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There's No Secret to Investment Success... Except This OneBy
Wednesday, September 11, 2013
Real business experience is your greatest advantage in the markets...
On Monday, I shared a private conversation I had with a wealthy friend of mine…
My friend is the CEO of a major global business. Several years ago, he asked me to help him with his personal portfolio.
"There's no secret to investment success," I told him. "As the leader of a big, global business, you've done dozens of very successful acquisitions. You know exactly what creates business success. And you know the appropriate price to pay for private companies. Just apply the exact same care to your personal investment decisions."
Today, I'd like to share the numbers that prove just how important business judgment can be to investors.
I'll also show you where to find the world's greatest businesses today...
Assume that you had perfect business judgment 20 years ago. You could tell, just looking at various public companies, which ones had "the right stuff." You decided to invest $100 each in 10 stocks. You picked your 10 investments by figuring out which companies would increase their per-share book value the most over the next 20 years.
Knowing the companies would thrive, you assumed stock prices would eventually follow.
If you'd done that, your $1,000 portfolio of 10 stocks would now be worth $74,283.60. That's an annualized return of a little more than 24% – about three times better than the market in general over that time.
Obviously, no one can possibly predict which 10 S&P 500 companies will produce the highest per-share book value gains over 20 years. But...
Gauging the qualities that make for a successful business is vastly easier and far more certain than trying to predict future investment performance any other way.
Interestingly, my hypothetical 24% a year, which assumed perfect knowledge, isn't that much different than Warren Buffett's actual record at his holding company, Berkshire Hathaway, where he has averaged about 19% a year over the length of his career.
His approach is based entirely on business judgment and paying a fair price.
Likewise, I believe my biggest advantage as a stock-picker is simply that I've owned and operated a successful publishing company for almost 15 years. I know from my own experiences in business the factors that really matter and allow a business to grow. I look for these same factors in the stocks I recommend.
But... what if you've never owned a business? What if you've never been a part of a senior management team? Is there any other way to begin to acquire some of the same insights into how businesses really work and the factors that tend to matter the most over the long term?
If I wanted to learn a lot about how businesses work best, I'd study the businesses that have been most successful in the past. I'd think about what allowed them to increase their value so rapidly over a long period. I'd try to figure out which companies today have those same qualities.
Looking at today's S&P 500, the companies that increased their per-share book values the most over the past 20 years (1992-2012) were:
You can break down these companies into one of three large baskets of superior performance. The first category is technological innovation. Qualcomm, Intuit, Cisco, Oracle, and EMC all participated in the dominant technological trend of the past two decades – the Internet. By creating the proprietary software, hardware, and wireless-networking technology that created the Internet and just about every other Internet-based business, these companies were able to achieve extraordinary profit margins and huge returns on equity.
This trend, by the way, continues today. More powerful extensions of the Internet are constantly being created, like "cloud"-based services, massively multiplayer online games, social networks, payment systems, and communication tools, like Skype.
Can you find any leading businesses in these sectors, whose innovations have created huge operating margins and whose shares are trading at a fair price? Hint: We recently recommended one in my newsletter... It's currently trading at less than 10 times cash flow. It has an operating margin in excess of 35%, and it's earning more than $1 billion a year on tangible equity of less than $2.5 billion. This is a great business, trading at a fair price. (Note: We currently rate the shares a "hold" simply because of our concerns about the overall market... but we're probably being too cautious.)
I'd call the second obvious category merchandizing: Express Scripts, Kohl's, Bed Bath and Beyond, and Urban Outfitters. Buffett owns a lot of retail stores for a reason. These are great businesses... if they have merchandise people love.
Kohl's' formula has been to get exclusive rights to certain merchandise – like Vera Wang (according to my wife) – which helps protect it from competition. That's what creates a double-digit operating margin and 15% annual return on equity. Even minor amounts of growth from new stores will create a lot of wealth.
I have to admit that the results at the other big retailers on my list are simply a mystery to me. I don't know how they do it. I was shocked to see a nearly 20% return on equity at Urban Outfitters and a 26% return on equity at Bed Bath and Beyond.
These companies have figured out how to merchandize expertly, then paired that skill with great financial management – especially at Bed Bath and Beyond. This company's results are simply amazing. It has no debt and continues to buy back mountains of stock (about $2 billion in the last three years). Today, you can buy the stock for only 12 times earnings.
Finally... there's Chesapeake Energy. I'd call the secret to that company's long-term success simply "discovery." It found tremendous amounts of natural gas in the United States over the last 20 years by looking in places (shale formations) that everyone else thought would never produce.
Plenty of companies are doing the same right now with oil all over Texas' Permian Basin, where the oil shale is much thicker than in other regions, like the Bakken in the Northern Plains or Texas' Eagle Ford. Look for companies like Laredo Petroleum (LPI), Devon Energy (DVN), and Concho Resources (CXO) to produce similar long-term results because of massive new discoveries.
I hope you've learned more about what makes for a great business over the long term. Work on learning more about these kinds of businesses – innovation, retail, and discovery – to continue to grow as an investor.
Regards,
Porter Stansberry
Further Reading:
If you want to become truly wealthy through investing, Porter argues, your best, safest choice is to buy "capital efficient" companies... They're able to raise prices along with inflation, while spending little on growing and maintaining their businesses. Get all the details here.
The problem with buying high-quality, capital-efficient companies – and reinvesting the dividends – is that most investors don't have enough patience or common sense to pursue this approach... Get "the best investment advice you'll never take" here.
Market NotesSIGNS OF STABILITY FOR THIS IMPORTANT U.S. COMMODITY After years of declines, natural gas prices have put in a bottom.
For years, we've been telling readers about the boom in U.S. natural gas production. New drilling technologies are allowing oil and gas producers to find more and more natural gas every day. But the huge jump in supplies sent prices plunging. After trading as high as $15 per thousand cubic feet in 2005, natural gas prices fell below $2 early last year.
Now, the U.S. is finding a use for all that gas. Natural gas consumption by U.S. power plants hit a new all-time high last year. Meanwhile, industrial consumption just hit its highest level in nearly a decade. Natural gas is an important raw material for making chemicals, fertilizers, and plastics.
As you can see in today's chart, since putting in a bottom 18 months ago, natural gas prices are in the middle of a big recovery. Prices are sitting around the same level they were four years ago. It's a sign that demand is catching up to the massive supply of natural gas. It's very unlikely the sub-$2.75 prices we saw in 2012 will return.
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