What are some of the great companies that came to your mind when you read the title?
Is it your favourite fast food restaurant McDonald’s or the well-known consumer electronics company Apple. Perhaps even American Express and Coca-Cola have popped up too?
These are exactly the companies Warren Buffett’s Berkshire Hathaway has invested in. These are great companies with strong brand names. There are not many other companies in the world that are able to rival their standings in their respective industries.
Investing in great companies
While there are in different industries, you may have already noticed some common characteristics they possess – large, well-known and successful. If you are like Warren Buffett and invested earlier on, you have probably made quite a sum on your investments to date.
Let’s have a look at the historical share price for McDonald’s:
If you invested in McDonald’s in 1984 for $2.49 per share, a $10,000 investment is worth $631,907 today. Mind you, that’s excluding dividends!
Warren Buffett has made astronomical profits through investing in such great companies. Does this mean that we should pick companies that are clearly good and doing well and jump on the bandwagon?
Getting the right price
If you’ve read our previous articles, you should be very clear of the idea of the value investing approach. Value investors derive a conservative estimate of the intrinsic value and compare it to the market price. If the market price offers a substantial level of margin of safety, we invest. By getting the entry price right, half the battle is won.
Most investors fail to see that the current market price is extremely important to how much returns they will be receiving in the future. Regardless of how great a business may be, if you are paying more than its fundamental value, you are taking on unnecessary risks.
Many individuals fell into the trap of investing in these “winners” just because successful investors like Warren Buffett have invested in them.
While great companies have high fundamental values. Very often those that have their glory days behind them are approximately already rightly priced, leaving you with little room to exploit any gap between market price and fundamental value.
So, no, not all great companies are great investments. Don’t fall into the trap!
“Alright then, I will just pick those companies that are about to take off. Surely out of the 100 companies chose, at least 1 will be the next Microsoft.”
If you think that’s the strategy to go, you may be better off investing in an ETF and let the index compound your money slowly and surely over time. Timing and speculating a stock, no matter how tempting it may be, will only lead to your portfolio’s demise in the long run.
Before you know it, your returns will be eroded by transaction costs because of your fear and greed while attempting to time the market. Following the crowd’s reactions and being constantly on the edge while you await the next market-moving event will do your emotional health no good too.
Many self-proclaimed experts claim confidently that they possess the secret to time the market and invite the public over for a free course. If they truly know what they are doing, do you think they will need a sustainable source of income from you instead?
Professional chartists have to constantly seek out for novel ways and different perspectives if they ever want to have the chance of performing in the stock market. Even then, their methods may not be sustainable or even work at all.
“Well, I won’t be doing any technical analysis. I believe I have a great eye for companies that will take off so why are you dissuading me from investing this way?!”
The crux of value investing is about certainty. The more certain your investments are, the greater capital you should be employing and the greater returns you will be guaranteed over time.
While you may think you have the unique ability to pick these stocks waiting to take-off, first, have a look at your own judgement.
Is your investment thesis fundamentally grounded? Is your approach sustainable? Or are you solely investing based on your gut feeling?
Put all the ego and pride on one side and first look at how sound your investment approach is.
Warren Buffett has always emphasized how investors should invest in what they are good and comfortable in. If you have great knowledge of the pharmaceutical industry, coupled with the value investing philosophy, you can make it big.
“How did Warren Buffett manage to pick such companies then?”
Warren knew about value and psychology.
Yes, he has an eye for good companies that will be greater because he understood the economics behind different industries and companies better than anyone else.
While everyone was panicking and off-loading all the stocks at hand, you can see Warren quietly sweeping up all the unwanted gems at dirt cheap prices.
Most important of all, he has a game plan in his mind always. He knew how value investing works, where the opportunities are and what he should do when he identifies one.
Hard work pays and it’s never too late to start now!
Be prepared before you make your next investment
Have you been “investing” blindly based on just investing in companies that you perceive as great with no notion of the valuation you are paying for? Maybe the returns aren’t that great and you are searching for alternative ways of growing your wealth.
Rest assured, you have absolutely come to the right place. By taking on the value approach, you will be investing with confidence and a peace of mind even when everyone is taking a hit.
Before you make your next investment, invest time in yourself and know what value investing is truly about here.