The No. 1 Thing I'll Teach My Kids About Stocks...
We’re sharing parts of an investment classic that Porter wrote a decade ago, at Stansberry Research. (For years, Porter’s musings in the Friday edition of the Stansberry Digest were required reading… and this was one of his best.)
The excerpts below are about one of the fundamentals of investing that is a centerpiece of Porter’s investment philosophy Through market cycles, overhyped fads, and speculative trends, Porter’s approach to building long-term wealth – as reflected in what we do at Porter & Co. – has remained startlingly consistent. Keep reading… you’ll see our current-day annotations in quoted text in italics...
Here’s Porter in 2014…
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For 15 years now, I (Porter) have been working hard to give individual investors the strategies, information, and insight they need to compete with the pros on Wall Street. A lot of the most important things I've published appeared here in the Friday Digest.
As we start 2014, I want to rededicate myself to serving you. And in that effort, I'm going to try to do something I shouldn't…
I'm going to give you the one, big secret. It's the only real, true secret of finance. And once you understand it, you won't need us (or anyone else) ever again.
As longtime readers must be tired of hearing me say… I write the Friday Digest personally because I feel a huge responsibility to tell you what I would want to know if our roles were reversed. You've paid us to help you make decisions about investing your hard-earned savings. We aren't fiduciaries; we don't offer any personalized investment advice, nor do we manage anyone's money. But this doesn't absolve us of responsibility to you. You deserve our best. And since I launched this business in 1999, I've always tried my best to live up to that obligation.
Porter’s present-day comment: Ten years later, my view on what I do hasn’t changed a bit. One thing has changed… instead of only writing to you once a week, as I did back then, here at Porter & Co. I write three times a week!
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So what's the most important idea I've discovered in finance? What's the one thing I'm going to teach my kids beyond the obvious stuff about saving, compounding, and risk management? What do I believe is the real secret to investment success? And... the biggest question of all… How do I invest my own money in securities?
Over the long sweep of your investing lifetime, strategies that only work extremely well in certain market situations are unlikely to play a dominant role. The big secret therefore is something you can use all of the time, for your entire life, as an investor. And here it is: Some companies are much better than others at compounding capital. Much better.
Porter today: Again… I wrote this a decade ago… and it’s still the key. It’s the foundation of our analytical framework at Porter & Co., and the main focus of our flagship publication, The Big Secret on Wall Street.
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If your goal as an investor is to compound your savings over time, wouldn't it be easier to simply figure out which companies will compound your capital at an acceptable rate, buy those firms (and only those firms) at reasonable prices, and then do something else with the rest of your time?
Here's a simple, but powerful example. Well-run insurance companies can produce what's called an "underwriting profit." They are literally paid money in advance to manage your capital. And they get to keep not only the investment profits, but profits from the premiums, too. That's like paying the bank to keep and use your money. No other business can compound capital so consistently.
Insurance companies have other fantastic advantages, too. They're able to legally defer most of their taxes. They're nearly immune from economic factors. They're scalable. I could go on. They're a focus for us because well-run insurance companies are legendary compounders of capital. Buy them at a reasonable price, and it's impossible not to do well.
Porter today: Property and casualty insurance stocks form the centerpiece of The Big Secret on Wall Street’s portfolio. Some things never change… in a good way. (If you’re not familiar with the dynamics of property and casualty insurance… you can learn a lot more here.)
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It's not an accident that the greatest investor in history, Warren Buffett, has long focused on insurance stocks and other companies that are highly capital efficient. That is, companies that are natural wealth-compounders. Starting with his 1972 investment in See's Candies, Buffett gradually over the years shifted the bulk of his wealth into a simple, long-term compounding strategy...
While Buffett didn't abandon all other forms of investing, his largest allocations since 1972 have all used this compounding strategy. That famously includes his 1988 purchase of Coca-Cola… when Buffett put roughly 25% of Berkshire's capital into a single stock! And it wasn't a cheap stock, either. At the time, Coke was trading for 16 times its annual earnings. Buffett had figured out the one, real secret of finance... the one secret to "rule them all."
To use a long-term, compounding strategy effectively, you really only have to answer three questions. First, is the company in question able to produce very high returns on its assets? In other words, is it a great business? Second, are these unusually high returns very likely to continue for decades, without requiring large and ongoing capital investments? Third, can the management of the company be trusted? Will bankruptcy never be even a remote possibility? If the answer to these questions is "yes," then all you have to do is simply not pay too much when you buy the stock.
