We get excited enough to commit a big percentage of insurance company net worth to equities only when we find (1) businesses we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively.” — Warren Buffett, 1978 Berkshire Hathaway letter to shareholders.
Buffett’s four rules for stock market success are embodied in the above statement in his letter to shareholders over 30 years ago.
If the oracle of Omaha were a Nigerian, he would have swooped on the Nigerian stock market to mop up low priced but fundamentally strong stocks which have met his four big rules for investing success.
In 1988, Coca-Cola fit into Buffett’s four criteria for a great investment. He did not take position. It took him about 10 years later before he put his four rules into practice when he invested in Coca-Cola.
The investment was a smashing success. Within 10 years, the share price of Coca-Cola appreciated so much that Buffett made huge profit in capital appreciation alone on Coke. Despite a pair of recessions since 1999, Coca-Cola stock has maintained its value in Berkshire Hathaway’s portfolio while generating billions of dollars in dividends.
Here, we have learned from the meltdown in the Nigerian Stock Exchange (NSE), which lasted between 2008 and 2012, that investors who buy stocks now at their bottom out prices will make unprecedented profit when shares rebound.
This is partly what Buffett’s four rules for stock market success teach. His first rule is buy stock in businesses that you can understand. There are surely technology start-ups you could invest in today that will crush the market in the next 10 years.
But if you are not a tech expert, how will you find them? (Remember, if you are buying a stock, someone else is selling because he sees better opportunities elsewhere).
Buffett’s point is: why bother? There are businesses out there with good prospects you can understand – if you are willing to do some homework. Sticking with what you understand gives you a leg up on a lot of investors.
Buffett’s second rule is to stick to businesses with good long-term prospects. There are plenty of companies that have a good year from time-to-time, but many of them do not have sustainable businesses. If you have any doubts that a company’s products will still be sought-after in 10 years, that is a big warning sign.
Buffett’s four rules for investing success have served him well over the past 50 years.
The third rule is to buy companies with honest, competent managers. In many businesses, good management is the difference between generating steady profit growth and lurching from crisis to crisis.
A management team with a long track record of success is likely to continue posting strong results.
Buffett’s final rule is to look for attractively priced stocks. You should be able to find plenty of companies with good long-term prospects and talented management in businesses you can understand.
If you overpay, you can still wind up with a poor result despite following the first three rules. If a business fitting the first three rules is really pricey, wait until you find another one that is cheaper!
Buffett’s rules three and four which promote buying the shares of companies with honest, competent managers and attractively priced stocks fit perfectly with most stocks on the NSE.
TheNiche has done a series of analysis on banks’ shares, some of which were at their lowest price ever by early 2012. For instance, the share price of United Bank for Africa (UBA) dropped to as low as N1.89 per share before it started trending up.
An employee in the corporate affairs department of the bank joined issues with us, advising that we bought the stock rather than write it off.
Eventually, when the market rebounded stocks appreciated so much that some returned over 500 per cent profit while others exceeded 500 per cent margin.
Anyway, nearly two years on after the rebound we can tell with precision the direction the stock market can turn from its current rock bottom.
As the saying goes, he who is down fears no fall. From their current low prices, stocks can only resume upwards movement hereafter. There is no better entry time into the stock market than now when the risk element is eroded by low price value.
Consider the shares of FBN Holding (First Bank) for instance, which traded for N6.98 per share on Wednesday, February 11, 2015. About seven months ago, the stock price stood at about N20 per share.
The stock becomes much more attractive to buy now than ever if it is realised that shareholders bought the stock for N33 per share when the bank issued its shares in initial public offer (IPO) in 2006.
In addition, the high yield potential of this stock recommends it to any investor seeking dividend paying stock with strong fundamentals. FBN is not alone in this category of stocks with impressive returns on equity (ROE).
Other stocks like those of Zenith Bank, GT Bank, Access Bank, and UBA are looking quite attractive to buy as their prices have dropped below their fair price valuation.
Access Bank has 7.8 million customers and the second largest in terms of customer base among the top three banks in the country, with one of the best income ratios, yet the stock is selling for less than N5 per share, implying that it is highly undervalued.
Therefore the price could only appreciate in the nearest future.
For the nine months up to September 30, 2014, the bank’s ROE rose 15.7 per cent, just as asset quality rose 2.5 per cent. Different performance indices are trending upwards.
In terms of capital adequacy ratio, return on equity, non-performing loans ratio, the bank is top three in the industry. As profitable as Access Bank is, the share price is too low.
Imagine buying the shares of FBN Holdings at N6.97 per share, and Access Bank at about N5 per share, and the prices hit N15 per share in three months’ time or thereabout.
Also consider buying the shares of Seplat Petroleum, which sold at N576 per share during its IPO and later appreciated to about N650 per share. Today, the bluechip stock is traded for over N370 per share despite its strong fundamentals.
The number of these lowly priced stocks are many and could make an investor suddenly rich.
If you stake N1 million on these lowly priced stocks with high returns on equity, the chances are high that you may become another Warren Buffett.