Will an ordinary investor be able to beat the market and compete with professionals?
Miscellaneous / / November 30, 2021
You can definitely learn some strategies from specialists.
Opportunities for amateurs and professionals are compared by Elena Chirkova, Candidate of Economic Sciences and investment banker. She not only discusses whether the average person will succeed in repeating the successes of billionaire Warren Buffett, but also highlights methods that can be borrowed from famous investors.
"Value investing in persons and principles", a new book by Chirkova, was published by the publishing house "Alpina Publisher". Lifehacker publishes Chapter 13.
Let's say we learned everything that value investors write and decided to try investing ourselves. Can an ordinary investor be able to manager a fund or, like Buffett, a company to beat the market? The second question - which of the principles of value investors can be borrowed and what is transferable to another country and another time? After all, investors wrote at different times and about different countries. Let's start with the first question.
Not all tricks will be available. For example, Berkshire
Berkshire Hathaway, an American holding company run by Warren Buffett. being an insurance company, it practically does not take on classic debt, moreover, it has a leverage, and very cheap. The fact is that she has obligations for insurance payments, which represent her debt. For insurance companies, the cost of raising debt is calculated as the difference between payments and premiums for a specific year, divided by the premiums.If premiums exceed payments in a certain year, then for that year the cost of debt turns out to be negative. For example, if premiums were collected for $ 100 million, and payments were made for $ 95 million, then the cost of the debt will be -5% per annum.
Buffett, being a very cautious insurer who does not dump during periods of low insurance prices, attracts debt for the most part at rates below discount or even negative. The performance of Berkshire shares is also determined by profitability its borrowed capital.
This is followed by the purchase of entire companies, but an ordinary investor cannot afford it. But in fairness, I must say that there are no calculations showing how Buffett earned a higher profitability - by portfolio investments or strategic.
Of course, an ordinary investor will not be able to repeat this, because he will not be given a loan at such rates.
Purchase of bankrupt companies from the same series. Here it is not only about money, but also about the position of a bankrupt judge. If you want to invest in publicly traded securities of a company in the stage of bankruptcy, then there are some difficulties here too: profitability largely depends on the speed and outcome of the bankruptcy procedure, which can only be correctly estimated with the help of American lawyers.
This hat is not according to Senka. Yet, as Marty Whitman aptly pointed out, all of today's great value investors have come to invest in bankruptcy. And again - no one counted the profitability of Buffett's investments in bankrupt companies, unless he did it himself, because the data for this in reporting not enough.
In the same way, we will not be able to make money, as Buffett does, on reputation deals. For Buffett, reputation plays at least a twofold role. First, selling the business to Buffett is prestigious. You are part of a private club of millionaires who sold the business to Buffett, and you can even write the book How I Sold My Business to Warren Buffett. Such a book really exists, but no one would have bought it if it were not for the name of the buyer. But fame comes at a price: according to my calculations, the Oracle of Omaha offers on average 20% less for the acquired company than other potential buyers.
True, when making a buyout of a private business, Buffett also morally subscribes to something: usually these are guarantees of dismissal the owner, who from the owner becomes a hired manager, retaining all his powers, jobs, and so like that. Sometimes it ends badly. Buffett once admitted that, trying to keep his promises, he kept a manager at work with Alzheimer's disease and fired him too late.
Again, no one knows if Buffett's limits outweigh this 20% discount. In my opinion, no, but this is just an assumption.
Second, Buffett is sometimes called upon to act as a white knight protecting the company from a hostile takeover. After all, he is known for the fact that he does not carry out hostile takeovers, or rather, the takeover of Berkshire, completed back in 1965, was the last of this series. There are preferences for such protection.
There is often a dispute among journalists about whether Buffett received certain securities - most often these are convertible bonds - on terms better than market ones. My opinion is that even if the financial conditions were more or less market-based, the very opportunity to make an exclusive deal is already an advantage.
We will not be able to compete with Buffett in terms of access to information. I do not mean playing on the inside at all. One of the popular books about how to turn a dollar into a billion, "how Warren does it", suggests going to an electronics store and ask consultants about which household appliances are better to check your investment ideas if you want to invest in it manufacturers.
Buffett can ask Bill Gates for advice, for example, which he does. So, it is known that Buffett was interested in the prospects of Eastman Kodak from Gates back in 1991, most likely referring to the onset of the digital age. Gates replied that the company is not a tenant. The market realized this much later - the peak of share prices was in 1996 (the company went bankrupt in 2012).
Which of your friends and acquaintances can have such a foresight of the future?
Another important factor is the country in which we live. Buffett many times, and not only for reasons of political correctness, said that he owes his fortune to the US economy, and if he was born in India, he would hardly have succeeded. He also said that he believes in the US economy. Due to the fact that we live in Russia, we understand this country and its economic mechanisms better than the American specifics. Therefore, it would be easier for us to invest in Russian stock market.
But does it have the same prospect as the American one, one of the best markets in the world and definitely the best big market? Buffett expressed himself unequivocally on this score with his actions and words. He also invests outside the United States, including in emerging markets: in particular, he is known about his investments in companies from the UK, France, Germany, Switzerland, Israel, Korea and China. He did not invest a dime in Russia. [β¦]
I recall how the SmartMoney magazine, which existed on the Russian market, published in each issue a heading, in which he tested whether a particular Russian public company would fit Warren's investment criteria Buffett. He sometimes succeeded in not, but often yes.
The answer "yes" was achieved due to the fact that journalists persistently did not include the key selection criterion investment goals, which Buffett has in the first place: "Is the management of the company crystal-clear, is the shareholders' money being stolen?"
According to Buffett, if this happens, then this factor will outweigh all others and shareholders will eventually suffer. At that time, these analyzes of SmartMoney seemed to me very funny and stupid, but in fact it is a very sad story.