Implicit in this is that these companies have a moat – because if they didn’t, competitors eager to beat them on price would enter the market, thereby killing margins.
Most of the companies that fit these criteria are branded consumer-products companies – stocks like McDonald's, Coke, Heinz, and Hershey. Buffett explained in his 1983 shareholder letter how he thinks about these companies. The secret to their long-term earnings power is very simple: It's their brand and the relatively unchanging nature of their products. These companies' products are so well-known (and adored) by customers that these firms can constantly raise prices to keep pace with inflation.
Meanwhile, the brands – while requiring some advertising – aren't like factories, gold mines, or drugs. They don't require massive investments of new capital. There's no new gold mine to find and build. There's no patent that's going to expire. And there's not even any new product that must be created: Coke's fans went crazy with anger when the company tried to change its product in a small way back in 1985.
All these firms have to do is continue to deliver the same thing, year after year. And that means they can afford to return huge amounts of capital to shareholders. Merely buying and holding any of the stocks I mentioned above would have made you 15% a year annually if you'd just reinvested the dividends for the last 30 years. Even if all you did was invest $10,000 and then nothing else – not a penny more – you'd still end up with $575,000 at the end of 30 years. If you invested $10,000 annually, you'd end up with $4.3 million.
And the best part? This approach can be used by anyone. The math is simple. And is it really that hard to realize that Heinz is the best sauce company… that Coke is the leading soft-drink business… or that McDonald's makes the best hamburgers for kids?
The No. 1 objection I get from readers when I talk about this strategy is: "That's great, Porter. Wish I'd known about that when I was 25. But it's too late for me now. I don't have 30 years."
That's nonsense. Think about it this way... Buffett was born in 1930. He didn't buy Coke until 1987. He was 57 years old. It has been one of the greatest investments of his life – bar none.
If that doesn't convince you, just think about it this way. How often do you make more than 15% on your portfolio in a year? Whether you've got three decades to invest or only one, you should aim to produce the highest possible annual return without putting your capital at undue risk. There's not a safer investment approach than this one, as your returns are being manufactured by great businesses. You don't need a "greater fool" to pay too much for your shares to make a profit. In fact... The biggest risk you face is selling at all because that will trigger taxes (in most accounts).
These companies all produce something akin to financial antigravity: They earn more and more money, year after year. But most investors will never see it. It's this seemingly invisible power that allows them to return massive amounts of capital to shareholders, a factor that sets them apart and greatly reduces investor reliance on capital gains. This is incredibly important over the long term.
Follow insurance stocks, for example… or consumer-products companies. Follow industries that have small capital requirements.
That's the big secret... the one I will work hard to teach my children... and the secret that guides my personal investing. Each year, I try to find one high-quality, supremely capital efficient company to buy and hold forever. I can diversify this portfolio over time, adding only one stock each year. This will allow me to manage risk without having to sacrifice quality…
I value the stocks I own the same way I value my own company – by the amount of cash it generates for its owners every year. I couldn't care less about the market price, as long as I know that the company continues to gush cash from operations and as long as I can trust the managers. With that out of the way – with all of my fear removed – I can concentrate on capitalizing on the opportunities created by the market's volatility.
Most investors will never have this advantage. And therefore... they will never be able to use the other profitable tools we also write about.
The lesson is simple: Take care of the basics first. Make sure your money is compounding at an acceptable rate. Once that's covered, you'll be in position to invest very successfully using other tactics.
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And we’re back to Porter today…
That feels like something I could have written… today.
More recently, I expanded on these thoughts in a special report titled “A Letter to My Son,” distilling lessons I’ve learned in my 30 years of investing with my first born, Traveler, on his 16th birthday. I wrote about the three factors you need to be a successful investor… four questions to ask when considering a lifetime investment in a company… and how much money Traveler would have made by now if he’d invested the $17,000 I gave him on his birthday in Hershey (HSY) back in 2007, when he was a newborn. You can read it here… It’s a timeless lesson in investing for anyone, of any age.
I shared the report in my weekly newsletter The Big Secret on Wall Street, where we publish a monthly recommendation of a world-class business exemplifying many of the traits I shared in today’s essay. While new opportunities differ each time, the investment advice behind them remains the same.
Good investing,
Porter Stansberry
Stevenson, MD
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