Very few investors have the kind of investing record that Warren Buffett has. Buffett writes an annual letter to the shareholders of Berkshire Hathaway every year. In the latest letter, he writes that between 1965 and now, the stock price of Berkshire Hathaway had gained 1,826,163 per cent. In comparison, the S&P 500, one of the premier stock market indices in the United States, gained around 2300 per cent during the same period.
Buffett, as is well known, follows the principle of value investing, which he learnt from his guru, Benjamin Graham. Graham wrote two books, The Intelligent Investor and Security Analysis (with David Dodd), in which he laid out the principles of value investing very clearly.
Having read The Intelligent Investor, I can safely say that it is one of the best possible books one can read on how to invest in the stock market and also make money in the process. The book has been in publication for many years now and anyone interested in learning the principles of value investing can easily read the book and pick up what it is all about.
Despite this, value investing is not a very popular investment strategy. People like to talk about it all the time, but very few people get around to using it to invest in the stock market. Why is that? Humphrey B Neill explains this in his book The Art of Contrary Thinking. As he writes: "Let us stress one psychological factor-a basic truism-that underlies the whole problem, because in the final analysis investment is a human problem."
And what does Neill mean by saying that investing is a human problem? "The average investor does not think and does not wish to think. Automatic forecasting methods relieve investors from sweating it out for themselves. They can "read" the findings of a given market-swing method and thereby avoid the backbreaking pick-and-shovel work that is necessary if one wishes to undercover the rich pay dirt that lies deeply buried," writes Neill.
Neill first wrote the book in the mid 1950s. Back then there were no television channels and websites offering stock market forecasts on a minute-to-minute basis. Value investing sadly does not lend itself to such forecasts. It doesn't promise any easy money that can be earned by investing in the stock market.It involves hard work of going through the books of the company and looking for other information as well. Hence, as Neill writes: "The "buy values" concept is without question a sound approach, but it requires applied head work and mental discipline. It will never be practiced by a large segment of the public."
Further, value investing does not lend itself to investing fads. Buffett stayed away from investing in dot-com stocks in the late 1990s because he felt he did not understand them. But this decision ended up making him look very stupid for almost half a decade.
In the five-year period between 1995 and 1999, the Berkshire Hathaway stock had given a return of 167 per cent. During the same period, the Nasdaq Composite (the dot-com stocks were largely listed on the Nasdaq stock exchange) had beaten it by a wide margin and given a return of 441 percent. Such was the strength of the bull run that it had even made a great investor like Buffett look stupid for nearly half a decade.
This also explains why most mutual funds don't run any funds based on value investing. Mutual funds need to show a performance in the short term to ensure that people stay invested and at the same time new investors keep coming in. Imagine a mutual fund following value investing during the course of the dot-com bubble. It would have performed very badly compared to its peers for a period of five years. How many investors would have still remained invested in it at the end of five years? And would that fund manager ever find a job again?
Buffett survived the dot-com bubble simply because he already had a stellar reputation by then. Anyone else in his place wouldn't have managed to survive. In fact, 1999 was the year when Buffett's company Berkshire Hathaway gave its worst performance ever. The stock price went up by just 0.5 per cent. In comparison the S&P 500 went up by 21 per cent, an under-performance of 20.5 per cent.
But as the dot-com bubble burst, Buffett had the last laugh, doing significantly better than the market between 2000 and 2002. In the letter to the Berkshire shareholders in 2000, Buffett explainedthe dot-com bubble: "By shamelessly merchandising birdless bushes, promoters have in recent years moved billions of dollars from the pockets of the public to their own purses (and to those of their friends and associates). The fact is that a bubble market has allowed the creation of bubble companies, entities designed more with an eye to making money off investors rather than for them. Too often, an IPO, not profits, was the primary goal of a company's promoters. At bottom, the "business model" for these companies has been the old-fashioned chain letter, for which many fee-hungry investment bankers acted as eager postmen."
He could say this because he had been patient for close to five years and not invested in dot-com stocks. Patience is an integral part of value investing and that is something most investors looking to make a quick buck lack.
Buffett went on to add: "But a pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons: First, many in Wall Street-a community in which quality control is not prized-will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest."
These are simple investing principles which are always worth remembering.
Vivek Kaul is the author of Easy Money. He can be reached at [email protected]
This column appeared in the June 2015 Issue of Mutual Fund Insight.