Words Of Wisdom

Two of the most successful investors of recent times, Warren Buffett and Terry Smith, have recently published their annual investor letters. These letters are always worth reading for their insight into how a successful stock market investor thinks. Although we are dealing with different aims, objectives and risk criteria, Clarion use similar methodology as these renowned investors in our selection of investment funds and asset allocation. It is, therefore, worth picking out a few highlights and similarities from the letters.

Mr Buffett sees few, if any, prospects for mega-sized acquisitions at the moment, as buying the whole is currently more expensive than buying a share. He expects to use his billions of pounds cash pile to make more purchases of listed securities. He confesses, however, that this is not a stock market bet as he has no idea how markets will behave next week or next year. He just buys shares in attractive businesses when their value is higher than the market price. At the moment, he thinks there are plenty of opportunities suggesting that values in certain areas of the stock market are still attractive.

At the age of 88 he says he, and his partner, aged 95, are not considering downsizing and becoming net consumers as opposed to capital builders. He quips “perhaps we will become big spenders in our old age.”

He comments on “bad corporate behaviour” induced by the desire of management to meet investor expectations. What starts as an innocent “fudge” can become the first step in a fully- fledged fraud. If bosses cheat in this way, subordinates will do so likewise.

He criticises the use of debt which he uses only sparingly. He says, “at rare and unpredictable intervals, credit vanishes, and debt becomes financially fatal.” It’s a Russian roulette situation, in essence.

Notably, he is still betting on the commercial vibrancy of the USA to produce investment returns in the future, similar to the past. He calls the nation’s achievement since 1942, when he first invested, to be “breathtaking”. An investment in the S&P Index, with dividends reinvested, would have turned $100 into $532,850 over that time frame. Better still is that if the same amount had been invested in a tax-free fund, it would have grown to more than $3 million, emphasising the importance of good tax and financial planning and minimising tax as far as possible.

On the other hand, an investor who might have been panicked by rising Government budget deficits and the unremitting growth of world debt and decided to invest in the ‘safe haven’ of gold, the $100 would only be worth $3600. Clearly Mr Buffett believes that investing in the shares of good businesses is the best way to protect against inflation and also a considerably better investment than “safe” assets.

He believes the USA has been so successful economically because the nation has reinvested its savings, or retained earnings, in their businesses.

The moral for private investors is that you should not spend all your dividends but at least reinvest some of them, or encourage companies to reinvest a proportion of their earnings rather than pay them all out as dividends. It is better to invest in companies that reinvest their earnings to obtain a good return. A strong theme in the Clarion investment philosophy.

Turning now to Mr Smith, his investment themes are:

Buy good companies. (Clarion invest in good Funds)
Don’t overpay. (Clarion blend active funds with passive investing to keep costs to a minimum)
Do nothing. (Clarion keep fund changes to a minimum)

Mr Smith believes it is “time in the market” rather than “timing the market” that matters. He counsels against being influenced by short term political noise or financial commentators who constantly predict market downturn.

No one can predict market downturns with any useful level of reliability, and he says that forecasts of what might happen in the market are about as reliable as Michael Fish’s infamous denial that there would be a hurricane in the BBC weather forecast on 15th October 1987.

Mr Smith’s overriding philosophy is to buy shares in good companies that can produce a high return on capital employed, in cash, and can invest at least part of that cash back into the business to fund their growth and so compound in value. This, in turn, produces good share price performance and better returns for investors.

In summary, both Mr Buffett and Mr Smith believe that the best way to grow wealth and protect against the twin ravages of inflation and economic downturns is to invest in the equity (shares) of good companies that consistently have a high return on capital which is reinvested back into the business to compound growth over time.

Ignore the doomsayers who are forever predicting the end of the world or a market downturn. A market downturn will occur at some point, but the best stance is to ignore it as it is impossible to predict or position an investment portfolio effectively to avoid it without forgoing gains. True, investors will need to have the emotional and financial stability to stick to this stance if and when a downturn strikes again.

It is a fact that economies and stock markets always recover, and despite all the problems in the world, capitalism will survive, and the world will prosper. Christopher Wren, architect of St Paul’s Cathedral, lies buried within that Church. The epitaph above his tomb famously addresses us (translated from Latin): “If you seek his monument, look around you.”

Those sceptical of the World’s achievements and mankind’s ability to survive and prosper should heed that message.