When I say "stock," what comes to mind?
If it's one that you own, do you think of a chart that is hopefully moving upwards? If it's one you're thinking about owning, do you think about how a few important numbers and metrics stack up against those of its peers?
One of the greatest investors of all time -- the one and only Warren Buffett -- looks at stocks in a way that is easy to understand yet incredibly hard to manage. But his strategy is one we should all remember when we think about the stocks we own and the ones we're thinking about investing in.
The simple wisdom
When Buffett discusses the progress of Berkshire Hathaway's (NYSE:BRK-A)(NYSE:BRK-B) four biggest individual stock holdings -- Wells Fargo, Coca-Cola, American Express, and IBM -- in his latest annual letter to shareholders, at no point does he mention their price.
Instead, he speaks of two critical things: Berkshire's ownership stake in the companies themselves and how much of their bottom-line earnings are actually available to Berkshire because of that stake.
Berkshire Hathaway's ownership of each of the big four has grown over the last few years thanks to its purchase of larger positions in Wells Fargo and IBM plus the share repurchase efforts of the management teams at Coca-Cola and American Express.
Although those slight increases in ownership may not raise any eyebrows, dominate headlines, or even inspire a Tweet, consider Buffett's own words:
If you think tenths of a percent aren't important, ponder this math: For the four companies in aggregate, each increase of one-tenth of a percent in our share of their equity raises Berkshire's share of their annual earnings by $50 million.
And that brings us to our second point: It isn't just the ownership stake that matters, but the actual results of the company that is owned. Buffett went on to say:
The four companies possess excellent businesses and are run by managers who are both talented and shareholder-oriented. At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business; it's better to have a partial interest in the Hope diamond than to own all of a rhinestone.
As a result of both increased ownership and the continued success of Buffett's "Big Four," the portion of earnings available to Berkshire -- although only the dividends paid out show up on its financial statements -- has grown dramatically since 2011:
But this growth is nothing new. In his 2011 letter to shareholders, Buffett said:
We expect the combined earnings of the four -- and their dividends as well -- to increase in 2012 and, for that matter, almost every year for a long time to come. A decade from now, our current holdings of the four companies might well account for earnings of $7 billion, of which $2 billion in dividends would come to us.
And while the earnings growth of the Big Four may not continue at its recent pace of more than 15% annually, $7 billion may even be a dramatic understatement.
The key takeaway
As Buffett's famed mentor Benjamin Graham said in his seminal book The Intelligent Investor: "Investment is most intelligent when it is most businesslike."
Ultimately, intelligent investors mustn't view stocks as numbers on screens or charts moving up and down, but as businesses. We must largely ignore movements in stock prices and evaluate the fundamental business dynamics, knowing that over time stock prices will reflect changes in underlying fundamentals and the results of the business.
For example, since Chipotle (NYSE:CMG) went public on Jan. 26, 2006, its stock has moved up or down by 5% roughly once every four weeks, or 132 times. But those investors who have patiently waited, ignoring the price gyrations and trusting in the company's hugely successful business, would have seen a $1,000 investment grow to nearly $14,000 at the time of writing.
Examples like this show why Buffett once remarked, "The stock market is designed to transfer money from the active to the patient."
Does this mean you should simply pour money into great businesses? No, because, as Buffett has also said, "A business with terrific economics can be a bad investment if the price paid is excessive."
But we must see that whenever we make an investment, we must always consider it part-ownership in a company, not simply a stock. Buffett does, and so should you and I.