HOW the WEALTHY USE DOWN to GO UP
"There are risks and costs to a program of action. But they are far less than the long-range risks and costs of comfortable inaction."
—John F. Kennedy
The best investment strategy I know is so counterintuitive, so shockingly upside down, such a crazy way of thinking about investing that hardly anyone who uses it wants to even try to explain it. It’s not at all hard to do, but it is hard to explain. It just sounds so . . . impossible. But smart investors do it all the time and, man, does it work! I mean it really works. It’s an “I can do whatever I want the rest of my life” kind of works. It works so well, it’s the secret to the investing success of the best and richest investors in the world. Seriously.
I know that sounds like hype, but honestly it’s impossible to overstate the effectiveness of this strategy. It really is the basis of the biggest fortunes in the world, including those of quite a number of Forbes’s World’s Billionaires list. For example, #3 is Carlos Slim Helu, the Mexican telecom entrepreneur who is worth $35 billion and is currently buying into cheap media, energy, and retail assets, including the New York Times, using this strategy. Lakshmi Mittal, #8, of India, created a $19 billion fortune and now runs the world’s largest steel company, ArcelorMittal. He built ArcelorMittal using this strategy in Eastern Europe in the 1990s after the Berlin Wall came down. Number 15 is Bernard Arnault of France, who built a $16 billion fortune by acquiring Christian Dior with this strategy.
Number 16 on the World’s Billionaires list is Li Ka-shing of China, who made $16 billion acquiring energy, banking, and utility companies with this strategy. Charles Koch and David Koch are ranked #19 with $14 billion each, which they got by using this strategy to build Koch Industries—one of the largest, privately held corporations in the United States. Michael Otto of Germany is ranked #23 and is using this strategy to take advantage of weak markets in the United States to buy up shopping centers in America. Don Bren is #26. He used it to become the sole owner of the Irvine Company and bank $12 billion. The Irvine Company is one of the largest construction companies in California and the developer of about a fifth of Orange County.
The list of billionaires who used this strategy to become mega-wealthy goes on and on but wouldn’t be complete without mentioning that the world’s second wealthiest man, Warren Buffett (worth $37 billion), the world’s best investor, used this strategy of investing to build his immense fortune and to increase his ownership and compounded return in companies like American Express, Washington Post, GEICO, and Coca-Cola.
This strategy is also the basis of thousands of little fortunes, including mine. In fact, as any of the billionaires I mentioned above would agree, it’s much easier to use the strategy if you are a small investor. Being a big investor is actually a huge disadvantage in using this strategy. Mr. Buffett once said, “Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money.”*
I used this strategy to build my wealth by buying shares of bioscience, software, and other private companies. And soon, if you pay attention and are willing to do a bit of fun work, you’ll discover that this incredible strategy can be the basis of your fortune, too.
I call this amazing strategy “stockpiling” . . . as in “stash,” “accumulate,” and “collect.” It means exactly as it sounds—stockpiling, as in piling up stocks. Not just any stock at any price, though. The essence of stockpiling is to buy stock in a business you’d be excited to own all of, then hope the price goes down so you can “stash,” “accumulate,” and “collect” as much as you can afford at as low a price as possible. Sounds strange, I know. But again, all of the billionaires I listed above and many more on Forbes’s World’s Billionaires list are stockpilers of businesses. (Note: This list might have changed by the time you read this but not the stories behind these guys’ wealth-building strategies.)
Buy a Business, Not a Stock
“Buy a Business, Not a Stock” was a chapter title in my first book. It’s such a key way of thinking that I can’t reiterate it enough: You must stop thinking that stock investing is any different from buying a business. When you buy a business you’re buying shares of the business. If you buy some percentage of the total shares, you become a part owner. Buy all the shares and you own the whole business. There is no difference between that process and buying public stock in a business. As long as you treat owning shares of public stocks as different from owning a piece of a business, you will fail to understand and execute the stockpiling strategy. A typical stock investor is unhappy when the price of his stock goes down, because he has no understanding of the true value of the business that stock represents. But that’s because typical stock investors are not investors at all. They don’t understand stockpiling, so they inadvertently have become speculators and outright gamblers.
The unfortunate truth is that the financial services industry has conned many millions of people into their game of stock speculation via mutual funds. I’ll have a lot more on that in the next chapter. For now, let’s just remember that for this book and for the rest of your investing career, you must think of stocks as shares of a business, and yourself as the owner of that business. So if you buy just ten shares of Coca-Cola, you’re a part owner of Coke—not a stock investor in Coke. Got that? When you begin to think like this, you’re joining some truly great investors like Buffett, and you’re on the first step toward becoming a solid stockpiler of stocks, er, businesses.
“The basic ideas of investing,” Buffett says, “are to look at stocks as a business, use a market’s fluctuations to your advantage, and seek a Margin of Safety. That’s what Ben Graham taught us. A hundred years from now, these will still be the cornerstones of investing.”
From the late 1990s until 2008, Warren Buffett bought very few public stocks. He mostly just sat on about $45 billion of Berkshire Hathaway’s cash, waiting patiently for Mr. Market to become fearful enough about the future to bring the prices of wonderful public businesses down to levels at which he was willing to buy. In May 2008 Mr. Buffett told his fans at the annual Berkshire conference that he hoped the stock market would drop 50 percent so he could finally put all his cash to work. Then the market crashed, and in October 2008 he invested $20 billion in public companies.
But here’s the classic part of the story: As prices of the businesses Berkshire owned—and still owns, as of this writing—plummeted, and the Berkshire stock price dropped accordingly, Mr. Buffett was attacked, again, for being over the hill and out of touch. The proof? The prices of businesses he owns were going down.
