustainable competitive advantage, something he calls a “moat.”

“Every business that we look at we think of as an economic castle… And you want the capitalistic system to work in a way that millions of people are out there with capital thinking about ways to take your castle away from you, and appropriate it for their own use. And then the question is, what kind of a moat do you have around that castle that protects it?”

— 2000 BERKSHIRE ANNUAL MEETING

A “moat” consists of things a company does to keep and gain loyal customers, such as low prices, quality products, proprietary technology, and, often, a well- known brand built through years of advertising, such as Coca-Cola. An established company in an industry that has large start-up costs that deter would be competitors can also have a moat.

3. “Operated by honest and competent people …”

“Generally, we like people who are candid. We can usually tell when somebody’s dancing around something, or where their — when the reports are essentially a little dishonest, or biased, or something.

And it’s just a lot easier to operate with people that are candid.

“And we like people who are smart, you know.

I don’t mean geniuses… And we like people who are focused on the business.” — 1995 BERKSHIRE ANNUAL MEETING

The quality of the business itself, however, takes precedence.

“The really great business is one that doesn’t require good management. I mean, that is a terrific business. And the poor business is one that can only succeed, or even survive, with great management.” — 1996 BERKSHIRE ANNUAL MEETING

4. “Available at a very attractive price.”

“The key to [Benjamin] Graham’s approach to investing is not thinking of stocks as stocks or part of a stock market. Stocks are part of a business. People in this room (Berkshire shareholders) own a piece of a business. If the business does well, they’re going to do all right as long as they don’t pay way too much to join into that business. — 1997 BERKSHIRE ANNUAL MEETING

Buffett’s goal is to buy with a “margin of safety” or when the market price is below a company’s “intrinsic value.” Buffett has said that the margin of safety is the “most important concept in investing.”

“The three most important words in investing are margin of safety…” ~ Warren Buffett

“The intrinsic value of any business, if you could foresee the future perfectly, is the present value of all cash that will be ever distributed for that business between now and judgment day.

“And we’re not perfect at estimating that, obviously.

“But that’s what an investment or a business is all about. You put money in, and you take money out.

“Aesop said, ‘A bird in the hand is worth two in the bush.’ Now, he said that around 600 B.C. or something like that, but that hasn’t been improved on very much by the business professors now.” — 2014 BERKSHIRE ANNUAL MEETING

References:

  1. https://fm.cnbc.com/applications/cnbc.com/resources/editorialfiles/2022/03/22/bwp22links.pdf

Focus, Discipline and Patience are Wealth Building Super Powers!

Intrinsic Value

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“Every investment is the present value of all future free cash flow.” Everything Money

Cash flow refers to the net amount of cash and cash equivalents that comes in and goes out of a company. Businesses take in money from sales as revenues and spend money on expenses. Cash received represents inflows, while money spent represents outflows.

“Intrinsic value can be defined simply as the discounted value of cash that can be taken out of a business during its remaining lifetime. “ ~ Warren Buffett

A company’s ability to create value for shareholders is fundamentally determined by its ability to generate positive cash flows or, more specifically, to maximize long-term free cash flow (FCF). FCF represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets.

Intrinsic value is defined as the discounted present value of all future cash flow of a business.

The only reason to lay out money for an investment now is to get more money later.  When you invest in a bond, its very easy to see the future cash flow and the terminal value of a bond, its printed on the certificate.

When you invest in a stock,

Investing in any financial asset involves laying out cash now in order to get cash later out of the investment.  And investing in a business, can the business deliver enough cash to you (the owner) soon enough that it makes sense to buy it as its current market value?

How much am I willing to pay for a business, considering it makes $24B in cash flow per year, and is growing at 10% annually.

Once we determine the business intrinsic value, we compare that number to the business’ current market capitalization.  Market cap is the product of the total shares outstanding and the current market stock price.

  • Market cap is higher than intrinsic value = overvalued
  • Market cap is lower than intrinsic value = undervalued

Discounted Free Cash Flow since one dollar today is worth more thant $1 in five years due to opportunity costs and lost of purchasing power of that dollar.

  • Step 1:  Find the current free cash flow – Free cash flow is the amount of money left over for the owners of the business, after factoring in cash outflows that support its operations and maintain its capital assets. The ideal FCF for valuation would equal Operating Cash Flow minu Maintenance CapEx
  • Step 2:  Grow the current free cash flow out 10 years in the future – the growth rate used will have a big impact on the final intrinsic value calculation. Check historical growth rate for cash flow and industry growth rate for cash flow.  Or, look at trend and future capital investments.
  • Step 3:  Add a terminal value – what you can sell the business for in 10 years.  Use FCF multiple.
  • Step 4:  Discount all future cash flows to present value at a rate of 12% to 15%
  • Step 5:  Add together all future cash flows to find intrinsic value
  • Step 6:  Add a margin of safety (of 20% to 30%)

In the current market environment, most companies will be trading above the intrinsic value.

References:

  1. https://www.investopedia.com/terms/f/freecashflow.asp

Warren Buffett: Morgan Housel’s Viewpoint

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“Compounding doesn’t rely on earning big returns. Merely good returns sustained uninterrupted for the longest period of time—especially in times of chaos and havoc—will always win.” ― Morgan Housel, The Psychology of Money: Timeless lessons on wealth, greed, and happiness

More than 2,000 books are dedicated to how Warren Buffett built his fortune. Many of them are wonderful. But few pay enough attention to the simplest fact:

Buffett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child, writes Morgan Housel in his seminal book, The Psychology of Money: Timeless lessons on wealth, greed, and happiness.

