George Salmon 8 January 2019
There’s no guaranteed recipe for success when it comes to getting the most out of your investments, but we share some tips that can help.
The stock market has proven it’s able to make great returns in the long-run.
Here, I take a look at how some of the investing greats have approached things, and how each has built on the success of the last.
This article is provided for your interest and isn’t personal advice. When deciding where to invest you should consider your own attitude to risk and investment objectives. If you're not sure if an investment is right for you, please speak to a financial adviser.
Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.
Benjamin Graham - the father of value
Graham is often called the father of value investing, buying investments that look undervalued compared to their true worth.
Like almost all revolutionary breakthroughs, his theory was simple. Graham aimed to block out the background noise and focus purely on the value of the company he was looking at.
To do this, he’d use what we now know as fundamental analysis. This involved poring over a company’s balance sheet and financial accounts to come up with his own estimates of what they were worth. He’d then compare this to the quoted market price of the shares. If his method implied the shares were undervalued by a fair amount, he’d invest. If not, he wouldn’t.
Graham often needed his estimate to be a lot higher than the open market value. He wanted a ‘margin of safety’ because he was careful to remember that he wouldn’t always be right about a company. Even when he was, stock price fluctuations could mean his investments fell in value before they rose.
The essence of Graham’s value-driven approach was making the most of inefficiencies in the market to buy companies for less than they were really worth.
As Graham himself put it, ‘in the short run, the market is a voting machine, but in the long run it’s a weighing machine’.
Warren Buffett and Peter Lynch - building growth into first principles
Warren Buffett is Graham’s most famous and successful student. Much of Buffett’s work builds on his mentor’s principals.
Together with his long-time business partner Charlie Munger, Buffett has headed up the Berkshire Hathaway investment company with considerable success.
The ‘Oracle of Omaha’ takes a long-term approach. He famously once said ‘If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes’.
Buffett’s success has been in finding big companies with clear and stable advantages, like a strong brand name and patented intellectual property. He then holds them over the long-term.
Examples include Coca-Cola, where the group is around 1,200% up on its original investment, taking the value of his stake to $17.3bn. Coke’s marketing expertise has kept it one step ahead. It’s helped the company steadily grow its market share , and its dividend has risen for 56 years in a row.
While Buffett based his philosophy around finding undervalued companies, a lot of his ideas lean more towards growth investing, in contrast to value investing.
Growth investors have tended to be happier to pay higher prices for what they see as outstanding companies. The company’s future prospects taking priority over last year’s financials.
For example, another of Buffett’s great quotes is ‘it’s better to buy a wonderful company at a fair price, than a fair company at a wonderful price.’
Fellow American Peter Lynch, whose fund made an average annual return of close to 30% from 1977 to 1990, wanted to build another bridge between the two strategies. He promoted the ‘growth at a reasonable price’, or GARP, strategy.
While still focusing on stocks he thought could grow, Lynch was wary of overpaying for those with high valuations. To help reduce this risk, he looked for companies with low PEG (price to earnings to growth) ratios. For this ratio to be below 1, he’d need a company trading on a PE ratio of 30 to grow its earnings by 30% in the year ahead.
Lessons for investors
Graham, Buffett and Lynch approached investing from slightly different angles. But we think there’s more that unites these three great investors than divides them.
While each is slightly more in-tune with ‘growth’ or ‘value’, it’s hard to imagine any of them buying shares in a company they didn’t think was going to do well over the long-term.
This echoes my thoughts that investing shouldn’t be overcomplicated. It should be about buying shares in high quality companies and holding them for the long-term.
The most important quality I look for is quality itself. This means investing in companies with diverse revenues, who are largely in control of their own destiny. Companies with proven management and stable business models might not be exciting, but if it was good enough for Warren Buffett, it’s good enough for me.
To borrow from Peter Lynch, if good quality investments can be purchased at attractive prices, that’s the cherry on the cake. But it should be remembered there are no guarantees and all investments can fall as well as rise in value.
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