This is not the first time he’s been accused of losing his touch. In the late 1960s he was sitting on a lot of Buffett Partnership cash. His unwillingness to chase high prices disturbed enough Buffett Partnership partners that Mr. Buffett dissolved the partnership, gave his partners back their money, and shifted his stockpiling strategy to Berkshire Hathaway, where he would no longer be required to deal with limited partners whining about his lack of investing activity.
Of course, he turned Berkshire into the world’s most successful investment vehicle. Ten thousand dollars invested in Berkshire in 1969 is now worth $40 million. Again in the late 1990s, as mutual funds racked up big gains by buying technology stocks, Mr. Buffett was accused of being behind the times. His ideas became more popular after the Nasdaq plunged 85 percent during the dot-com bust.
The fact is, stockpiling is something people either get right away or never understand at all, no matter how much sense the strategy makes or how much money the people who practice it make.
The Secret to Risk-Free Stockpiling Is Knowing Price Is Not Value
Okay, there’s obviously more to stockpiling than just buying a stock and hoping the price goes down. What Warren Buffett and a lot of other billionaires know is that the price of a stock doesn’t always have a whole lot to do with how much that business is actually worth. To put it another way, you have to learn how to look beyond stock price and at a business’s value.
The one and only secret to stockpiling is to make sure the value of the business is substantially greater than the price you are paying for it. I swear to you that’s all there is to it. If you get this right, you cannot help but get rich. Most investors make the mistake of thinking the price they paid has some necessary connection to the value of the thing they bought. I don’t know why stock market investors think that when it’s so manifestly and obviously not true in any other sort of market they buy in regularly. Surely they bought a used car sometime in their lives. They wouldn’t confuse the price being asked for a used car with the value of that car, would they? Just because a guy is asking $5,000 for his old Toyota doesn’t mean it’s actually worth $5,000. If you’re reasonably smart, you go look the car over; you make sure its got an engine that works and the body isn’t a disaster. You check to see what similar cars are going for and use that price as a guideline, but only if it’s reasonable.
Why wouldn’t investors do something similar when they buy stock? Because they don’t know how to calculate the value of a business the way they do with cars. Well, we’re going to fix that in this book.
I’m going to show you how to calculate value—and make sure it’s higher than price—in Chapter 4, but for right now just understand this: price is just the amount you paid. That’s all it is. It doesn’t mean a damn thing other than that. If you want to know the value of the thing you bought, well, that’s an entirely different question. Price is what you pay but value is what you get. Those two things can be and often are quite different. We’ll start our lessons on how to stockpile undervalued companies and make millions with that: Price is not the same as value.
Since I haven’t taught you how to figure out the value of a business yet, allow me to make my point with an example from my horse farm. I wasn’t a very good rider but I wanted to learn, so I was looking for a horse that knew a lot more than I did about what I’m supposed to do. My partner, Melissa, got a lead on a Level-4 dressage horse that was for sale because the owner died. The family was wealthy, so they were just looking for a good home for the horse. Melissa called and found out they’d bought the horse for $60,000 plus shipping from Germany. They wanted $35,000 for a quick sale. She told them we weren’t interested but they should call us back if they didn’t find a buyer at that price. Two weeks later they called and offered us the horse for $10,000. We drove over for a look. We could see why they were having a problem selling him. He needed to get his feet trimmed and reshod. He needed to be fed better. And he hadn’t been ridden for months. I got on him and he tried to toss me, but he was too out of shape to get into it. I wasn’t impressed. A big, bony, out-of-shape, cantankerous horse wasn’t what I was in the market for.
Melissa, however, is the former owner of a horse-importing and -training business and she’s been a national champion rider several times. She knows horses. She took a ten-minute look at this guy moving around the arena, pulled me aside, and said, “Let’s take him home. He’s amazing.”
Where I just saw the superficial problems, she saw a $60,000 horse and a great horse to teach me to be a better rider. We paid $6,000 and loaded him up, and he’s in our barn now with new shoes, getting fat. What’s his value? I’m sure even in this market, he’s at least a $20,000 horse. Maybe a lot more. The lesson? Superficial problems that have nothing to do with value can have a big impact on price.
Before we get back to businesses and the details of calculating value, I want you to notice one more thing about the purchase I made: It was essentially risk-free. There was no way I could lose money on that horse. Even if he died, I’d make money on the insurance.
Think about that for a second. If we know the price of a thing is less than what it’s worth (its value), then something remarkable becomes possible: We can buy it and be certain we will make money.
“Certain?” you ask. “Come on. There’s no way to be certain you’re going to make money.”
Yup, there is a way to be certain and it’s really simple. Just put on your logical, rational hat and follow me: If the value of the thing you bought is greater than the price you paid, you are guaranteed to make money. You have gotten rid of the risk of making the investment. The only question is how long you have to wait for the price to come back into line with the true value.
In the case of our horse, Sherman, we bought him so cheaply we could sell him for a profit immediately after doing some basic maintenance. If we want to sell him for the maximum amount—his full value as a Level-4, 17-hand, beautiful dressage horse with amazing action—we’ll have to be more patient and wait for a better market when the price will come up to the value.
The same thing applies to owning shares of a business. If you buy at a price well below the long-term value, you may not be able to sell for a profit immediately. In fact, the price may go down before it goes up. There’s no guarantee that the short-term price for Sherman won’t fall lower. But in the long term, the price will come up to the value. True for a horse. Especially true for a business.
From the Hardcover edition.