What? What is the secret ingredient? Is it superior intelligence? Superior knowledge about accounting and business? Helpful, yes. But they aren't the single most important element for truly superior investors. It is innate in some people, but it also can be learned.
It is simple: To be a great investor, you must have discipline.
Warren Buffett is disciplined. He has a circle of competence, and refused to deviate from it even when the market told him year after year in the late 1990's that he was wrong to avoid technology stocks. Wanna know how he stomached Berkshire Hathaway's (NYSE: BRKa ) underperformance to the tech-heavy Nasdaq in 1998 and 1999? It's simple. He didn't worry about it at all.
The man was called "out of touch," and "past his prime." A Robertson Stephens analyst named Paul Johnson sent an open letter to Buffett, trying to convince him that his investment in Coca-Cola (NYSE: KO ) -- which has earned billions for Berkshire since Buffett bought it -- was nothing compared to the returns he could expect from Cisco (Nasdaq: CSCO ) .
In these years, Berkshire stock tanked, having lost, from peak to trough, more than 50% of its market price. Buffett never lifted a finger to "defend" the company's stock price, because he knew that, as sure as the sun will come up tomorrow, eventually Berkshire's stock would reflect its true value.
Buffett has famously said that he could return 50% per year if he were working with a smaller amount of money, by focusing on mispriced situations with small-cap stocks. We're not talking about chasing the momentum plays like Travelzoo (Nasdaq: TZOO ) or Dialysis Corp. of America (Nasdaq: DCAI ) , which giveth until they taketh away, sometimes in cruel fashion. We're talking about potential Hidden Gems, companies that the market ignores: Denny's (Nasdaq: DENN ) at less than a buck, Middleby (Nasdaq: MIDD ) during its restructuring.
The problem with small caps is that with the opportunity of outsized gains comes the potential (and the occasional promise) of large losses. That's where the discipline comes in. If you can stomach the fact that you will make good decisions but the market will routinely disagree in the short term, you can make a lot of money. The key is not minding the disagreement and, in fact, viewing it as an opportunity.
Bill Mann is the guest analyst for Hidden Gems in a titanic duel with Tom Gardner. Come see what they're cooking up now! Afree 30-day trialis yours for the asking.
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