Newsletter February 18, 2012
InvestorsFriend Inc. Newsletter February 18, 2012
Investment Performance this new year.
Stocks are off to a roaring start in in 2012. The Dow is up 6.0% since January 1, the Toronto Stock index is up 4.2% and the S&P 500 is up 8.0%. Our six Strong Buys are up an average of 9.0%. My own portfolio is up 6.1%.
The Definition of Investing
Warren Buffett gave a definition of investing in a Fortune magazine article this month. Warren Buffett said “investing is forgoing consumption now in order to have the ability to consume more at a later date”. This article, like anything that Buffett writes, is a must-read for serious investors.
I like his definition of investing. Actually I applied the same thinking in my article back in 2001 about whether people should invest some money rather than spend it all. I described investing in terms of the choice between eating all your potatoes now as opposed to cutting some up and planting them so as to eat more potatoes next year.
The Wonders of Compound Interest and Returns
Albert Einstein said that the most powerful force in the universe is compound interest.
Consider if you will, the following fundamental truths about compound interest and compound growth:
If any thing, no matter how small it is today, grows annually and forever at a rate larger than the growth of some other thing that today is vastly larger, then eventually the small thing must surpass the larger thing in size.
Ponder the implications of this.
A single dollar growing at 15% will surpass a hundred thousand dollars growing at 1% after 90 years. And it will surpass a million dollars growing at 1% after 108 years.
Yes, that is a long time, but in the history of man it is nothing.
A single dollar if it can be grown at 20% per year will surpass a million that is not growing in 77 years. Perhaps of more interest, $1000 growing at 20% annually will surpass a million that is not growing in 40 years. And $10,000 growing at 20% reaches a million in 26 years and it reaches 10 million in 38 years.
For a real life example, $1000 invested in Berkshire Hathaway in 1965 when the shares were $15 is worth $7.9 million today, 47 years later, with Berkshire trading at about $119,000. The compounded return has been about 21% per year.
You can understand why compound growth is a great worry to the likes of David Suzuki. It’s a fact, if the human population grows at even a very slow rate then there WILL eventually come a time when we would occupy every square foot of the planet.
No company can forever grow faster than the growth in the overall economy since it would eventually be larger than the entire economy — an impossibility since it is a part of the economy.
No invested pot of money can forever grow faster than the entire economy since it would eventually be larger than the entire economy — an impossibility.
It would be impossible for a majority of the population to grow wealth at a rate faster than the overall rate of growth of wealth in the entire world. Obviously, only a minority of the population can ever grow their wealth at a rate faster than average.
My Personal Experience in Compounding Wealth
Back in 1989, I was 29 years old and my financial net worth was just below zero (given that I had little equity in my house or even my car and given a modest student loan and almost no savings). But, not to worry, I was highly educated and was several years into my career by then. It was in 1989 that I started to think more about investing. I read one of those books (Common Sense by A.L. Williams) that showed how much you can grow your money if you get a reasonable return, but that the real key was starting young.
Well it was too late for me to start investing at age 20, but I did the next best thing and started investing in the stock market at age 29. At first in mutual funds and later in individual stocks.
It’s worked out pretty well. I have tracked the figures meticulously over the years. Using my average annual returns for each year, I calculate the following.
The $2000 that I invested in 1989 is now $24,282. Perhaps surprisingly, it “only” took an annual compounded return of 11.5% to get there. The power of time and compounding is illustrated if you consider the fact that if I now achieve an 8.3% return on this $24,282, that is $2000 or another 100% on the original investment.
The $7500 that I invested in 1990 is now worth $83,349. (I borrowed the money for a large RRSP catch-up contribution, and I have not deducted the interest paid here, but clearly this was a great investment even after paying the interest on the loan). Following this I had several years of not investing at all but most years I did invest.
Turning to more recent years, the $4,884 that I invested in 1999 is now worth $22,477. The $11,105 that I invested in 2006 is now worth $19,267.
