Patience is the approach used by the billionaire investor Warren Buffett.Getty Images/iStockphoto
John Reese is CEO of Validea.com and Validea Capital, and portfolio manager for the National Bank Consensus funds. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service. Try it.
If only they had seen it coming.
Investors often regret missing out on the Apple or Costco or FedEx that could have turned their $10,000 nest eggs into million-dollar lottery jackpots had they simply recognized the opportunity early and stuck with it.
It's easy to judge stocks by their past performance. Twenty years ago, Apple traded at less than $1 (U.S.); now, it's north of $117. Costco shares have gone from approximately $12 to $149 over the same time, and Monster Beverage from 8 cents to $147. These all look like solid gold performers.
What investors tend to overlook, however, is the volatile journey these stocks – and these companies – have had over time. After all, Apple, Costco and Monster started out as small unknown companies decades ago and had a fair number of skeptics and stumbles along their way to becoming large companies and familiar brands. As former investment columnist Morgan Housal pointed out earlier in the year, Monster, which is one of the top performing stocks since 1995, has seen four distinct drops of 50 per cent or more over the past two decades, lost 66 per cent value twice and the shares fell more than 75 per cent once. Having the gumption to stay invested in the stock would be almost impossible for most investors.
But successful long-term investing is less about finding the next big thing and more about finding well-run businesses with reliable returns and not overpaying when buying those stocks. Patience is the approach used by the billionaire investor Warren Buffett, whose Berkshire Hathaway has held some of his handpicked investments for decades.
Mr. Buffett looks at a company's record over many years to find those with strong management, consistent profits and good long-term prospects. These are better barometers of a stock's performance than the near term trading activity would suggest.
In his 1988 letter to Berkshire shareholders, which references his purchase of a large stake of Coca-Cola that year, he borrows a phrase from Peter Lynch, the former Fidelity Magellan Fund star manager.
"When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever," Mr. Buffett wrote. "We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behaviour to cutting the flowers and watering the weeds."
Berkshire has stuck with Coke shares, which have gone from about $2.30 to more than $42, to this day. Speaking of Mr. Lynch, he prevailed over Magellan at a time when the S&P 500 was on a long bull run, but even that wasn't without major shocks such as the 1987 crash, when markets fell more than 30 per cent. Markets would go on to recover and Mr. Lynch's approach continued to produce strong returns for Magellan.
Mr. Lynch used to say it didn't matter how many winning stocks you had in your portfolio, as long as you had enough of them over the course of time. "If seven out of 10 of my stocks perform as expected, then I'm delighted. If six out of 10 of my stocks perform as expected, then I'm thankful. Six out of 10 is all it takes to produce an enviable record on Wall Street."
That is to say, many stocks aren't winners. Public companies fail or merge into other companies or their shares lag competitors. And investors with fewer resources than Mr. Buffett and Mr. Lynch might not have the opportunity to park their money in a single stock for decades.
Investors who are willing to stick it out get paid based on that risk. Over the long-term they accept that volatility is going to be a big part of their journey.
Here are three stocks that fit the styles of Mr. Buffett and Mr. Lynch.
This Minnetonka, Minn., managed health-care provider matches with Mr. Buffett's style of investing because of its above-average return on equity. The company has averaged ROE of 17 per cent over the past decade, only slipping once below Mr. Buffett's preferred 15-per-cent hurdle.
The maker of equipment used to control the air and environment in offices and homes falls under the Lynch strategy, which favours companies that have several years of fast earnings growth. Ingersoll's growth in earnings per share has been 23 per cent based on the average of the past few years. The growth combined with the valuation gives the stock a price/earnings to growth (PEG) ratio of 0.52, a positive for our Lynch-based model.
One of the biggest American banks has a friend in Mr. Buffett, who is its largest shareholder with a 10-per-cent stake. Wells shares have been battered by regulatory and public scrutiny following a scandal over unauthorized customer accounts, but its solid brand and strong market share give it the industry positioning Mr. Buffett likes in his companies. Shares are down 20 per cent since mid-2015, but the fundamentals and now lower valuation help the stock get high scores based on the Lynch and Cornerstone Value quantitative approaches.