Nine years ago, during a trip to Tokyo, I had a conversation that profoundly changed my understanding of work, loyalty, and investment. I met a Taiwanese family who had been living in Tokyo for nearly four decades. Over dinner, they shared a concept deeply ingrained in Japanese work culture – lifetime employment.
I remember the father, Mr. Nagayumi, explaining how his daughter was evaluating job offers. “It’s not just about the starting salary,” he said, “but about the lifetime compensation of a career path.” This approach, looking at the long-term returns of a career choice, struck me as remarkably similar to a principle in investing.
In Japan, for many years, lifetime employment was the norm. This model was built on mutual loyalty: employees would rarely leave their company, and in return, companies would commit to their employees’ job security, even during economic downturns. This loyalty translated into a range of benefits – from bonuses and retirement plans to company housing.
But this loyalty extended beyond the workplace. Men were often expected to work late, and coming home early was sometimes perceived as a sign of incompetence. Socializing with colleagues, sometimes until dawn, was commonplace.
Now, let’s pivot to the world of investing, where these principles find an intriguing parallel. Consider the relationship between a loyal employee and their company. In many ways, it mirrors the relationship between shareholders and the stocks they invest in.
Understanding Intrinsic Value
Warren Buffett, the Oracle of Omaha, offers a succinct definition of intrinsic value that forms the bedrock of his investing philosophy. He describes it as the “discounted value of the cash that can be taken out of a business during its remaining life.” This principle, at its core, is about understanding what a business is truly worth, irrespective of its current market price.
So, how do we apply this concept to the evaluation of a listed company? It starts with a thorough analysis of the company’s future cash flows. These are the earnings the company is expected to generate in the years to come. However, a dollar earned in the future is not worth as much as a dollar in hand today, due to the time value of money. Therefore, we discount these future cash flows to their present value, which gives us a more accurate picture of the company’s worth.
But how do you determine the right discount rate? This is where the art meets the science in investing. The discount rate typically reflects the risk associated with the business and the investor’s required rate of return. A higher risk business demands a higher discount rate, which lowers the present value of its future cash flows.
Once we have an estimate of the intrinsic value, the next step is crucial – seeking a margin of safety. This is where Buffett’s strategy really shines. He advises buying stocks at a price well below their intrinsic value. For example, if you estimate a stock’s intrinsic value to be $1.00, you should aim to buy it at around $0.60. This margin of safety protects the investor from errors in estimation or unforeseen market fluctuations.
This approach to valuation is about finding good businesses at prices that offer a buffer against the unknown. It’s about ensuring that even if your assumptions aren’t perfectly accurate, you still have a reasonable chance of achieving a satisfactory investment outcome.
The Art of Holding On
A common adage among the investing elite is that more often than not, their biggest regret is not what they bought, but what they sold too early. This sentiment is deeply rooted in the philosophy of letting your winners run, a practice that can lead to owning what are known as multi-bagger stocks – stocks that increase multiple times in value.
The concept of multi-baggers is brilliantly captured in Chris Mayer’s book, “100 Baggers.” This book studies stocks that returned $100 for every $1 invested. Mayer delves into the characteristics of these companies and how they were able to deliver such extraordinary returns. What’s fascinating is that many of these success stories weren’t overnight sensations. They were the result of patient, long-term investing.
One key takeaway from Mayer’s research is the power of compound returns. The longer you hold onto a growing asset, the more significant its exponential growth becomes. This ties back to the concept of intrinsic value and margin of safety. Investors who identify a company with strong fundamentals and acquire its stock at a price well below its intrinsic value have set the stage for potential multi-bagger returns.
However, it’s essential to differentiate between blind holding and strategic patience. The goal is not to hold onto stocks indefinitely but to hold onto those that continue to grow in value, have strong fundamentals, and still align with your initial investment thesis. It’s about recognizing that selling a performing asset too early can mean missing out on its most productive years.
Mayer’s book also emphasizes the importance of a business’s ability to reinvest its earnings at a high rate of return. A company that can continually reinvest its profits effectively is likely to keep growing and increasing its value over time, thus rewarding its long-term shareholders.
Long-term as if Lifetime
In essence, sensible value investing mirrors the principle of lifetime employment that’s revered in cultures like Japan’s. Just as a loyal employee commits to a company, believing in its long-term success and stability, so should an investor with a well-chosen business. When you identify a company that not only has robust fundamentals but also aligns with your values and investment goals, it’s akin to finding a workplace where one’s talents and contributions can flourish over a career. Hold onto these stocks with the same dedication and foresight. Just as lifetime employment offers stability and cumulative rewards over the years, long-term investment in a good business can yield substantial, compounding returns.
This is the art of investing – not merely a transaction, but a commitment, paralleling the loyalty and steadfastness seen in lifetime employment, leading to mutual growth and prosperity.