Warren Buffett’s estimated net worth is $110 billion as of November 2022. Of that, $109.2 billion was accumulated after his 50th birthday. $107.5 billion came after he qualified for Social Security, in his mid-60s. Warren Buffett is a phenomenal investor.

But you miss a key point if you attach all of his success to investing acumen. The real key to his success is that he’s been a phenomenal investor for three quarters of a century.

Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him. Consider a little thought experiment. Buffett began serious investing when he was 10 years old. By the time he was 30 he had a net worth of $1 million, or $9.3 million adjusted for inflation.16

What if he was a more normal person, spending his teens and 20s exploring the world and finding his passion, and by age 30 his net worth was, say, $25,000? And let’s say he still went on to earn the extraordinary annual investment returns he’s been able to generate (22% annually), but quit investing and retired at age 60 to play golf and spend time with his grandkids. What would a rough estimate of his net worth be today? Not $110 billion. $11.9 million. 99.9% less than his actual net worth.

Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. If you had invested $10,000 with Warren Buffett in 1966, today you would have over $160 million! That same $10,000 invested in the S&P would be $140,000.

Buffett’s skill is investing, but his secret is time. That’s how compounding works. Think of this another way. Buffett is considered by many to be the most famous and successful investor in history. But he’s not necessarily the greatest—at least not when measured by average annual returns.

“Doing well with money isn’t necessarily about what you know. It’s about how you behave. And behavior is hard to teach, even to really smart people.” ~ Morgan Housel

References:

  1. Morgan Housel, The Psychology of Money: Timeless lessons on wealth, greed, and happiness., Harriman House, September 8, 2020.
  2. https://www.goodreads.com/work/quotes/65374007-the-psychology-of-money
  3. https://www.celebritynetworth.com/richest-businessmen/richest-billionaires/warren-buffett-net-worth/

Small Cap Investing

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A focus on finding small cap companies with great fundamentals and big growth prospects.

A small-cap stock is a stock of a publicly-traded company whose market capitalization ranges from $300 million to approximately $2 billion, explains Corporate Finance Institute. The word “cap” in this term refers to a company’s market capitalization.

Savvy investors cannot afford to overlook small-cap growth companies. Although, there are several pros and cons of investing in small-cap stocks that must be considered.

Small-cap companies, in general, tend not to get the same kind of publicity as their large-cap siblings. They aren’t going to lead a segment on CNBC or the home page of the Wall Street Journal on a daily basis.

With smaller market capitalizations, small-cap companies tend to fly under the radar.

The Rise of Small-Cap Stocks

Reasons that people may invest in small-cap companies are capital appreciation — they think the stock price will go up and dividends — where the company pays you to hold it.

But some of these are solid companies and excellent small-cap stocks to buy.

Small-cap equities are more sensitive to the economy (inflation, rising interest rates and dollar strength), so a robust economic rebound would favor them.

Small-cap stocks are popular among investors because of their potential for providing better returns in the long term relative to their large-cap peers.

The advantages of investing in small-cap stocks are:

1. Growth potential – Relative to bigger companies, small-cap companies show significantly higher growth potential. For small-cap companies, it is easier to grow significantly their operational and financial base than is the case for most large-cap stocks.

Picking the right small-cap stock can turn into a profitable investment.

2. High probability of inefficiencies in the market – Information about the small-cap stocks is harder to find compared to large and mid-cap companies. Analysts typically give little attention to these companies; thus, there is a high probability of improper pricing of small-cap stocks. This situation creates vast opportunities for investors to leverage the inefficiencies in market pricing and earn a great return on their investments.

3. Financial institutions do not push prices up – Financial institutions, including mutual and hedge funds, should comply with certain regulations that do not allow them to invest heavily in small-cap stocks. For this reason, it is unlikely that the stock price will be artificially pushed up because of large investments from major financial institutions.

Nevertheless, there are some disadvantages of investing in small-cap stocks:

1. High risk – Investing in small-cap stocks involves higher risk. First, small-cap companies may have an unreliable and faulty business model which can result in company’s management not being able to adjust the business model, and can result in poor operational and financial results. And, small-cap companies usually have less access to new capital and new sources of financing. Due to this reason, it is more likely that the company will not be able to bridge gaps in its cash flows or expand the business because of the inability to undertake the necessary investments.

2. Low liquidity – Small-cap stocks are less liquid than their large counterparts. Low liquidity results in the potential unavailability of the stock at a good price to purchase or it may be difficult to sell the stocks at a favorable price. Low liquidity also adds to the overall risk of the stock.

3. Time-consuming – Investing in small-cap stocks can be a time-consuming activity. Due to the under-coverage of small-cap stocks by financial media, institutions and analysts, the amount of available research on small-cap companies is usually limited.

Moreover, small cap technology and all small cap stocks are discounted to a great degree by investors in a rising interest rate environment, purely due to the fact that they have the bulk of potential earnings and cash flow far out into the future. The higher long-term rates are, the less those future earnings and cash flow are worth. This goes for virtually all unprofitable growth tech stocks.

Essentially, small-cap stocks may provide investors with an opportunity to earn a substantial return on their investments. However, this type of investing should be approached with caution as small-cap stocks are often risky and volatile.

References:

  1. https://investorplace.com/2022/11/7-excellent-small-cap-stocks-to-buy-before-this-year-ends/
  2. https://corporatefinanceinstitute.com/resources/wealth-management/small-cap-stock/
  3. https://news.yahoo.com/10-best-small-cap-stocks-140302020.html