As I mentioned in the first commandment; the most successful investors buy good quality companies. By evaluating the fundamentals of a company, whilst assessing the manner in which the directorship approaches the business; investors can hand pick companies that have the opportunity and probability of growing in value over the longer term. This more traditional model of investing comes with volatility. However, over a term in excess of 10 years, the exposure to quality equities will provide the best long-term results.
Source: Shiller, Robert J. (2015). Irrational Exuberance. Princeton University Press. (2nd ed.). U.S. Bureau of Labor Statistics. Federal Reserve Board.
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As you will note from the above graph above1, the growth in the value of invested wealth over time is heavily weighted in favour of equity exposure. Large capitalisation, or blue-chip, companies are generally more mature and typically reflect less volatility than their small-cap cousins. Small capitalisation companies are general less mature and have not yet achieved their targeted market share or revenue streams – giving greater opportunity to grow their balance sheets.
When investing, ensuring you have some exposure to assets that have an ability to grow in value, whilst reducing volatility to your investments through diversification, will benefit your financial success over the longer-term.
The complexity of investing then comes down to selecting quality companies, taking time to analyse the fundamentals ahead of investment. Investment Managers and Fund Managers typically employ teams of analysts, removing the necessity for many investors.
n the 2019 year-end letter to Berkshire Hathaway Shareholders2, Warren Buffet wrote in length about the power of retained earnings. Referencing Edgar Lawrence Smith’s 1924 Common Stocks as Long Term Investments, Buffet explains a strategy that his investment empire has held close to their hearts; investing into companies that invest in themselves. Smith’s evaluation focused primarily around the stock vs bond preferences and industrial industry equity. The resultant conclusion was to look for any equities that self-invest.
When companies generate profit, they have an inherent obligation to keep shareholders happy. If we look at utilities as a sector, their high dividend distributions regularly protect them from capital redemption by shareholders. When companies retain some of the profits to invest into more R&D or infrastructure, the income the investor could have received now starts to work as a form of compound interest. As Buffet2 says, “Reinvestment in productive operational assets will forever remain our top priority”.
Past performance is not indicative of future performance.
The value of an investment will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than you invested.
This article is a general communication being provided for informational purpose only. It should not be relied upon as financial advice and it does not constitute a recommendation, an offer or solicitation. No responsibility can be accepted for any loss arising from action taken or refrained from based on this publication. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted.
1 – Shiller, Robert J. (2015). Irrational Exuberance. Princeton University Press. (2nd ed.). U.S. Bureau of Labor Statistics. Federal Reserve Board. © 2020 S&P Dow Jones Indices LLC. All rights reserved.
2 – 2019 Letter to Berkshire Hathaway Shareholders – Warren Buffet