Here's a little tip most Wall Street types would prefer you not know: The recipe for great long-run success in the stock market is startlingly simple.
You heard me
You might find that hard to believe, since we're in the midst of the worst bear market since the Great Depression. How can it be true? Well, empirical research from professors Eugene Fama and Kenneth French, along with that of Jeremy Siegel, supports the notion that excess returns await those who look for value-priced stocks.
But scholarly research is one thing. Application is another. If you're looking for a real-life example of the power of taking a long-run, value-focused approach to investing, look no further than the jaw-dropping success of one of the world's richest men: Berkshire Hathaway 's Warren Buffett.
How it works
This proven process for beating the market is actually pretty straightforward:
Want more color? Let's dance.
Buy great businesses
Businesses with quality management and durable competitive advantages (a.k.a. economic moats) drive supreme long-run value for their investors. These competitive advantages allow companies to consistently earn returns in excess of their cost of capital, helping to fund growth, share repurchases, and dividend hikes -- and, of course, boosting share prices. Put simply, moats make money.
Durable competitive advantages come in several forms. A few of the most valuable and well-known are:
FedEx (NYSE: FDX) or UPS (NYSE: UPS).Cost advantages: Think ExxonMobil (NYSE: XOM).Intellectual property: Think IBM (NYSE: IBM).High switching costs: Think Automatic Data Processing (Nasdaq: ADP) or Intuitive Surgical (Nasdaq: ISRG).A quick way to judge whether a company has a durable competitive advantage is to look at its historical returns on invested capital. If they're consistently strong (generally speaking, higher than 13%), you're probably looking at a strong business.
2. Buy them cheap
Finding great businesses takes you a long way toward market-beating returns. But there's just one problem: Great businesses rarely look cheap by traditional metrics. Let's look at some of the top-performing S&P 500 stocks from 1957 to 2003, according to the work of Jeremy Siegel:
Company
Annual Return
Average P/E
Altria
19.8%
13.1
Abbott Laboratories
16.5%
21.4
Bristol-Myers Squibb
16.4%
23.5
Tootsie Roll
16.1%
16.8
Merck
15.9% Continued... |