Every day in the stock market, tens of thousands of individuals and institutions set out to try and make money. Every one of these stakeholders has different levels of information on different stocks, and some rely on intelligence (IQ) to try and gain an edge over the competition. Others rely on algorithms or faster computers, although Wall Street is engaged in a constant arms race where the next development in technology or financial insight is never far away.
The overriding goal of these strategies is to gain an edge over the competition - to know something others do not, and leverage it as much as possible for success. That is the only way to get ahead in investing.
Finding an edge
Every investor has to find their edge if they want to be successful. If they don't, or they don't have one, then a better solution may be to stay out of the game altogether. That is a different argument for a different day.
Finding an edge is not as easy as it first appears. As I noted above, Wall Street is engaged in a constant arms race for success. Institutions and investors are fighting each other all the time to try and get the upper hand.
With this battle going on in the background, some devoted value investors have extracted excess profits from the market by focusing on unglamorous securities. The most famous of these investors is, of course, Warren Buffett (Trades, Portfolio). For the past seven decades, he has specialized in finding value where other investors are not looking. As such, he is highly skilled in the art of finding and profiting from hidden value.
Around 20 years ago, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) made a significant investment in PetroChina. At the time of the deal, Buffett had spotted that the company, one of the largest oil producers in the world, was trading at a significant discount to its international competitors. The group was also promising massive dividend payouts and had a relatively clean balance sheet. Buffett was able to purchase a large block of stock in the company at an attractive price.
The right temperament
Discussing the PetroChina situation several years later at the 2004 annual meeting of Berkshire shareholders, Buffett said that he did not need any "blinding insights" or a "high IQ" to find an operation like PetroChina. He had discovered the investment by reading through annual reports and comparing the company to its peers in the global hydrocarbon sector.
The most important quality required for finding these sorts of opportunities, he explained, was temperament. Without the right temperament, investors would struggle to complete the research necessary for these hidden opportunities.
"You wouldn't say that requires any high-level insights or anything," he added.
Buffett's right-hand man, Charlie Munger (Trades, Portfolio), added his thoughts at this point, noting:
"I think that takes a certain amount of what an old Omaha friend used to call 'uncommon sense.' He used to say, "There is no common sense. When people say common sense, they mean uncommon sense." Part of it, I think, is being able to tune out folly as distinguished from recognizing wisdom. And if you just got whole categories of things you just bat away, so your brain isn't cluttered with them, then you're better able to pick up a few sensible things to do."
Simply put, Munger and Buffett described that their advantage over other market participants was the ability to ignore the noise and concentrate on the simple facts. They were not interested in the next high-flying tech stock or profitable trading strategy. Instead, they stuck to their tried and tested approach of finding undervalued investment ideas through detailed research and reading annual reports.
It is not a particularly revolutionary strategy, but it has given these two billionaires an edge that made them, well, billionaires.
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