And, yes, I did have some negative years. I lost about 8% in each of 1998 and 2002 and I lost 23% in 2008. In all other years since 1989, I made money.
When it comes to compound returns and investing for long periods of time, I can attest that it has worked for me.
Some readers will protest that they don’t necessarily have 23 more years to live or that they simply are not prepared to wait that long.
Well, most readers will still be around in 23 years and those years will go by whether they invest or not. But some will not invest and some will be net borrowers. And ultimately those of us who can invest can only do so if some of you are net borrowers or corporate users of investor’s money. And if you think that’s not fair, consider that no one could borrow unless others saved and invested.
In 2007, I wrote in detail about compound returns and how you could use them to plan to get rich (rather than merely hope).
Do You Know Anyone Who is Rich, And do you know how they got that way?
I believe I read in his autobiography that Benjamin Franklin used to have some kind of regular social club meetings and that a standing order of business was to discuss the question “Do You Know Anyone Who’s Rich, and do you know how they got that way?”
Well that was over 200 years ago but I think that is still a useful question. I suspect most people around us who are rich got that way through owning businesses of one type or another. Most of us are not in a position to own and operate a business, but we can certainly own our share of businesses through owning stocks.
Last year I wrote an article that compared owning a business to owning shares in a business.
If you have interesting information on someone who is rich and how they got that way, I’d be interested in hearing about it at firstname.lastname@example.org
People everywhere tend to want the same things
I’ve recently had the opportunity to do some traveling. And, of course, I like to observe a bit about shops and restaurants that are doing well in the areas that I visit.
In North America we tend to have plenty of national chains of stores, restaurants and Hotels. In many ways that takes away from the uniqueness of our towns and Cities. But it’s a fact, from Miami Florida to Anchorage Alaska or from Los Angeles to St. John’s Newfoundland, we like our Starbucks and our Holiday Inns and our McDonalds and our Coke. In Canada we have blanketed the country with Tim Hortons and Canadian Tire stores and also with Walmarts and Staples and Costcos and Starbucks.
When I was in Europe (London, Paris, Lucerne, Florence, Venice and Rome) in 2010, I certainly saw lots of Starbucks, McDonald’s and Coke. In Paris some of the more popular stores were brand names that also exist in New York and I suppose most other large cities in the world.
On a Caribbean cruise last month I saw Subway sandwich shops and McDonalds. Tiny St. Thomas which as I recall is not larger than about 3 miles by 20 miles was crowded with cars. The cars were not tiny either, instead they were the same size as in North America. Cell phones were everywhere. It may be sad, but the stores that I bought something in included Tommy Hilfiger and Guess, although I did buy a few small things from local shops as well.
I just heard today that China is the second biggest television market for the NBA.
My conclusion is that people everywhere tend to want the same things. We are just not that different. The consumer society will continue to spread around the globe. And I think that is a very good thing. (I mean is it fair that anyone live in squalor or in some primitive village while most in North America sip lattes?).
This has implications for investing as well. Warren Buffett concluded decades ago that big consumer brand names could be great investments. He invested heavily in American Express, McDonald’s, Coke, Dairy Queen and Gillette among others. He also invested in smaller brand names like See’s Candies, Benjamin Moore’s, World Book Encyclopedia, Pampered Chef, Kirby Vacuums, and many more. In a world that is going to continue to globalize, “consumerize” and standardize, the future is very bright for the best brand names in this world.
This year with the Arab Spring, we also saw that people everywhere want democracy and self determination. Perhaps there is hope that world wide consumerism can basically help us all live in harmony. And what is consumerism other than wanting to get more out of life? I see nothing wrong with that.
And if you think too much consumption is wrong, consider that investors must FORGO consumption today in order to save and grow their wealth. In the end investors have the right to consume more in future, but a lot of times they never spend much of their wealth. Investors as a class of people have nothing to apologize for.
Shawn Allen, President
To see older editions of this newsletter, or to get off of this email list , click here.