The Warren Buffett way
COVID-19 and the recent oil price decline has caused the S&P/ASX 200 Index (ASX: XJO) to plummet 26% in just over 2 months. That decline is for the index as a whole, but the economic impacts of the current crisis are different across industries and even at an individual business level. Looking at buying individual stocks can provide greater opportunities for buying at discounted prices, boosting your chances of beating the market’s average returns.
Warren Buffett’s Berkshire Hathaway Inc (NYSE: BRK.A) has made investors millions by implementing this philosophy, particularly in the conglomerate’s early days, where Buffett could exploit smaller but more valuable opportunities. You, as a retail investor, have this opportunity too!
Charlie Munger’s change
When Charlie Munger joined Berkshire Hathaway, his investment philosophy complemented that of Buffett’s, though Munger was much more willing to pay a reasonable price for a great company versus Buffett’s cheap price for an OK business.
This is personally the investment strategy that I like to follow. Great businesses, with great management and a comparative advantage, can continue to grow at extremely high rates for a long time.
Everyone loves pizza
A perfect example of a quality business is Domino’s Pizza Enterprises Ltd (ASX: DMP). Now you may think that Domino’s just sells pizza, but the company has a proven track record of innovation and executing a long term vision. In fact, the stock has returned a whopping 2,514% (excluding dividends) since 20 May 2005. Domino’s has achieved this by being able to maintain high growth rates for key metrics like sales, profits and return on equity, for much longer than people expected.
The key to Munger’s strategy is to pay a fair price. Businesses that succeed over many years will see their stock valuations grow. Sometimes these valuations will get ahead of the business fundamentals and sometimes the market will be overly pessimistic or throw the baby out with the bath water. But as Buffett says, “be greedy when others are fearful”.
The biggest tool of all time
Berkshire Hathaway has made the majority of its wealth (in absolute terms) in the last few years. This is thanks to compound interest and time. All of us, myself included, struggle to comprehend the power of compound interest, so here’s an example.
If a $10,000 investment grows at 10% for 10 years, you end up with $25,937. That’ll definitely help in retirement. But if you have a longer time to invest, you can do even better. If you take a 25 year timeframe with 10% growth per year, your initial $10,000 investment will grow to $108,347 by the end of that period. Even more impressive is that in the final year, you almost make your entire initial $10,000 investment in 1 year!
Foolish bottom line
Your chances of picking the bottom of a bear market or recession are highly unlikely. It makes a lot more sense to average into the market and then take the opportunity to buy some additional stocks when the market presents opportunities like COVID-19.
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Motley Fool contributor Lloyd Prout owns shares in Berkshire Hathaway Inc and expresses his own opinions. The Motley Fool Australia has recommended Domino's Pizza Enterprises Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.