I started this process quite some time ago. Early on I noticed that there were at least two types of successful investors. One group possessed an uncanny sense of market timing and often took tremendous risks jumping in and out of investments. Clearly this group was focused on how much money they could make from a particular investment. Even as a teenager I knew that if my investment returns were based on my market timing and predictions about the future, my capital would be at risk.
“Rule number 1 is not to loose money...
Rule number 2 is not to forget rule number 1.” -- Warren Buffett
The second group of investors seemed to approach each investment from the perspective of how much money they were likely to loose, if they were wrong about the investing thesis. This approach represents a tremendous departure from the investors in group one. So I quickly decided that I would prefer to study and learn from the investors in the second group. Investors in this group include Warren Buffett, Charlie Munger, Donald Yachtman, Ray Dalio, Joel Greenblatt, etc.
As I dug into the track records and holdings of investors within this group I immediately noticed something distinctive. They all had large holdings in many of the companies that I would consider large household brand companies like Coca-Cola, Pepsi, Proctor and Gamble, General Mills, etc. That got me thinking as to why they might be invested that way. I'm sure some of my readers are pointing out that these investors control a large amount of capital and therefore need to invest it in the largest, most liquid companies.
That is partially true and Mr. Buffett says as much when he mentions that he could generate a higher percentage return if he had less money to invest. If they were invested this way strictly as a result of the amount of their capital, they probably would buy a larger pool of corporate behemoths or maybe have a core holding in a market-wide ETF. I believed, however, that there was something unique about these businesses.
Then one day it hit me. These companies sold products that people bought year in and year out. They also had the pricing power to pass along higher costs to customers. If the value of a company is the earnings that company produces over its lifetime, then consistent and growing earnings would be ideal. In recessions and in boom times consumers will still buy breakfast cereal, soda, and razor blades. Then I took a look at the earnings per share (EPS) and free cash flow per share (FCF) for the group. For the most part their business results proved out my theory. Proctor and Gamble has struggled over the past few years, but look at the EPS and FCF results from Pepsi and General Mills.
Incredibly consistent, aren't they? Both companies came through the credit crisis and great recession practically unscathed. This is tremendous and speaks to the resiliency of these businesses. Assuming you don't overpay for the businesses, how much money are you likely to loose on companies like these? While companies in more cyclical sectors were worried about falling sales and potentially going bankrupt, this group was trimming a few costs and conducting business as usual. These are the type of businesses I want to own, and clearly the investing legends above feel the same way.
Disclaimer: I own stock in the KO and PG. I may add PEP and GIS to my profolio in the near future. The discussion above in for informational purposes only and should not be considered a recommendation to buy, sell, or hold stock in any company.