Does chance favour the patient mind?

Warren Buffett, known as the investment expert, once said: “The stock market is designed to transfer money from the active to the patient”.

He and his partner Charlie Munger have always advocated for the buying stocks of high-quality corporates at reasonable prices and the holding of these enterprises for the long-term, to leave them sufficient time for business development and accompany their growth. From the beginning of 1964 to the end of 2021, Berkshire Hathaway, a flagship company under Buffett, has shown an impressive growth of 36,416.13% in its market value over those 57 years, as well as a compound annual growth rate of 20.1%.

Could Buffett ever be wrong?

However, in earlier years, Buffett’s return on investment once underperformed, causing members of the stock market to challenge his expertise and the effectiveness of his value investing strategies. Most of these criticisms come from people who bought stocks in a bullish market, earning high returns in a short period of time through speculation. Taking the qualitative easing implemented in the US during the pandemic as an example, it allowed many retail investors to become stock market experts overnight as the price of many growth tech stocks surged within a short time.

Yet, this year, unfavourable factors like the persisting pandemic situation, the anticipated rise of interest rates in the US by the stock market, and ongoing wars and conflict posed serious setbacks to the rise of growth tech stocks prices, causing many to be reduced by 50%, while some even dropped over 80%, and consequently, many investors suffered significant capital losses.

As seen from the comparison made above, the compound annual growth rate of some investors can indeed exceed that of Buffett in a relatively short period of time, but such performance cannot be sustained. Till this day, it appears that Buffett is the only investor who can achieve a compound annual growth rate of 20% that can be maintained for over 50 years.

Holding period: “forever”

So, what has Buffett been doing while retail investors were speculating in the bullish market? He too made many business deals, but his major holdings did not experience significant change. Since January 2020, in slightly more than two years’ time, the price of his major holding stock, Apple, rose by more than 100%. Although his overall return on investment still performed below market average, Buffett did not sell his holdings but instead held onto his stocks.

As he has an in-depth understanding of the corporates he invests in, once he identifies a high-quality corporate, he buys and holds its shares for a long time. Even though he advocates for strategic investment diversification, his top five holdings take up more than 75% of his overall investment portfolio.

When observing market data in a holistic view, it is found that since 1964, the macro environment has undergone a wide variety of changes in slightly more than fifty years’ time, but the S&P 500 Index still surged by more than 300 times in this time period, and its compound annual growth rate could even reach 10.2% every year.

As stressed by Buffett, “Time is the friend of the wonderful company, the enemy of the mediocre”. Investors need to allow high-quality corporates sufficient time for their businesses and market value to grow with compound interest.

Lacking an in-depth understanding of corporates, some investors are unable to identify high-quality companies and could accidentally buy shares from enterprises of unstable quality, possibly causing them to lose all their invested capital.

At a general shareholders’ meeting, Buffett commented that value investors should make considerable efforts in order to earn a return on investment that outperforms the market for a long time. As the saying goes, “No pain, no gain”. One shouldn’t take chances. For investors who are not able to perform fundamental analysis on corporates, Buffett recommended exchange-traded funds (ETFs) as a considerable alternative.

Meanwhile, Buffett also encourages investors to invest in knowledge. As with high-quality corporates, in time, knowledge can also bring about a compound effect and help you develop a strong investment acumen.