This simple formula creates wealth

The financial services industry would have you believe investing is a complicated science. But as Warren Buffett has proved, says Tom Bulford, nothing is further from the truth.

MoneyWeek magazine is known for getting the big ‘sell’ calls right. So you couldn’t call it optimistic in its outlook. Editor–in-chief Merryn Somerset Webb warned recently, “You aren’t going to find much in the way of good news in this week’s edition.”

And so it proved. James Ferguson told us to prepare for “a dangerous bond market collapse”. Matthew Lynn advised that wealth taxes will leave the UK economy in “even worse shape than it is already”. Sterling is “a big sell”, Slovenia “is heading for bankruptcy”, there is a “dangerous flow of hot money” into London, house prices are overvalued, and when it comes to child trust funds, “it is time to get angry”.

This is enough to have you stick your savings under the mattress for another week. And yet this same issue of dire foreboding also mentioned that Warren Buffett recently shelled out $28bn to buy Heinz. Some critics have had a pop at this trade, too. Buffett, they say, has overpaid and “lost his touch”. Me? I doubt it.

In today’s issue, I want to explain to you why I would always put my faith in Mr Buffett over any piece of financial commentary. That’s a simple strategy. But with so many opinions coming from all angles, it’s easily forgotten.

Why Buffett knows best

If it comes to a contest between the pundits and the world’s greatest investor, my money is on the latter every time. And here is why. Buffett understands this simple truth: the best way to multiply your money is to invest it in a business that will multiply it for you.

It is the successful business that is the wealth creating unit of an economy. It is the successful business that creates value by making a product at a cost of 100 and selling it for 120. By doing this year after year and reinvesting the profits, it will multiply its invested capital, including that from its shareholders.

Any private investor who does not understand this is doomed not to make money. It has been said that the job of a financial journalist is “not to be right but to be interesting”. This, I am afraid, is the last refuge of the intellectual.

 

There are many financial commentators – and I include City professionals as well as my fellow journalists – who talk stridently and confidently. But the fact is, much of their advice is simply wrong.

With so many different opinions out there, it is difficult to assess which is the correct view to listen to. The secret of successful investing is not to take a view on everything. Very few people understand this. Most of us reckon we are pretty intelligent, that our views are sensible and reasonable and should deliver investment success. But as often as not, they don’t.

The trick to successful investment is to narrow down the field of investment opportunities and find things we know will work.

Ignore the bigger picture

Betting on ‘asset classes’ is not a sustainable investment strategy. It is what most of the geniuses of the hedge fund game do, and although some of them have made famously successful bets from time to time, almost none of them have done so repeatedly. The sustainable strategy is to invest in successful businesses. And this is exactly what Warren Buffett does and how he made his billions.

In the last five years, a time when the market commentators have been warning us all off the market, 33 companies in the FTSE All-Share index have delivered returns of 200% or more. Headed by Arm (ARM), Oxford Instruments (OXIG), Dialight (DIA) and including such brilliant businesses as Telecom Plus (TEP), Diloma (DPLM) and Telecity (TCY), they simply deliver a great product that customers want to buy.

Private investors should not worry about the bigger picture. All they need to do is identify successful companies and invest directly into their shares, avoiding investment funds or any other construct of the financial services industry. Nobody tells you this, because there is no money in it for the industry. But it’s what you should do.

Think of it this way. The world of financial services is like a supermarket, packed full of products that will all do something different for you. But you don’t need to inspect and form a view of all of them. All you need to do is go into the store and find the things you need, and ignore the rest.

This is what Warren Buffett does. He takes little notice of the big picture, but simply finds great businesses and buys them. That is why he has become one of the world’s richest men while the scribblers continue to scribble.

[cfsp key=”daily-reckoning-signup”]

 

You may like

In the news
Load More