“By far the best book on investing ever written.”—Warren Buffett
Many times in investing, as in life, we will overthink things. I once had a convoluted idea regarding the U.S. dollar, a new president, and Mongolian coal as it related to Chinese power production. My mentor rocked back in his chair, put his feet on the desk and told me with the thrust of an index finger that my investment theory had too many moving parts, any one of which could go sideways.
And he was right. After three decades of investing, I’ve learned to reduce my investment theories to one if/then statement.
For example, a few months ago I theorized that If the Fed signals it will cut interest rates, then interest rate-sensitive companies such as Zillow (Z), Redfin(RFDN) and Rocket Mortgage (RKT) will go up in value. This has held true. Over the past two months, these stocks are up between 81% and 103%.
Or, I thought, if the Houthis shut down the Red Sea via drone bombs, then shipping companies would have to travel farther and would get paid more. Again, companies like Scorpio Tankers (STNG) doubled.
My current thesis is that if AI demands more electricity, then utility companies will benefit over time. Simple…
This thesis is also holding up at the moment.
KISS This
Keeping it simple isn’t an original idea. In fact, Warren Buffet’s mentor Ben Graham who wrote the book Intelligent Investor had a few simple rules or principles. Here are the three basic ones.
Always Invest with a Margin of Safety
Graham was the original value investor. He wrote that you want to buy a stock at a significant discount to its intrinsic value. This will give you plenty of upside as well as reduce the downside risk. In other words, Graham’s goal was to buy assets worth $1 for $0.50. His ultimate goal was to find companies where the liquid assets minus the debt was worth more than their market capitalization. Graham’s followers called these “net net” stocks.
These are hard to find but when you do discover them you buy them. They are typically found at the bottoms of markets and they will look unsavory, beaten up, and hated in general. There will be some stinking well-known reasons they trade less than cash. But still, you swallow hard and buy. I’ve bought about six of these in my life and they are always huge winners.
Expect volatility and profit from it.
Don’t run from down markets. Buy lower, average down, and dollar cost average. Graham’s goal was first to preserve capital and then to make it grow. He had a rule that if your cash holdings could earn more than the dividends on stocks, then you should own the cash (or bonds).
Today you can get 5% in a money market and the S&P 500 is paying about 3.6% in dividends. There are no stocks trading today (that I could find) that have more money in liquid cash minus debt than they have in market cap. Given this, according to Graham’s rules, you would put 75% in bonds and the rest in stocks.
Know Your Type
Lastly, Graham wanted you to know your investor type. Are you passive or active, an investor or a speculator? Do you have the guts to buy stocks when they are cheap and everyone is running for the exits? Psychology is everything in the market. Know your type and find an investing method that fits you.
Warren Buffett Took Graham and Ran
Buffett is one of the richest people on the planet. He has beaten the S&P 500 over the last 24 years by about 4x. Here is BRK-A performance versus the S&P 500 chart going back to the year 2000:
I had to look twice at this chart.
People forget that the S&P 500 went sideways for about 13 years after the dot.com crash.
Anyway, Buffett makes his money at the bottom of markets by buying great companies on the cheap. When he has nothing to buy he puts money in cash. Right now, Berkshire Hathaway has the largest cash position it has ever had.
Buffett will tell you he isn’t a market-timer. He buys value. Often he is very early going to cash and misses the big gains at the top of the market. That means he misses being a bag holder as well.
Buffett seems to be correct in his timing at this point in the cycle. Unemployment is climbing, manufacturing is down, the consumer is played out, the yield curve just raised a red flag, the dollar is falling, volatility is up and the Fed is about to start cutting rates in a panic. And in spite of all this investors are extremely bullish.
I am investing in defensive stocks like utilities, and commodities like gold, silver and oil. I am selling tech, and playing downside options. But mostly I am raising cash in anticipation of those “net net” stocks that will start showing up in March of 2025.
All the best,
Christian DeHaemer
Outsider Club
Warren going to cash:
https://www.cnbc.com/2024/08/03/berkshire-hathaway-earnings-2024-q2.html
Leave the party early:
https://www.outsiderclub.com/stocks-take-the-elevator-down/
Know Nukes:
https://www.outsiderclub.com/going-nucular-in-ghana/
What will the code monkeys do now?
https://www.outsiderclub.com/learn-to-code-they-said/
