A few days ago, I had dinner with KC Lau. It was the first time I met him after he has migrated to the United States last year. We had Banana Leaf Rice and spent quality time catching up with each other as we feasted. Soon, our conversation was naturally and inevitably diverted to the topic of stock investing. From it, we exchanged ideas and I must say that I had gained a few highly profound insights from it. Thus, in this article, I’ll share 3 things I’d picked up from KC in regards to compounding wealth via savvy stock investing. They are as follows:
#1: What Will Happen 10 Years Later …
KC shared, ‘According to Warren Buffett, if you buy yourself a new house today, in 10 years time, it will become a 10-year old house. However, if you invest into a stock where it has a business model that continues to grow sustainably in the long run, in 10 years time, the stock is more valuable for it has more assets that delivers more earnings and cash flows annually to its investors.’
From it, the keywords that I have picked up are:
1. Grow Sustainably.
2. More Assets.
3. More Earnings and Cash Flows.
Let us take Berkshire Hathaway Inc. as an example.
It is a company that achieved sustainable growth through organic means and as well as acquisitions into highly profitable businesses. Over the last 10 years, the company has invested at least US$ 100 billion (on average US$ 10 billion a year) in expanding its business portfolio with acquisitions such as Precision Castparts Corporation, Burlington Santa Fe Corporation, Lubrizol, NV Energy, Duracell and so on and so forth where they become subsidiaries of Berkshire Hathaway Inc.
In addition, Berkshire Hathaway Inc. had built itself a mammoth stock portfolio worth US$ 220 billion in Q3 2019 via other people’s money known as insurance float. Its portfolio consists of well-known brands such as Amex, Coca-Cola, Bank of America, Apple, Wells Fargo… etc. As compared to US$ 55 billion in Q3 2009, it had successfully achieved a CAGR of 14.85% in portfolio valuation for the last 10 years.
As a result, Berkshire Hathaway Inc. has recorded higher revenues and earnings which led to sustainable growth in its stock price for the long-term:
Source: Google Finance
Thus, Secret #1 to compounding long-term wealth in stock investing involves us to invest in stocks where they have built a long-term track record of growth and have the ability and desire to continue reinvesting their earnings to pursue long -term sustainable growth in the future.
#2: Who Stands to Gain the Most in an Economic Crisis?
Answer: Berkshire Hathaway Inc.
This is because Berkshire Hathaway Inc. understands the importance of keeping a sizeable cash reserves for two specific reasons. First, it allows the company to absorb any unprecedented insurance losses, if it arises. Second, the company is able to seize investment opportunities especially in times of financial turmoil, if it happens in the future. This is why Berkshire Hathaway Inc. has accumulated a total of US$ 75.3 billion in cash reserves for Q3 2019.
So, what about us? How do we apply the same wisdom into our own finances?
First, it is not for us to predict when the next financial crisis will arrive but to be prepared for it before it arrives. Second, the key to investing in present times of great uncertainty is to invest in stocks where their business models are resilient and their financial results are rock-solid. In a way, investing is about building an all-weather portfolio which is able to profit consistently in all market conditions and not an attempt to speculate in pursuit of the spectacular in the short run.
#3: Words on Dividends
I’m a dividend investor who is earning recurring dividend income from my stock portfolio. Hence, despite knowing that Berkshire Hathaway Inc. is intrinsically a solid company, I didn’t make an investment into it because it never pay a single cent in dividends and I know that it does not plan to do so in the future.
But, KC did as he is okay with not collecting dividends from his investments into Berkshire Hathaway Inc. Here is why.
KC explained, ‘There are two reasons for it. First, dividend income in the United States are taxable, unlike receiving it here in Malaysia and Singapore. Second, it is financially wiser for profits made by Berkshire Hathaway Inc. to be reinvested to expand its businesses to generate greater profits and thus, leading to greater valuation of its stock in the future. This is because the management team has a solid track record of reinvesting profits to earn greater profits and believes that they can compound wealth of shareholders more efficiently if earnings are kept within the company.’
‘However, if a stock is not efficient in reinvesting earnings for higher earnings, it would be better for it to pay dividends to its shareholders from its earnings as it offers investors an opportunity to decide how best to use or invest their cash in the future.’
Let me give you two examples to illustrate the points above.
First, let us use Heineken Malaysia Bhd as an example. Despite raking in tons of cash flow every single year, it is unable to reinvest its profits to construct a new brewery in Malaysia, unless our government has a change of heart. Thus, in the case for Heineken Malaysia Bhd, it is more practical to make dividend payments to its shareholders for there is little use of money sitting in its bank account.
Second, we have Scientex Bhd. The company is also pretty good in bringing in a steady flow of positive cash flow from operations. However, unlike Heineken, it has plans to grow its manufacturing capacity of flexible packaging products and expand its property development business. The management has a solid record for reinvesting profits to generate higher earnings for the last 10 years. Thus, in this case, it is more practical for Scientex Bhd to have lower dividend payout for the management is more effective in compounding wealth for its shareholders.
Conclusion: Arguably The Best ‘Mutual Fund’ in the World …
All in all, I had an insightful meeting with KC Lau for he has generously shared a wealth of ideas and wisdom on investing over a Banana Leaf Rice meal. From it, I am almost convinced that Berkshire Hathaway Inc. is arguably the best mutual fund kind of stock listed in the world presently as the company is an investment holding entity that owns some of the most profitable businesses in America. Of course, with that being said, KC also stated that it is best to use valuation ratios like P/B Ratio to gauge your own purchase price of Berkshire Hathaway Inc. This is because an investment into it at the wrong price is also a wrong investment.
So, don’t overpay for it if you want it.
Perhaps you wonder, ‘How is the above going to help me to invest better?’
Here, I’ll leave you with three simple questions if you have a stock portfolio:
1. Are the stocks in your portfolio filled with good companies which are good in reinvesting their earnings for greater earnings for the last 10 years?
2. What are their current financial position? Are they cash rich companies?
3. What are their growth plans in the past and in the immediate future?
If the answers are unsatisfactory, I think it is a great idea to reflect on the hows and whys you invest in the stock market. For more educational articles on stock investing, you may check out the following articles: