Buffettology: More to investing than returns

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September 21st, 2011 Jitendra kumar Gupta

Most of us want our investments to offer returns similar to the ones generated by the legendary Warren Buffett. To that end we try to learn from his investment style to get superior returns. But the question is, does one have to look at parameters beyond just returns to become wealthy?

Even if one generates returns comparable to Buffet, there is a possibility of one remaining poor or not being able to build enough wealth.

The magic formula

Consider some facts about the Oracle of Omaha. While Buffett was little over 11 year of age, he bought three shares of Cities Service Preferred for himself and while in high school  invested in his father’s business. Buffett filed his tax return at the age of 14. From his early days he tended to save. According to one estimate by the time he finished college, Buffett had accumulated more than $90,000 in savings measured in 2009 dollars.

Nine women or nine months

Buffett has always emphasised on giving time to your investments to grow. Even if one buys the right stock at the right price, the fortunes are made in time.

As Buffett explains in his 1985 annual letter to shareholders,  “No matter how great the talent or effort, some things just take time: you can’t produce a baby in one month by getting nine women pregnant.”

These words explain the power of compounding and the time that it takes before it starts to kick in. Compounding is simple and I know most of us understand the concept very well. However, we need to implement it in its true essence. Hope some these examples should be worth noting.

At 16 per cent annual returns, it takes five years for Rs 100 to become Rs 200. But if one holds the same Rs 200 for another five years it becomes Rs 440.

Differentiating factor

Like early investing, how much one invest is equally important. A Rs 100,000 compounded over the next 10 years with the annual returns of 20 percent would just total little over Rs 6 lakh. However a Rs 10 lakh invested today compounded with the same rate and over longer periods say 30 years would be worth about Rs 24 crore. This is a huge difference. The point I am trying to make is even if we exhibit the best stock picking quality, returns alone may not lead you to the pot of gold.

The widening gap between poor and rich

Here’s another example. Say investor A invests Rs 10 lakh and investor B invests Rs 1 lakh. Today the difference between both investors in absolute terms is Rs 9 lakh. If both of them remain invested and their money grows at a rate of 20 per cent per annum by the end of 30 years, the wealth of A would be Rs 23.7 crore compared to that of B at Rs 2.37 crore. This is a difference of over Rs 21.3 crore as against the current difference of Rs 9 Lakh between investors A and B.

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4 Responses to “Buffettology: More to investing than returns”

  1. sridhar Says:

    i fully endorse what koshy is telling. What may start as a great investment may suddenly turn zero if churning is not done on time. The other fact is you cannot get stock always at lowest point.Good example is Tata Motors.Look at where it is today.Most of the gains from 2009 has been lost in this crash.Second very important thing for the investor is building of capital. Hence with limited capital you just cannot keep locked for 10 years.If things do not work out you will be back to square one.

  2. Aksyjo Says:

    Nice piece….this is the philosophy that holds good when the markets are the way they are now.

  3. Omigosh Says:

    Gosh, isn’t it amazing how the world has changed?

    Thank you for this piece. Value investing is the way to go. Well pointed out. It is time for investors to rediscover what investment was originally about: participating in business, NOT speculating on prices of tradable objects (virginities are being traded on eBay these days… what next?).

    The key to true value investing, to my mind, is to stop looking for capital appreciation of your stock portfolio. Stop ‘playing’ the market. Instead, search for cheaply priced stocks (price-earning multiples beaten down to pulp irrationally by euro-frazzled and recession-wringed financial institutions), and then behave like a co-owner of the company whose stock appeals to you.

    In other words, think dividends, not liquidation of holdings, and stay invested for the long term. This means you buy stocks on strict critera:

    a) The company must be built for long-term survival of its business.

    b) It should have smart management.

    c) It should be trustworthy (integrity of management)

    d) It should have a healthy positive dividend yield on its current market value, a figure no less than one-eighth of what an FD will give you.

    Then you put in your money and wait for dividends to grow as the company expands. After 10 or 20 years, Rs 10 lakh invested now in a high dvidend-yield stock should be paying you a decent sum every year without needing to sell the shares (whose value presumably would have risen in line with earnings to retain its PE multiple at the minimum).

    That would be your own retirement plan.

  4. koshy Says:

    The quality of stocks is more important than the holding period. Stock evaluation has to be dynamic to better understand the sustainability and scalability of earnings which ultimately determines valuation. A stock may seem to be good at the time of investment but one needs to bear in mind that even an experienced investor may not be aware of all the factors affecting the stock and some adverse factor can come to light a few months down the line which should prompt a relook at the stock. This requires an investor to be emotionally detached from the stock. The benefit of compounding cannot be enjoyed if an investor is wrong from the start and is unwilling to take corrective action. Such pig headed attitude can be seen even among self styled experts in broking outfits as well as the print and visual media. A serious investor should also refrain from leverage however great an investment opportunity might seem to be. After all, markets can remain irrational longer than an investor can remain solvent.


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