With Enough Insider Information and a Million Dollars, You Can Go Broke in a Year

What you require for fruitful investment results is not insider information, nor a large initial corpus, is the clear message of the title, which is one of the many golden quotations of Warren Buffett.

Many believe, that in order to make riches on the stock market, one needs to have access to insider information or prior information of significant happenings in a company’s affairs.  Yes it is true that many have made large sums in this way, out of short-term fluctuations in the share price.  A number of people have gone to jail too, as it is a crime to use such privileged information for personal gain.  Recent confinement of “Rajat Gupta”, a renowned banker of Indian origin, in the United States is a perfect example.

The second important facet about insider information is, that it is useless for successful, long-term investment.  It is useful only for speculating, which is not investing at all, and this blog is meant only for long-term investors and clearly not meant for speculators.

Buffett is also trying to warn common investors about the inherent dangers associated with the approach, as only a select few, who work on the boards of listed companies or top level advisors will have access to such key and sensitive information and what percolates down to the layman is mostly junk in the form of Tips from brokers, which is a sure way to losses.

Having read this article, I hope you would have certainly realized veracity of the quote “with enough insider information and a million dollars, you can go broke in a year”.

It is Far Better to Buy A Wonderful Company at a Fair Price than a Fair Company at Wonderful Price

When Warren Buffett said, “It is far better to buy a wonderful company at a fair price than a fair company at wonderful price”, he is clearly stating that the investor should only buy excellent companies’ shares and pay a reasonable price for them. 

So there are two distinct caveats in his advice – Excellent Company and Reasonable Price.

What is an Excellent Company?  Buffett has given ample clarity.  It should not only have had a long and successful existence, but should also be capable of thriving for a long time in future, and its products or business should be such that people will need them for foreseeable future. Mere longevity is insufficient, the business should have been profitable for a long time into the future and should be capable of generating profits and “”Free Cash Flows” well into foreseeable future.  The company should stick to its core business, never or insignificantly borrow, and shall possess the culture of rewarding the shareholders with handsome, regular and uninterrupted dividends.  Let us take the example of Gillette.   It produces excellent razors.  One can never foresee a replacement for razors or people not needing a shave, thus endowing permanence to the company’s business.  Thus, Gillette satisfies all the qualifications of an “Excellent Company”.

Now let us examine the price element.  We should not pay a fancy or unrealistic price.  If we do so the “Return On Investment” or “ROI” for the money we have invested will be poor.  However, this is easier said than done.  Today, on 7^th July 2016, Gillette India Ltd. Shares are trading at an unrealistic, “Price-to-Earnings” or “PE” multiple of 63.76 as against the acceptable 10, and a “Price-to-Book Value” or “P2BV” of 20.44 as against the recommended 1.5.  Under such impractical market conditions what can we do? 

No reason to despair.  One can always find a handful of excellent companies whom the market is disfavoring at that time.  We should invest in those companies.  We should also make a list of the other excellent companies but which are expensive.  We should revisit them during large market crashes like the post “Lehman Brothers”.  My own experience shows that even during such extremely depressing times, companies like Gillette will not be available at the idealistic PE of 10 and P2BV of 1.5.  You may find them at a PE of 25 and a P2BV of five to ten, at that time you should BUY.  If you hesitate, you will never get the opportunity to own such companies.  I had vacillated, and let me admit, I do not own any of these good companies.

On the other hand, when people buy shares based on “Tips”, usually given by brokers and the So-Called-Experts, they end up doing the opposite of what Warren Buffett has warned, Buying Fair Companies At Wonderful Price, instead of Wonderful companies At Fair Price.