Good morning! Today Troy continues about the investing for beginners series. You can check the previous posts about What are stocks and how to value them, How does Currency Trading Work, How are Currencies Traded, Investing in Commodities, What Fundamentals Affect Commodity Prices, What are ETF’s, What are Options, How are Options’ Prices Structured, Investing for Beginners Part 2 – Different Investment Strategies, When does Buy and Hold not Work
In my previous post I discussed the reasons why the conventional buy and hold method doesn’t work. Why? Because the likes of Warren Buffett and other buy and hold supporters are keeping you in the dark on some critical things. Below are the additional “factors” you need to add in order to make buy and hold work for you. Without these factors, buy and hold will not work – you’ll be like the poort sap who dumped their stocks at the bottom of the 2008/2009 stock market crash.
You Need a Side Business
Warren Buffett’s company Berkshire Hathaway (really just a legal entity that owns other companies) is a very unique business. And no, it’s not because “Warren Buffett buys cheap stocks, value stocks, Buffett’s a great guy blah blah blah”. It’s because of Warren Buffett’s investment model. Buffett’s true buy and hold strategy works something like this.
Start off with $200,000 in 1950 (yes, Buffett’s dad was a Congressman in the 1940’s/50’s). Buy a company (let’s call it Company A). Use the cashflow from that Company A to buy shares in another attractive company (let’s call this Company B). Eventually have enough cash from Company A to buy all of Company B. Use the newly combined cashflow to buy shares in Company C. Eventually have enough cash from Company A and Company B to buy all of Company C. Repeat this process with Companies D, E, F, G, and so on.
Thus, Berkshire Hathaway is a Buy and Hold Machine. That’s why Buffett’s biography is called The Snowball. Your investments will snowball as you own more and more companies. The mechanisms of this investment strategy are real slick. The cash generated from businesses goes into investing in other businesses, which increases the cash flow, which allows for more businesses to be bought, which generates even larger cash flows. And the cycle repeats itself.
Obviously, you and I don’t have $200,000 to start off with ($200,000 in Buffett’s time is equivalent to $2 million today). Thus, we need to start our own business. Since most of y’all are working full time in other jobs, this will have to be a side business. Many financial bloggers are doing this – Pauline (based on her monthly income reports) makes somewhere in the neighborhood of $3000, and she’s doing this while touring Europe!
Once you have that side business up and running, feed it into your Buy and Hold machine. The other beauty of having a side business is that if you lose your job, you won’t be forced to sell your stocks at possibly the worst price ever. You can use the money from your side business to make ends meet at home for a while.
The fact that you have a side business is great – you can feed the profits from that business into your buy and hold investment strategy. However, all of this is useless if your business is not a cash cow.
If your business works something like this, then it is not a cash cow company.
- It’s 2013. I signed one contract for $50,000, and it’s going to take me a year and a half to complete this contract.
- It’s 2015. I just signed another contract for $45,000, and it’s going to take me a year to complete this contract.
If the time lapse inbetween “cashflow” (Contract #1 vs. Contract #2) is a long time (in this case, over a year), then this is not a cash flow company. What’s wrong with that? Because if you look at Warren Buffett’s model, he buys a ton of stocks whenever the economy’s in trouble and other companies are cheap. However, he is only capable of doing this because his businesses are cash cows – they throw off a steady stream of income, meaning that when he needs to buy a company, he will certainly have the cash ready (his businesses always throw off cash). Here’s an example.
Your side business works off of 2 year contracts. Contract #1 started in early 2008. Contract #2 started in early 2010. That means you missed a window of opportunity in March 2009 when stocks were dirt cheap.
But if you had a steady cash flow, you would have been ready (time-wise) to buy when stocks were cheap in early 2009.