With all this, we can borrow the main elements of the strategy of value investors, but with one caveat. When I started with Buffett in the early 2000s, I thought I was working on how to make a lot of money. After several years of studying, I realized that I was working on a different topic: how to earn worthy and how not to lose much. And the second is also extremely important.
Buffett himself suggests focusing on this: his principle is to try not to lose on any of the investments, because this is what pulls down the overall profitability.
And yet the topic of this chapter is somewhat broader than the question of why we, ordinary investors, are worse than the geniuses of the financial market. We were going to talk in general about which of the value investor strategies it is possible to borrow and which is not. The general answer to this question is that you donβt need to borrow specific ideas about a country, an industry, or a particular company. Everything is changing very fast.
A simple example. Literally in October 2019, I spotted a country market underestimated by today's standards - Korea, whose P / E was only about 12. While I was going to invest, it grew to 17, and the investment idea was rotten.
The situation with companies is even worse: not only can the price change, but also the prospects of the business and even the industry affiliation. Warren Buffett's case study that doesn't invest in tech companies. In 2011, for some reason, he started buying shares of IBM. A question immediately followed from journalists who had learned his mantra about technology companies. To which Buffett replied that IBM, which was once a technology company, is now just a service provider. This investment turned out to be one of the most unsuccessful ones, of which Buffett has very few. Maybe because it is unsuccessful because a high-tech company has ceased to be such?
The answer to the question of what is portable and what is not is very complex. In my opinion, all general principles that are closer to psychology or the investor's approach to investing in general and which I have hardly touched on in this book are transferable. For Buffett, this is, for example, a thorough study of the issue and independent, without looking at the crowd, actions.
The main principle of value investing has retained its relevance - not to invest in companies with inflated prices simply because their shares are growing in value. Yes, you can earn a lot in the moment, but you can also lose money forever. Perhaps investing with an eye on fair value is the most important thing that we should borrow from value investors.
It is important to understand that this principle may not at all contradict the purchases of expensive fast-growing stocks: they can be valued fairly or even underestimated taking into account future growth. Lynch Peter Lynch is an American financier and investor. He was in charge of the investment fund Magellan. repeatedly said that an investor could increase his money many times over by investing in Walmart or Microsoft even several years after the IPO.
The trick here is that these examples are hindsight.
And these are examples of companies that have won the competition in their field, despite the fact that this field, that is, the market, is huge, it is not a narrow niche, the limits of which are limited.
The fact that it is much more difficult to guess without hindsight hints is evidenced by the fact that in September 2003 Bill Ruan, who once invested in Walmart and made a new investment in Walgreens pharmacy chain, said that the first three letters of the coolest US retailers are W, A and L. That, too, was an afterthought: Walgreens' shares rose fivefold from 1995 to 2003. And what about today? The company's shares are roughly where they were in 2003. Investors only earned dividend profitability, which is high (approaching 5%) only now and was much lower in previous years.
However, if you bet on the winners, even if they are expensive, you could win, because their growth, in fact, could be even greater than what was once implied in their price. Rouen is appropriate here: value and growth are not two different categories of investment, growth is just a parameter of the value equation.
Accordingly, if we have already decided that we are ready to invest in stocks with a high growth rate of net profit per share, then we cannot be tied to quantitative measures of cheapness and high cost. For example, ignore the fact that Rouen almost always sold stocks when their P / E hit 12. This was said in 1981 when the stock was cheap.
At the same time, the requirements for quality stocks are quite relevant. Just when you see Graham's demands Benjamin Graham is a renowned American economist and professional investor. Known for his value investing strategy. to growth, companies are extremely modest, treat them as minimum or lower bounds. You can set your own, more rigid ones. The relationship between the stock valuation and the expected growth cannot change either - this is the basic maths, and nothing else (another question is how to predict growth correctly).
From the point of view of today, the thesis about the desirability of investing in companies that pay dividends is controversial. As I said, many issuers are increasingly making payments to shareholders through share buybacks. This is good too: the number of shares outstanding decreases and future earnings per share increase. Take a look at Apple, for example. Its dividend yield is laughable, but the company regularly and in large quantities buys shares from the market. And earnings per share are growing much faster than the company's earnings.
I think the least portable is the choice of industries to invest in.
Perhaps the most contentious issue is Buffett and Lynch's attitude to technology investment. Both brought about the same arguments against, which boil down to the fact that the prospects of a particular technology are very difficult to foresee and one technology can change the other instantly. Lynch adds that if you have invested in a restaurant chain, you will see a threat approaching, because building a new chain is not a quick business.
At the same time, Lynch in one of his speeches cited Microsoft as a good action, and Buffett made a huge bet on Apple (the share of Apple in Berkshire's capitalization is more than 20%), having recently announced that it regrets that it did not go for it earlier. Are these examples the exception to the rule? Hard to say. Lynch could point to the fact that Microsoft is, in fact, a monopoly (which has not been dismembered). Buffett could have said about Apple what he once said about IBM: Apple is not so much a technology company as a marketing company, and it sells dream. And the fact that she is a technology leader may not play the most important role in sales growth.
I think when it comes to the technology sector, an investor could at least take an intermediate position: invest in a technology company when it has become a clear leader in its market.
Lynch has an example of investing in Microsoft: if you invested in it three years after the IPO, you still earned 10 times more. (This example is not about technology, he says the same about Walmart.) And he said that many years ago. Now that would be about 400 times more. I think he could do the same thing now, but both Apple and Amazon could be examples.
If you suddenly want to compete with Buffett, "Value Investing" is a great way to understand his strategy and avoid mistakes that happen not only for beginners, but also for experienced ones investors.
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