As the memories and pain from the GFC begin to fade away, and our business and investment minds turn to what is happening now or in the near future, some of the wisdom harvested from the experience has to be remembered, or we'll just do the same thing again next time.
Take Berkshire Hathaway (NYSE: BRK-B) founder Warren Buffett. He has been teaching investors for decades how to get the most out of your investments. If only we'd listen occasionally, we could get the same return — or better — as he did. He may work on a larger scale, but with the same tools and guides, you can match him.
Between 2008 and 2011, he made six deals, investing a total US$25.2 billion in the following companies:
- Bank of America (NYSE: BAC)
- Dow Chemical (NYSE: DOW)
- General Electric (NYSE: GE)
- Goldman Sachs (NYSE: GS)
- Mars/Wrigley
- Swiss Re
All of these are good, well performing companies that in regular times make good, stable profits. Their reputations and management are exemplary, and they aren't faddish or likely to disappear any time soon. That's step one: buy companies with staying power.
Next, if you can't buy great companies at great prices, buy them at fair prices. Remember this as "GARP" — growth at a reasonable price. A company with fantastic growth rates or potential can get priced to the skies because investors factor in the potential, and just like an auction, their exuberance drives the price up farther than it should go.
In the GFC, when Buffett came riding into town from Nebraska with his saddle bags stuffed with cash, he could cut a pretty good bargain for himself. That's step two: know what price is reasonable or even a bargain for good earning power.
The US stock market sold off to almost half its previous high, and fear was palpable. It created fantastic bargain prices, giving Buffett (as well as many individual investors) the third step: have a margin of safety. After you buy a stock, it could possibly sell off 30%-50% on bad news or terrible market conditions, but what if the big sell-off just happened? If the worst case is already priced in, then your price has a built-in margin of safety since the chance of it going lower is much less now.
To date, Buffett has earned about US$9.95 billion on his $25.2 billion investment, or about 40%. Spread out over about four years, that would be about 8.7% annual interest, so they weren't fantastic investments, but they were executed in a fantastic way with the three steps.
The fourth step is to have cash ready to go when the timing is good. Always have a cash buffer to take advantage of pricing opportunities. Save up your money, and when the market is fearful about something, use the first three steps to identify good stock buys.
What were some great ASX 100 buys over the past five years?
- Ramsey Healthcare (ASX: RHC): +241% (27.8% p.a)
- Flight Centre (ASX: FLT): +166% (21.6% p.a)
- Seek (ASX: SEK): +131% (18.2% p.a)
- Crown (ASX: CWN): +126% (17.7% p.a)
Foolish takeaway
Looking at those examples, they weren't obscure high-tech start-ups, but strong, sturdy companies that are just good at making money. Most of us would know these companies by name already, so you don't have to spend hours just to find some company off the beaten path.
You do have to do your homework, so that is your time investment before your cash investment. Use the four rules, and you might even beat Buffett at his own game.
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More reading
- 5 industries – and companies – to drive the economy for 20 years
- 4 companies that grew dividends by more than 20% this year
- Australia's biggest oil and gas project gets a $5 billion makeover
Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.
