Tuesday, December 19, 2023

Lessons to Indian Investors From Munger's Market Beating Run for 45 Years

Finally it happened. Jerome Powell backed off from destroying the American economy and the world economy further by not only pausing from an interest hike yet again, but by hinting that 2024 might witness up to three rate cuts.

It was the perfect excuse that the Indian markets needed to move even further up. Our nation already had structural strengths due to the ongoing economic reforms and infra push, plus the booming mutual fund inflows, and this move by the US Fed is surely a long-term positive.

Did someone mention long-term just now? Yes, and it was intentional, as there is now a chorus that the market will only go up and up. A little more conscientious souls are saying that only the large-caps may move up now, and not the mid or small caps, which are way too heated up already.

But this too has become a chorus now, and every time such a chorus is emerging, beware, a correction might just be around the corner. A 10-15% correction is a healthy norm in a bull market, but it can catch most traders and investors on the wrong foot, as this time around it may involve Nifty diving down by over 3000 points and Sensex by over 10k.

In Warren Buffet’s words, yes, it is a time to be fearful. As the Oracle of Omaha said in near perfect words - “To be fearful when others are greedy and to be greedy only when others are fearful.” But such a dip too is sure to be bought in rapidly, giving you a fruitful opportunity to be greedy.

So, this kind of rapid buys against sharp falls is what the long-term qualifier is all about. And not that the markets will go only up and up. Of course, long-term has much more positive implications in the capital markets. Charlie Munger who passed away on November 28 was one of the best practitioners of it.

It is said that many of the quotes and wisdom that people attribute to Warren Buffett were actually from his long-term business partner Munger. One such quote where Munger likely had a great role was this - “Our favorite holding period is forever.” Such was his conviction about a unique advantage that only comes from the long-term holding of stocks - the power of compounding.

Compounding is no rocket science. At its heart, it is only middle school arithmetic. But 99% of investors in stocks and mutual funds do not get to reap its benefits. In fact, Munger excelled in it precisely because it was only basic math. Despite his towering intellectual capabilities - lawyer, architect, analyst, investment strategist, business head & thinker - he was careful to choose only simple generalized knowledge from the various domains.

Munger had a well-known disdain for specialists and their too specialized knowledge. His argument was that specialists tend to focus too much on their specialized knowledge, while ignoring what a multidisciplinary approach could have easily solved, by bringing together basic knowledge from all connected domains.

Anyway, compounding was one such basic skill that Buffett and Munger excelled in, that it won’t be an exaggeration to state that this strategy had more than a 50% role in their astounding success at Berkshire Hathaway which they together grew into the world’s largest holding company worth nearly $800 billion.

Munger’s appreciation for the power of compounding is evident from one of his best known quotes - "The big money is not in the buying and the selling, but in the waiting." Indeed, what he achieved for Berkshire Hathaway by way of compounding can never be overstated.

In fact, Munger’s strategies including his reliance on long-term compounding was central to Berkshire Hathaway shifting away from Buffett’s philosophy of investing in fair companies at wonderful prices (which he learned at Columbia University from his professor Benjamin Graham, the Father of Value Investing). 

Instead, Munger - who never attended any b-school unlike Buffett - convinced Buffett that what they should be doing is investing in wonderful companies at fair prices. Since this involved buying at higher prices than in value investing, it invariably required the power of compounding to work, and it proved to be so, as most of these companies proved to be really wonderful in the long-term! 

Buffett himself has gone to great lengths to credit Munger for this complete strategy shift and for creating a new blueprint for Berkshire, often saying that “it was Charlie who straightened me out” and that “listening to Charlie has paid off.”

Between 1978 and 2023, that is, for 45 long years, Berkshire Hathaway grew investors’ wealth at a compounded annual growth rate (CAGR) of 20%. Most people don’t readily realize what this achieved for their public shareholders - it multiplied their wealth by 3700 times within these 45 years!  

It is a feat never done before and never likely to be done again in the future. This is especially so as despite this intervening period being witness to America’s largest ever economic growth, that sent its benchmark S&P 500 index over the roof at 163 times wealth creation, Berkshire Hathaway’s performance beat even this superlative returns by nearly 23 times!

So, what exactly is this power of compounding in layman terms? It would be best to describe it with an example. Suppose you have Rs.10 lakhs to invest in 2023. And you invest all that in a stock priced at Rs.50, after a careful study. So you get 20,000 shares.

For this stock to double your wealth, it has to go to Rs. 100 or go up by 100%. Suppose it does that within a year or two. So now you have doubled your wealth to Rs. 20 lakhs. Now, to triple your wealth you know the stock has to triple in value, that is, become Rs. 150 per share. But do you know how much it has to grow now in percentage terms to reach Rs. 150 from Rs. 100? It has to grow only 50%, and it will triple your investment to Rs. 30 lakhs!

If it is an excellent stock in an excellent market, it will achieve that within the next year. So now you have tripled your wealth. You know that if it adds another Rs. 50 to its value, it will quadruple your wealth to Rs. 40 lakhs, that is increase it fourfold. But do you know how much that growth is in percentage terms - from Rs. 150 to Rs. 200? It is merely 33.33%! And similarly for your investment to grow fivefold - from Rs. 200 to Rs. 250 and from Rs. 40 lakhs to Rs. 50 lakhs - all it takes is a 25% up move, which can sometimes happen within a week!

Now suppose you were really fortunate that your chosen stock was one of the best growth stocks in the market, maybe within the top 1% of the best small caps, that becomes a 100X multibagger by 10 years, that is, by 2033. So now your Rs. 50 stock is trading at around Rs. 5000, and your Rs. 10 lakh investment is now worth Rs. 10 crore. What happens now is the real magic.

Do you realize how much your stock has to move up now for it to add one more times in return, that is to add one more 10 lakhs (your original investment), or in other words to move from 100X to 101X? If you are quick at arithmetic, yes, you guessed it right, it should just rise by 1%. Imagine, a stock moving up by merely 1%, and you adding one more times of your original investment to your wealth!

This is what the magic of compounding is all about. Do you think this is a far fetched idea? Absolutely not. Even in the Indian market, there are dozens of stocks that have done this within the last 10 to 20 years, and now with the kind of better quality companies and startups hitting the IPO street, there will be hundreds of companies achieving such feats in the 2023-33 period.

This is why Buffett and Munger always held seemingly boring stocks like Coca Cola and American Express in Berkshire’s long-term portfolio without ever divesting them. These stocks continue to be incredible wealth compounding machines for early investors like them, who have also used their high dividends to reinvest!

And this magic of compounding is what drove this remarkable duo to state counterintuitive stuff like, “Our favorite holding period is forever” and that "The big money is not in the buying and the selling, but in the waiting." It is a wisdom that runs diametrically opposite to the current trend of dangerous practices like only microseconds long algorithmic overtrading, futures & options and heavily leveraged bets.

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