book.chapter Stockpiling principles

Warren Buffett, a titan of the investment world, has long preached the fundamental principles of investing, which are timeless in their application. These principles include viewing stocks as actual pieces of businesses, leveraging the inevitable fluctuations of the market to one's benefit, and always seeking a margin of safety. These cornerstones are expected to remain relevant and serve as the bedrock of sound investment strategy for centuries to come. The concept of stockpiling is essentially about identifying a business that you would be delighted to own entirely, assuming you had the financial means to do so, and then beginning to invest in it. The hope is that the stock price will decline, presenting an opportunity to purchase more shares at a more favorable price in the future. Stockpiling is, in essence, a shrewd execution of value investing principles. Investing in a company's stock should not be viewed differently from the decision to purchase an entire business. When you discover a business of exceptional quality and its stock price decreases, it should be a cause for celebration, not dismay. This is because it signifies the chance to acquire a greater stake in the business with the same amount of capital. Similarly, as an investor, understanding the intrinsic value of a company should lead to elation, not sorrow, when its market price falls. This scenario presents a golden opportunity to generate substantial profits. The true essence of stockpiling lies in the deep understanding of a company's value. As long as the business's intrinsic value significantly exceeds the market price you are paying, you are poised to emerge victorious over the long term. Market prices will eventually align with the true value of a business, despite short-term fluctuations and distortions. It is these variations that the astute investor uses to their advantage. Once you grasp the distinction between a company's true worth and its current market price, you position yourself to reap substantial rewards when the price realigns with the underlying value. Stockpiling is not just a theoretical concept; it is a practical application of the power of compounding returns. If you consistently invest in a company you favor and its stock price continues to drop, the average cost of your investment per share decreases. Consequently, when the stock price rebounds, your returns are amplified due to the lower acquisition cost of the later shares. The mathematics are straightforward: the less you pay for an asset, the higher your compounded return will be in the future. This translates into a more rapid accumulation of wealth. Warren Buffett himself has noted that investment performance is inversely related to the size of the capital being managed. He has boasted of his ability to generate exceptionally high returns on smaller sums of money, a feat that becomes increasingly challenging as the amount of capital grows. Stockpiling requires investing in companies that you can understand and value, using more than just the current stock price as a measure. To be successful at stockpiling, you must be willing to think independently and not rely on the consensus of the market. Remember, successful investors have been employing this strategy for decades. The allure of entrusting your funds to a professional investor, such as a mutual fund manager, is a seductive one. However, this approach is fraught with issues. Mutual funds impose fees regardless of their performance, which can significantly erode any potential gains or even the initial capital over time. Furthermore, mutual fund managers are notoriously inconsistent, with this year's star often becoming next year's underperformer. The likelihood of selecting a mutual fund manager on the cusp of a downturn is high. Additionally, mutual funds are not focused on stockpiling or investing with the investor's best interests at heart; their primary goal is to maximize their assets under management, which has no bearing on an individual's financial success. The collapse of major investment banks in 2008, such as Merrill Lynch, Bear Stearns, and Lehman Brothers, serves as a stark reminder of the risks associated with mutual funds. When markets are stagnant or declining, mutual funds typically perform poorly. Therefore, it is advisable to eschew mutual funds in favor of taking control of your own investments through stockpiling. Stockpiling involves purchasing shares in exceptional businesses that are temporarily undervalued and holding onto them until their true market value is realized. Identifying a "wonderful" business involves three key characteristics, each beginning with the letter "M": Meaning, Moat, and Management. These traits are subjective and will differ from one investor to another, based on individual competencies, interests, and preferences. A wonderful business is one that holds significant meaning to you; it operates in an industry you are familiar with and sells products you understand. It possesses a sizable moat, indicating a durable competitive advantage over its competitors. This advantage can stem from a strong brand name, proprietary information, market control, high customer switching costs, or the ability to offer the lowest prices. Additionally, a wonderful business is led by competent and honest management, passionate about serving stakeholders and aggressively pursuing growth targets with integrity. Warren Buffett's acquisition of Berkshire Hathaway in the 1960s is a testament to the power of stockpiling. Despite the company's initial downturn, Buffett strategically invested the minimum required to keep it solvent while using excess cash flow to acquire other, more profitable businesses. This strategy can be emulated by creating an investment account, or "Berky," and filling it with funds dedicated to stockpiling. The goal is to have a consistent cash flow into the Berky, which can come from various sources such as income, dividends, or other financial gains. Setting up the Berky as a tax-advantaged account, such as an IRA or 401(k), allows for pre-tax contributions and the potential for significant financial freedom over time. Phil Town suggests that with discipline, knowledge, and a steady job, one can achieve financial freedom by consistently investing in a Berky. Assuming an annual contribution of $12,000 and an exceptional stockpiling return of 24 percent, one could amass $3.6 million over twenty years, providing a substantial post-retirement income. A margin of safety in investing is created when there is a discrepancy between the intrinsic value of a business and the current market price of its shares. To ensure a margin of safety, aim to purchase shares at a price that is at most 50 percent of the company's intrinsic or retail value. Calculating the intrinsic value involves analyzing four key numbers: the earnings-per-share (EPS) for the last twelve months, the projected EPS growth rate for the next ten years, the expected price-to-earnings (PE) ratio in ten years, and your minimum acceptable rate of return, which should be at least fifteen percent to account for inflation, bond rates, and taxes. This valuation exercise may require practice, but it is a skill that can be honed over time. Warren Buffett has built his career on such analyses, and while individual investors may not have the same capital, the methodology remains consistent. Determine the projected intrinsic value of a company based on its EPS growth and purchase shares when they are available at a significant discount. By incorporating a substantial margin of safety, investors can achieve success. As Charlie Munger aptly put it, it is always preferable to buy a great business at a fair price than a fair business at a great price.