Friday, June 26, 2009

Tiger Woods and Bill Gates

Very different skills, similar advice.

Tiger Woods: Best advice (from his Dad)? Keep it simple.

"My dad's advice to me was to simplify. He knew that at my age I couldn't digest all of golf's intricacies. He kept it simple: If you want to hit the ball to a particular spot, figure out a way to do it. Even today, when I'm struggling with my game, I can still hear him say, "Pick a spot and just hit it." When I'm making adjustments during a round, I know some of the television commentators theorize that I'm changing this or moving that, but really what I'm doing is listening to Pop."

Bill Gates: Best advice (from Warren)? Keep it simple.

"Well, I've gotten a lot of great advice from Warren. I'd say one of the most interesting is how he keeps things simple. You look at his calendar, it's pretty simple. You talk to him about a case where he thinks a business is attractive, and he knows a few basic numbers and facts about it. And [if] it gets less complicated, he feels like then it's something he'll choose to invest in. He picks the things that he's got a model of, a model that really is predictive and that's going to continue to work over a long-term period. And so his ability to boil things down, to just work on the things that really count, to think through the basics -- it's so amazing that he can do that. It's a special form of genius."

I don't know much about golf...but the reasons to invest in a business should be pretty simple:

Something like this is a great investment because the company...
  • owns dominant brands with broad distribution creating a wide economic moat and durable high returns on capital.
  • is selling at a fair price relative to its long-term prospects.
  • has competent management with a solid track record.
  • is built around a conservative capital structure.
I noted in previous posts that Buffett believes there should be little need for tricky calculations* but you need to have the patience to wait for that fair price.

Having that patience is easier said.

Coca-Cola (KO) is a good example. If someone started investing in the mid-1990's and decided KO was a good business back then...that person would not have been able to buy it at a fair price until 2006. Patience is more important than IQ. Seeing that KO was overvalued back then required 4th grade math. It was selling at over $ 80/share in 1998, was earning less than $ 1.00/share yet informed market participants were still buying. Efficient markets? Today KO is selling in the mid to high $ 40's/share and will earn $ 3.00/share this year. So it can be bought at a fair price.

By the way, that's a rock solid $ 3.00/share of earnings that will grow over time. Earnings will not always be smooth but the general direction is up. So KO tripled its earning power per share in slightly more than a decade. Some cyclical businesses** can appear to triple earnings rapidly in an economic upturn but those profits usually get crushed during a downturn. These highly variable, not necessarily durable earnings need to be normalized across a business cycle to get a true picture. Not so for the KO's of the world...that triple in earnings power is the real deal.

With its growth in earnings KO intrinsically has become much more valuable over the last ten years. It's just that the stock price has been a very poor proxy for this increase in intrinsic value.

"I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There's no penalty except opportunity lost." - Warren Buffett in Forbes


One challenge in investing is the pressure from taking a swing now, but not getting meaningful feedback for many years. Some may say that quarterly earning reports, or the stock price itself provide a scorecard, but I mostly disagree. Quarterly earnings do not tell you whether a competitor will emerge (or a substitute technology) that alters the economics of a business a decade from now. You may see some cracks emerging but that's about it. Being able to see that the moat will be there ten years out or more is what matters. The rest is distraction. At the very least, this differentiates investing from things like golf, other sports and stock speculation where the performance feedback loop is more immediate.

So investing is easier if you can figure out the long-term strength of an economic moat. Things like quarterly earnings and recessions become just noise.

I know the businesses I like. I'm buying those businesses now. If it turns out my judgment is poor on the strength of the moat, it'll be tough without a time machine to make a meaningful adjustment that improves the result.

Traders and speculators live in a different world than this. They swing at many pitches and seem to accept a lot of mistakes as long as the gains are greater than the losses. In contrast, Buffett's approach is to take less swings...make few mistakes...but do your homework until you feel confident of the outcome.

Adam

* Not much complex math is required but as Charlie says: "Anyone with an engineering frame of mind will look at [accounting standards] and want to throw up in the aisle." The deconstruction of income statements, balance sheets, and cash flow statements into something meaningful economically is a bit of an art unto itself. So you need to not only have the ability to read financial statements in your "toolbox", but develop good judgment on what the numbers actually mean.
** There are plenty of good cyclical businesses you just have to take care to normalize the earnings.
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