The Ox and the Scales
Vida Económica, 30 December 2016
The Ox and the Scales

Several years ago, John Kay, famous scottish economist and Financial Times columnist, told, in an opinion piece, the parable of the ox, transcribed below:

“In 1906, the great statistician Francis Galton observed a competition to guess the weight of an ox at a country fair. Eight hundred people entered. Galton, being the kind of man he was, ran statistical tests on the numbers. He discovered that the average guess was extremely close to the actual weight of the ox. This story was told by James Surowiecki, in his entertaining book The Wisdom of Crowds.

Not many people know the events that followed. A few years later, the scales seemed to become less and less reliable. Repairs were expensive; but the fair organiser had a brilliant idea. Since attendees were so good at guessing the weight of an ox, it was unnecessary to repair the scales. The organiser would simply ask everyone to guess the weight, and take the average of their estimates.

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Executive Digest, 30 May 2016

Intelligent investing is not complex; that does not mean it is easy. What the investor needs is the ability to correctly appraise properly "chosen" investments.

The best companies are those that are able to invest large quantities of capital with high rates of return, above the sector and market average. Those are the companies we are interested in.

Warren Buffett defines competitive advantages as the tools companies use to keep competitors at bay. Competitors will always try to snatch those profits and, most of the time they succeed, bringing the rates of return down. There are however companies that are able to maintain and grow their competitive advantages for decades. These are the superstars, companies that achieve sustainable returns above their cost of capital.

It is important to know how the company was successful in keeping its profits. It is essencial to be in an attractive industry and benefit from a strategy that reinforces competitive advantages.

There are, in general, five ways in which a company can build a sustainable competitive advantage:

  • Product differentiation through functions, technology or patents
  • Perceived differentiation via brand reputation
  • Providing a similar product or service at a lower price
  • Tying” customers with high switching costs
  • Keeping competition at bay by creating entry barriers

How can we evaluate competitive advantages and their sustainability

  • Analysing historical profits and ascertaing if the company has been able to generate solid returns on its assets and equity
  • If the company achieves consistent returns and profits, why can´t its competitors “steal” them?
  • How long will these advantages last?
  • What´s the competition like in this industry? Are there many lucrative companies or is everyone just trying to survive?

The investor should look for a collection of great companies whose businesses have excellent economic fundamentals, are managed by honest and able people and buy them at sensible prices. From time to time, these businesses trade at prices which give us a margin of safety. That´s when we buy.

This way, we are maximizing something we can predict – the financial performance of the company – and minimizing what we cannot guess – the emotions of the market.

Remember, a company is worth the present value of all the money it will generate in the future.

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Buy from pessimists and sell to optimists
Forbes, 30 April 2016
Buy from pessimists and sell to optimists

The investing world is upside down. Today, if you want to lend money to a good payer you will have to do it with a negative yield, that is, you will have to pay to lend your money. Swiss, german french and dutch 6 to 8 year government bonds have negative yields. Corporate bonds from great companies also have negative yields. Investors seem to prefer losing money rather than keeping it in cash or investing it in other asset classes.

What happened to the time value of money? Faced with this, what are the best choices that guarantee safety of capital and an adequate return?

What really works and achieves consistent returns is Value Investing. For the past six decades, Warren Buffett and Charlie Munger are living proof of the success of Value Investing. Investing in the stocks of great companies, with strong balance sheets, above average returns, durable competitive advantages and honest and able managers, at prices below their fair value is still the way to go for these legendary investors.

In a time when the financial world seems to make no sense, it is even more important to have a value philosophy and stick with it.

Investing in Value is buying 1 euro for 50 cents, it´s buying a lot of value with little money. The secret of investing in stocks can be boiled down to the thorough analysis of the assets and their ability to generate cash in the future and the discipline and patience to buy only when the asset is cheap and to sell when it reaches fair value.

Most investors have tremendous difficulty in executing such a simple recipe: Buy when everyone else is selling – because the news are bad – and sell when everyone else is buying – because the newas are good. However, most people do the exact opposite. Financial institutions prefer strategies with lots of transactions that allow them to be the greatest beneficiaries of the clients's wealth.

In a world where everyone know the price of everything and so few know the real value of the assets, most of the investors do not have an investment horizon or the adequate temperament to apply this recipe and benefit from the compounding returns over time. The individual investor, that can and should have an investment horizon of decades, should allocate a significant part of his portfolio to stocks – the asset class that has achieved the best returns on capital in the last 115 years: 9,5% a year despite two world wars, several recessions a great depression and the financial crisis of 2008.

Investing in a diversified portfolio of stocks from excellent companies bought at a sgnificant discount from their true value – with a margin of safety – is the best way to protect and grow your financial patrimony. These businesses entitle you to dividends – nowadays much higher than bonds and deposits – and capital gains over time. These companies are money making machines for their shareholders. The secret of investing is that there is no secret: invest with a margin of safety and buy from pessimists and sell to optimists.

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