During the height of his career, Albert Einstein was in the middle of hearing his notes dictated to him by his secretary when he stopped and asked her, "Did I really write that? I could have put that so much simpler."
Just as Einstein was able to simplify even the most complex concepts, the world's top investors have a knack for focusing on the two or three big factors that lead to a successful investment, ignoring the meaningless noise of millions of other factors.
So many numbers, so little comprehension
It can be easy to get lost in the complex world of investing. There are so many things you can pay attention to: quarterly earnings releases, economic forecasts, stock price movements, interest rate changes, buyout rumors, etc. You could spend all day focusing on the nitty-gritty details ... and quickly drive yourself nuts.
Yet some of the world's greatest investors have achieved success with ideas that are as simple as pumpkin pie. In a recent interview on Fox Business Chanel, Warren Buffett explained how he spends most of his day, saying "I've got something that's fairly simple that works for me. And that's to sit down and look at hundreds of companies and try to figure out if a company is worth X and I can buy it at half of X in the market."
That's it. No mind-bending formulas, no complicated market timing, no tick-by-tick news updates. Sounds to me like a formula for less stress and, possibly, lots of money. Let's see how it's done.
Success is simple
Peter Lynch once recommended that investors should have a simple investment thesis, called the two-minute drill. The idea was that if you couldn't summarize why you're investing in a company in just a few sentences, you are probably looking at too much information. You should be able to say something like "I'm investing in X because it's the industry leader and it's selling for 8x earnings. It owns 50% of company Z, which contributes 90% of the market cap. I'm getting all the rest of the business for just 10% of the total market cap and that business generates Y profit each year." You might have 20 more pages of detailed due diligence, but boiling it down like that helps you focus on the important stuff.
Profiting from simplicity
Here's an example of just that. Back in 2003, hedge fund manager Mohnish Pabrai began purchasing shares in oil-tanker company Frontline (NYSE:FRO). At the time, oil shipping rates had plunged to $5,000 per day due to low oil prices. Frontline needed to charge $18,000 per day to stay afloat. Fearing the worst, investors panicked and fled the stock in herds.
While other investors were worried about what the future price of oil would be -- a key determinate in oil-tanker pricing -- Pabrai took a simplified view and focused his attention on a clear-as-day factor largely ignored by others.
His two-minute drill might have read something like, "Here's a company that has to charge a large dayrate, which at the moment is difficult. However, the scrap metal value of the tankers is worth significantly more than the current price of the stock. If oil prices come back up, and Frontline can survive until then, this company currently selling for less than the scrap value of its assets should be a good investment. At worst, we'll get a smaller return if the company does have to scrap things."
Pabrai wasn't certain what the future price of oil would be. He didn't know exactly where shipping rates were heading in the near future. What he did know was quite simple: Regardless of unknown factors, Frontline was undoubtedly worth more than the share price based on scrap metal value alone. Investors who kept it simple this way ended up making as much as 20 times their money in two years. Simplicity at its finest.
The master in two minutes
Berkshire Hathaway's (NYSE:BRK-A) (NYSE:BRK-B) purchase of Washington Post (NYSE:WPO) stock in 1973 turned out to be one of Buffett's best ideas ever, and it too was painfully simple. The short summary of why Buffett invested wasn't hard to understand. The Post owned a collection of wonderful businesses, was managed by the best in the industry, and was selling at a fraction what it would be worth in a fire sale. His original $10 million investment is now worth well over a billion dollars. End of story.
In recent months, Buffett has been gobbling up railroad stocks such as Burlington Northern (NYSE:BNI), Union Pacific (NYSE:UNP) and Norfolk Southern (NYSE:NSC). What might his two-minute drill look like for these companies? Rather than focusing on complicated details, Buffett probably drilled down to something like, "The railroads have gained an edge over trucks in the past several years. There are high barriers to entry and, as the price of oil continues to rise, their advantages should get better." Less time worrying, more time for bridge.
Nobody can handle understanding every variable that surrounds a company. Thankfully, you don't have to. Focus on the few important factors that will lead to a successful investment and ignore the rest. The more complicated your investment idea is, the more likely it will fail to come true. Keep it simple, Fool!
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