The #1 Rule To Follow For Successful Long Term Investing

November 14, 2017

The #1 Rule To Follow For Successful Long Term Investing

  • Investing is full of trends and fads. Are you sure you want to be part of them?
  • One extremely simple rule can make a huge difference in your investing life.
  • I’ll conclude today’s article with the second most important thing for investors to remember.


The current investing trend assumes that stocks will only go up and that passive index investing is the best. Valuations keep getting higher, companies keep piling on the debt and doing expensive buybacks, and no one cares because the only important thing is that stocks continue to rise.

Now, I know that by thinking otherwise I won’t be getting a huge fanbase, but I can’t help myself. I like to look at what has worked historically in order to limit my risks and reach healthy, sustainable returns. And who better to learn this from than Warren Buffett and his performance with Berkshire Hathaway (NYSE: BRK.A, BRK.B)?

If you open any annual report from BRK, the first page will show its performance since present management took over, but not the stock’s performance.

Figure 1: BRK’s performance in the last 52 years. Source: BRK.

The first column on the first page of BRK’s annual report reviews the change in book value that the company delivered in the given year. Why do you think Warren Buffet has been showing the change in the book value as the first thing on his annual reports? Because it’s the most important metric for an investor.

The change in book value, plus any dividends, is the ultimate measure of performance and also the most precise indicator of the intrinsic value that has been created during the year. With the exception of equity capital raises like Tesla (NASDAQ: TSLA) has been doing, nothing can fool book value. So I feel pretty confident when I say that the change in book value is the ultimate metric investors should follow.

If you look back at Buffett’s favorite table, you can see how the stock market performance is in line with the increases in the book value in the long term. Buffett has been increasing book value at 19% per year over the last 52 years while the stock has achieved 20.8% over the same period. The 1.8% yearly over-performance means the stock is overvalued, but what stock isn’t overvalued in the current market? The difference is thanks to the recent increase in valuations.

The Problem With Book Value

The main problem related to looking at the change in book value is that nobody cares about it right now.

As I’ve already mentioned, right now the focus in on buybacks, taking on as much debt as possible, and not so much on long term value creation. This situation reminds me of all of the bubbles of the past that have imploded on debt and no hard assets or any kind of value creation.

Stephen Letwin, the CEO of I AM GOLD (NYSE: IAG), just wonderfully described how such behavior usually isn’t the fastest way to trouble but is a sure way to get there. He described his experience when he worked for North America’s largest oil and gas business, Dome Petroleum, which went bust due to too much debt when oil prices collapsed, he also described what went on at Enron and how the greed and debt led to what happened, and also described how the craze about gold going into 2011 was unsustainable as no one was interested in operating costs or return on investments but rather only on how much gold ounces a company could add to its production.

From my perspective, a similar situation is surrounding current markets. If you mention book value to people, they’ll laugh in your face as it’s mostly about how many users a company has, the future potential in disrupting the world, and how to pump current earnings higher through buybacks. Such an attitude works well until something in the system changes. What would change the whole environment is interest rates and I mentioned how inflation is moving in yesterday’s article.

So if you want to be invested and feel protected if something changes in the financial environment we live in, focus on book value and shareholder value creation. It isn’t for nothing that Buffett shows it on the first column on the first page of his annual report.

Think Like A Business Owner

Focusing on book value makes you think like a business owner. You don’t care about what goes on in the market, but focus on what goes on in the businesses you own and whether or not they are creating value for you. I understand it’s extremely tempting to focus on what’s going on in the markets because it’s exciting to look at stock prices, but that doesn’t have too much to do with investing and I wonder whether people will still look at stock prices with such excitement the next time the S&P 500 drops 50% or more.

The only time you have to look at the stock price is when you are buying to see how much below book value the price is, because why shouldn’t you take advantage of the irrational investors who populate financial markets?

If you look at how the book value growth (in blue) of BRK has been stable over the past 52 years while the stock price has been extremely volatile, you get the advantage that those who focus on book value have over the rest of the market in the long term.

Figure 2: Changes in book value and stock market price for BRK per year. Source: BRK, author’s charting.

So it is up to you. Do you want to follow the rest of the crowd or do you want to invest for the long term, sleep well at night, and know that what you are doing will lead you to your investing goals?

I’ll just finish up with something that may change your perspective. Our average life expectancy isn’t pushing 80, it’s becoming more and more probable that you’ll live well-beyond 80, 90, or maybe even reach 100.

This means that if you are reading this and you are 20, you still have up to 80 investing years ahead of you. If you are 50, you still have another 50 more years. Or if you are 70 and optimistic, you still have 30 years to invest. Considering this, really think about whether your current investing strategy can be sustained over the next half a century. If not, focus on book value and long-term shareholder value creation.

Figure 3: Average life expectancy. Source: Population.

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