Don't Buy Trading Sardines
Value investing can take many forms, all of which revolve around purchasing a stock at a discount to the investor’s assessment of the intrinsic value of the business. Montgomery Global’s fund offerings adopt a value framework but apply a further requirement: investments must be in high quality businesses with sound prospects.
High quality businesses typically exhibit the ability to employ capital at very high rates of return. Enormous sums of money can be made simply by identifying these businesses and holding them for long periods, assuming they continue to reinvest in their business and that the high returns on incremental capital are sustainable. A corollary of this is that investments in these great businesses must be given sufficient time for the companies to make the investments that will underwrite their future growth.
The above might all sound well and good but the human desire for short term gratification can often overcome a well-reasoned investment approach. Warren Buffett once remarked that “investing is simple, but not easy”. The psychological wherewithal required to remain invested in these high quality businesses, even as the vagaries of the stock market produce wild price movements, is no small ask. Daily stock price quotes, the accessibility of low-cost trading platforms, as well as market prognosticators with hot stock tips all have the effect of spurring trading activity.
A hyperactive approach to purchasing stocks creates the risk that decisions are driven by speculation rather than sensible investing principles. A memorable allegory from Seth Klarman’s fantastic investing book Margin of Safety helps illustrate some of the key differences between investment and speculation.
“There is an old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, “You don’t understand. These are not eating sardines, they are trading sardines.”
The temptation to speculate – in the above example treating the sardines merely as prices that move up and down – is strong; speculation circumvents the need to perform rigorous research, can be lucrative in a rising market, and has an element of excitement to it. However, speculation is foolish and downright dangerous. A disciplined value investing approach never devolves into speculation but instead rests on fundamental research.
The benefits of following a value philosophy and keeping the discipline to stay in a great business are highlighted by the extraordinary returns of Berkshire Hathaway, the publicly traded conglomerate assembled by Warren Buffett over the last half-century. Berkshire Hathaway has produced an overall gain from 1964 to 2015 of a mind-blowing 1,598,284 per cent, or a 20.8 per cent compounded annual gain.
What is of note is that over this period there were four years where Berkshire Hathaway stock declined by greater than 15 per cent in a year. Investors would do better not to rent stocks, but to stay in good businesses for the long term where their patience will serve them well.
Are you looking for a simple way to invest in high quality global businesses? Applications to the new Montgomery Global Equities Fund are now open. To access the PDS and find out more, please visit the MOGL website.
Roger's step-by-step guide to valuing the best stocks and buying them for less than they're worth, Value.able, is available exclusively at rogermontgomery.com. Skaffold is an online stock-picking application that rates ASX-listed stocks from A1 to C5. Watch a demo of Skaffold at www.skaffold.com.