Thursday, October 28, 2010

Basic investing lessons from John D. Rockefeller

I remember watching an interesting documentary about the Rockefellers quite some time ago. From watching the documentary and from what little reading I did on the subject of John D. Rockefeller, I managed to identify a few basic investing lessons. Most of us probably already know these lessons, but they are, nonetheless, still very important. Here are the lessons I think I learned from John D. Rockefeller, one of the richest man in history:

Maintain ample liquidity

Rockefeller understood the importance of maintaining ample liquidity from a young age, as his father would sometimes just call a loan that he made out to John.

We might not have a dad that’s out to cheat us or suddenly ask us to pay back some money that he lent us, but maintaining ample liquidity is still, obviously, very important. If we have liquidity, we can make investments when the market panics (as John D. Rockefeller once said,” The way to make money is to buy when blood is running in the streets.”) and we wouldn’t be put in situations where we need to sell our investments in case something unexpected happens.

We should also look for companies that have enough cash on their balance sheets, as this will allow them to keep their operations running in economic downturns without taking on debt or issuing new shares and create shareholder value by acquiring assets on the cheap.

Frugality

Rockefeller is a great believer in frugality and even recorded all of his expenses in a ledger. I think that I read at Wikipedia that Rockefeller actually took the train to work when he was already a very wealthy man.

While it’s ok if we don’t actually have a book or an excel document where we record our daily expenses, we should adopt frugality and at least have a budget and measure our spending against our budgets. The less we spend, the more money we have to invest; after you amass a certain amount of money, it becomes much easier to make more money, and the best option for a lot of people to reach their first $100,000 or whatever is to spend less and invest more. We should measure our spending against our budget as there can generally only be improvements if the thing you want to improve on is measured.    

Avoid serious risks

Instead of following the crowd and trying his luck at digging up oil wells, Rockefeller went into the oil refinery business where the risks are lower and the returns more stable.

We can avoid serious risks by not investing in companies (no matter how cheap they might be) that have been consistently racking up losses (with no end to the losses in sight), have lots of debt, and have no competitive advantage whatsoever. Serious risks can also take the form of derivatives, special purpose vehicles, and risky and potentially toxic assets, and we must be vigilant in identifying these risks when analyzing a company’s annual reports.

Buy and hold

Rockefeller became one of the richest men in history because he hardly sold the shares he owned in his company, letting a great investment just compound over many, many years.
If we find an investment that we think can sustain great returns over the long-term, we should bet big, reinvest any dividends, and never sell (as long as the fundamentals remain intact). Let the power of compounding work for you; investors can get rich just by holding average investments and letting them compound for long periods of time. So, needless to say, investors can become incredibly wealthy if they find a few above average investments to hold for the long-term.

An investment that generates a 20% return annually, and reinvests those returns at the same rate, will multiply its value by about 6 times in 10 years, and by about 38 times in 20 years. True, it’s incredibly difficult to find stocks or companies like these, but investors will still do well holding investments that generate average returns.

An investor will also most likely underperform the market over the long-term if he or she is constantly buying and selling, as the commissions the investor pays will, obviously, eat into his or her returns.

Competitive advantage

Rockefeller’s company had a great competitive advantage, a monopoly of the refined oil market. This competitive advantage obviously played a huge part in allowing him to amass one of the greatest fortunes in history.

While there might hardly be any monopolies we can invest in (at least in developed markets), we should generally only invest in companies with good competitive advantages, as a competitive advantage is probably the only thing that will enable a company to keep growing and creating value for its shareholders. Competitive advantages can come in many forms: Great management and employees, being the low-cost producer, and having a product that has become the de facto standard are just some of them.


If you have any questions, or have anything that you would like to share please feel free to comment. Thank you for reading, and may you always sustain good returns on your portfolio. Take care.