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Thursday, September 21, 2006
Suppose you were building a house.
Wouldn't it be great if you could build the foundation... and have the foundation automatically build the floors? And have the floors spontaneously generate the walls? And have the walls automatically grow the roof?
Once you laid the foundation, your only remaining job would be to do nothing...to sit and wait for the house to finish building itself.
The dream of a foundation that builds a house is a perfect description of what happens when you harness the greatest wealth-building power there is...a power that Albert Einstein called, "the greatest mathematical discovery of all time."
Einstein was talking about the power of compounding.
If you want to know how Warren Buffett turned $105,000 into a $40+ billion fortune, the answer is compounding.
Buffett's fortune has compounded at an average annual rate of 21.5% a year since 1965—an unparalleled achievement in the investment world. All he did was decide ahead of time what were the best companies in the world. Then he waited until their stock prices fell because of a market collapse or a scandal. Then he bought. The rest, as they say, is history.
Time and compounding did all the rest of the work. Buffett was wise enough – and as an investor, passive enough – to let compounding do its work. As he once said, "I make money while I sleep."
Most people with small amounts of money to invest think they need to double their money every year to become wealthy. So they take big risks. This usually causes them to take big losses. Big losses cut into their available investment capital...and the effects of compounding are weakened.
Some small investors think it's necessary to win lottery-like returns, making thousands or hundreds of thousands or even millions for each dollar invested.
But that's simply not true. If you start today with $10,000 and average 20% a year for 20 years, you'll have over $380,000. Add $2,000 a year to the pot, and you'll wind up with $756,751 after 20 years. Granted, 20% a year is not easy to achieve. But even if you only make 10% a year, you're still going to become very wealthy over the long term.
So here’s how you double your money every year:
Buy a high quality business or asset at the moment of greatest pessimism and hold it for the long term.
That's what Warren Buffett has done his whole career. That's why he says his favorite holding period is forever. For just one example, though Buffett’s Coke shares have lost about half their value since their 1998 peak, Buffett would be a fool to sell them now...or ever.
According to David Clark and Mary Buffett’s book, Buffettology, Warren Buffett bought Coke shares twice: once in 1988 for $5.22 per share and again in 1994 for $21.95 a share.
For every $5.22 share Buffett bought in 1988, he now owns 8 shares, due to three 2:1 stock splits. The shares sell at around $44.36 today. So, for every $5.22 he spent back then, he now owns eight shares worth a total of $352.
That’s great, but it’s not the whole story. For every $5.22 invested in 1988, Buffett now earns about $9.92 in dividends – every year, no matter what happens to the price of his stock. That's a dividend yield of 190%, nearly tripling Buffett's original purchase price, every single year. Sure, those were 1988 dollars, and these are 2006 dollars, but the capital gains have left inflation far, far behind. The dividends are gravy—oceans of it.
Don't let the stock splits confuse you. They don't change anything. Coke has a great business, and it has raised its dividend consistently.
At today's prices (a P/E of 21 today), I’m not inclined to be a buyer...though perhaps I should be more interested. If the next 18 years hold anything like the last 18 for Coke shareholders, the stock is clearly a screaming buy today. In fact, when Buffett paid $21.95 for Coke shares in 1994, his initial rate of return was about 4.5%, based on the earnings per share and the share price. Today, the initial rate of return would be slightly higher than that, at about 4.85%.
I leave it to you to decide if Coke is a buy. At just 15.1 times pretax earnings, it’s definitely worth a look.
So the “How to” I promised in my title is simple, but perhaps not easy for the average impatient investor. You merely have to exercise a capacity that almost no investor is willing to use in a world where almost no one really thinks long term anymore: patience.
Buffett's strategy and his stellar results jibe perfectly with the great tax advantages of being a buy-and-hold investor. You can wind up with several times the amount of wealth on a safe, cheap investment, simply by never selling.
Correction: In yesterday's DailyWealth we listed the contact number for Van Simmons as 800-795-7575. Van’s contact number should have been noted as 800-759-7575.
MILITARY COUP IN THAILAND
There was a military coup in Thailand on Tuesday. The coup was bloodless. The Prime Minister was out of the country and didn’t put up any resistance. Thailand’s monarchy endorsed the military action last night and appointed General Sondhi to head of the council.
The General stated there would be a democratic election in Thailand by October 2007.
Last week, we produced a list of the world’s cheapest stock markets in Datastream using two methods.
Thailand was at the bottom of both lists. Its p/e ratio is 7. When we compared this valuation to Thailand’s historical average p/e ratio, we found a 46.5% discount to the median.
CLSA is large investment bank and brokerage firm specializing in the Asia-Pacific market. Yesterday they sent out an analysis of the situation in Thailand:
“The overwhelming probability is that this provides a tactical buying opportunity in Asia’s cheapest market, though it would help if the Thai authorities opened the market,” the report concluded.
On Tuesday, news of the coup pushed the Thai Fund (TTF) down 7% before the market recovered to a 4.4% loss on the day.
Thai Stocks versus Asia Stocks: