This simple formula creates wealth

MoneyWeek magazine is known for getting the big ‘sell’ calls right. So you couldn’t call it optimistic in its outlook. Editor–in-chief Merryn Somerset Webb warned recently, “You aren’t going to find much in the way of good news in this week’s edition.”

And so it proved. James Ferguson told us to prepare for “a dangerous bond market collapse”. Matthew Lynn advised that wealth taxes will leave the UK economy in “even worse shape than it is already”. Sterling is “a big sell”, Slovenia “is heading for bankruptcy”, there is a “dangerous flow of hot money” into London, house prices are overvalued, and when it comes to child trust funds, “it is time to get angry”.

This is enough to have you stick your savings under the mattress for another week. And yet this same issue of dire foreboding also mentioned that Warren Buffett recently shelled out $28bn to buy Heinz. Some critics have had a pop at this trade, too. Buffett, they say, has overpaid and “lost his touch”. Me? I doubt it.

In today’s issue, I want to explain to you why I would always put my faith in Mr Buffett over any piece of financial commentary. That’s a simple strategy. But with so many opinions coming from all angles, it’s easily forgotten. 

Why Buffett knows best

If it comes to a contest between the pundits and the world’s greatest investor, my money is on the latter every time. And here is why. Buffett understands this simple truth: the best way to multiply your money is to invest it in a business that will multiply it for you.

It is the successful business that is the wealth creating unit of an economy. It is the successful business that creates value by making a product at a cost of 100 and selling it for 120. By doing this year after year and reinvesting the profits, it will multiply its invested capital, including that from its shareholders.

Any private investor who does not understand this is doomed not to make money. It has been said that the job of a financial journalist is “not to be right but to be interesting”. This, I am afraid, is the last refuge of the intellectual.

There are many financial commentators – and I include City professionals as well as my fellow journalists – who talk stridently and confidently. But the fact is, much of their advice is simply wrong.

With so many different opinions out there, it is difficult to assess which is the correct view to listen to. The secret of successful investing is not to take a view on everything. Very few people understand this. Most of us reckon we are pretty intelligent, that our views are sensible and reasonable and should deliver investment success. But as often as not, they don’t.

The trick to successful investment is to narrow down the field of investment opportunities and find things we know will work.

Ignore the bigger picture

Betting on ‘asset classes’ is not a sustainable investment strategy. It is what most of the geniuses of the hedge fund game do, and although some of them have made famously successful bets from time to time, almost none of them have done so repeatedly. The sustainable strategy is to invest in successful businesses. And this is exactly what Warren Buffett does and how he made his billions.

In the last five years, a time when the market commentators have been warning us all off the market, 33 companies in the FTSE All-Share index have delivered returns of 200% or more. Headed by Arm (ARM), Oxford Instruments (OXIG), Dialight (DIA) and including such brilliant businesses as Telecom Plus (TEP), Diloma (DPLM) and Telecity (TCY), they simply deliver a great product that customers want to buy.

Private investors should not worry about the bigger picture. All they need to do is identify successful companies and invest directly into their shares, avoiding investment funds or any other construct of the financial services industry. Nobody tells you this, because there is no money in it for the industry. But it’s what you should do.

Think of it this way. The world of financial services is like a supermarket, packed full of products that will all do something different for you. But you don’t need to inspect and form a view of all of them. All you need to do is go into the store and find the things you need, and ignore the rest.

This is what Warren Buffett does. He takes little notice of the big picture, but simply finds great businesses and buys them. That is why he has become one of the world’s richest men while the scribblers continue to scribble.

• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

6 Responses

  1. 07/03/2013, Elizabeth wrote

    I absolutely endorse your praise of Telecom Plus. I bought some at £2.30 in February 2007 and they’re now close to £10. Their brand is the Utility Warehouse, and more information about what they do is on http://www.saveandearnmoney.co

  2. 08/03/2013, MichaelL wrote

    Buffet probably does know best, thats is why he is winning the bet – tracker vs hedge funds and why he suggested most people are better off buying a tracker that reinvests dividends, rather than trying to outperform the market yourself. It is hard being Ben Graham in todays world.

  3. 08/03/2013, Blacksmith wrote

    Very good points in this article. In the end investing is a practical discipline.

  4. 08/03/2013, Changing Man wrote

    I am relieved at last to read such a balanced well-judged article on this website! For too long we have been drowning in the headline grabbing, doom-mongering editorials harking back to the messages of the “survivalist” movement of the 1980′s Cold War era i.e. “fill your garage with tinned food and keep a revolver and a stash of gold coins under the bed”! The buy gold “bullying” movement may sell magazines but creates a dangerous “groupthink” mentality. Try challenging the opportunity costs in holding gold with the goldbugs and you will get an aggressive response.
    Magazines that wallow in sensationalism deserve their branding as mere “rags”. I hope your editor takes notice but somehow I doubt it?

  5. 09/03/2013, Sid wrote

    Tom

    A very interesting article with many good points. I am often astounded at how poor mainstream financial journalism is. You are either mislead or the people writing come over as intellectual and what they are saying feasible, then it turns out to be delusional or utter tosh. One only has to re read all the financial journalism leading up to the 2008 crash to get a snap shot. ( I remember money week was one of the only publications warning of a meltdown ) . It is also easy to be drawn to sensationalism because we know there are considerable risks out there, and have zero faith in the people who run our affairs. However you make a good point about investing, especially long term investing, and using Warren Buffets success as an analogy. It would be great if you could expand on this in future articles.

  6. 19/03/2013, Pete C wrote

    Tom makes a very good point that’s lost on a lot of people. A lot of my friends and family view investing in shares as nothing more than taking a punt. Yet they seem to miss the point that when you buy a share you’re buying part of a company. Choose a good company and you will benefit from its growth. Sure, finding good companies to invest in takes careful research, but this is very different to taking a blind punt on any old share (which is no different to gambling).

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