Most of the FIRE movement is devoted to index funds, and with good reason - they’re the great democratiser for share ownership, meaning that you don’t need any special expertise in order to use the stock market successfully.
It is almost sacrilege to talk about owning shares in individual companies.
But if you do think you have some of that special expertise, should you use it? Probably not! A little knowledge is often a dangerous thing, and it’s easy for the unwary to lose their shirts when investing.
I became an investor before I found the FIRE movement. I’ve taken my lumps, learnt difficult lessons along the way with painful losses along with some successes. That learning process had taught me to like and respect Warren Buffett, and to see the appeal of the company he’d built - Berkshire Hathaway. I was already an owner when I found FIRE.
Looking back with the benefit of hindsight, I can now frame this in a logical way. Index funds are the benchmark that we should use. If we’re going to stray away from them, then we need to understand what we’re trying to achieve, and what pitfalls to consider. I think the goal has to be to get an improved return compared to the index. Not instant riches, because that always involves heightened risk. But a slightly improved return, which due to the power of compounding means a significantly improved result over time.
Most methods of getting an improved return are duds. Day trading, swing trading, charting candlesticks and plotting moving averages are all methods which are risky. And in any case they tend to involve frequent trading, meaning that there are added trading costs which wipe out any gain. Equally, backing the “next big thing” in its early days tends to go badly, with most startups failing.
Improved Returns
The only method proven to be successful is a system known as Value Investing. It involves watching for entry points when the market is mispricing a stock in your favour. Let’s say you have found a profitable company, Coca-Cola. You like their operation, they have a great brand leading to good profitability, but the shares are priced to reflect that high quality. Then there’s a global panic because some dictator starts lobbing missiles, and share prices tank, including those of Coca-Cola. It’s an opportunity to load up at bargain prices.
The Value Investor will call this buying with a margin of safety. He’s calculated what he thinks the operation is worth - by looking at the cashflows the company produces for its owners. This is known as intrinsic value. His calculation may not be entirely accurate, which is why he looks for a margin of safety. He can buy at that point with less risk that the share price will fall even further out of whack with the intrinsic value.
Then there are two approaches. The value investor can wait till the share price normalises, and bank his profit from the share price appreciation. Or he can leave things be, and remain a long-term holder in a quality business.
The difficulties in this method are a) working out the intrinsic value of companies, b) spotting any pitfalls and traps, and c) having the patience to wait for that moment of opportunity. I’ll not go into great detail about these here; there’s an entire other article to be said on these. Let’s just take it as read that it’s hard.
The man who first devised Value Investing was Ben Graham, and today many successful investors follow his ideas, and further developments of them. The most famous of these is Warren Buffett, who has spent half a century following this method to acquire dozens of great profit-making companies and tucking them into his business empire, a company called Berkshire Hathaway.
Berkshire Hathaway
Berkshire Hathaway is publicly listed, meaning you and I can buy shares and sit alongside Warren as co-owners. It trades under the tickers BRK.A and BRK.B. The “A” shares now trade at over half a million dollars each, giving you an idea of how successfully the company has grown. Fortunately there are the more accessible “B” shares, which are worth one 1500th of an “A” share.
Berkshire has been very profitable. Its core is a group of insurance companies, and insurers have one odd advantage - they collect premiums and hold them for the year, while claims tend to come later. This leads to the company holding what is known as a lot of “float”, and Buffett has deployed this capital to good advantage.
Berkshire doesn’t pay dividends, it retains all profits to use as capital to grow its operations. This is often through acquisitions, and the conglomerate now contains around 600 wholly-owned companies as well as owning stock in other publicly listed companies.
The media often portray Buffett as a trader who plays the stock market, but he would be better thought of as a company picker. He invests for the long-term, saying famously that his favourite holding period is forever. He looks for companies which produce a superior profit, and buys that profit-generation capacity.
Many onlookers dismiss Berkshire due to Buffett’s advanced years, but his life’s work is not about to crumble once he’s gone. He has built Berkshire for permanence. Without him at the helm, the owned companies such as Duracell and Fruit of the Loom are still going to have great operations and powerful brands that continue to spin off good profits.
In terms of succession planning, Buffett has not been idle or blind to his own age. A great team is in place to both manage operations and deploy new capital. His investing lieutenants are some of the best in the business - these guys are not share traders but, like Buffett himself, people who study companies deeply and select the best Value plays.
In Berkshire Hathaway we have an opportunity to ride along with Buffett as co-owners and reap the same rewards as him. It has many of the characteristics of an index fund - we have the diversity of 600+ companies, and low overheads (in fact, unlike an index fund, there is no ongoing charge for ownership). We don’t directly pay for fund managers to curate our holding in the sense that you would with an active fund - we have the much smaller diluted cost of the company’s investment managers, all of whom have a significant portion of their own wealth in the stock too. Our interests are well aligned.
Over the years Berkshire has outclassed the S&P500 index. Now that it is so huge, its ability to maintain much advantage is reduced, as there are so few opportunities which would move the dial significantly. Some people take this to mean that the golden goose has finished laying. Buffett himself will tell people this in order to moderate their expectations.
For myself, I continue to have much of my wealth invested in BRK.B. I’ll only sell them when I need some income in retirement. It’s a financial fortress, run by grown-ups with values which I respect. I’m confident that it is a higher quality company to own than the worse half of the index, so I figure that it should continue to do as well as the index, or slightly better.
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