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Too Long Didn’t Read: for Basic Investing Strategy:
- In the long run, earnings and cash flow matter most.
- An economic moat – or technically, competitive advantage, is a factor that could preserve (or even grow) earnings and cash flow.
- Time plays an important role, a high number of ROIC is useless if it can’t last in the long run. Time becomes the test for ROIC.
Chapter 1: How to win the game
The basic investing strategy could be learned from the compounder.
The simplest yet most efficient strategy of investing is picking the company with growing revenue, earnings, and cash flow – then sit down. And do nothing unnecessary.
To get more perspective, consider this fact. Earnings of Apple grow from 8,2 Billion in 2009 to a monstrous 94,6 Billion in 2021. In the same period, the cash flow grows 10 times from 9 Billion to 92 Billion. This solid growth delivers the stock price of iPhone makers up from 5 levels to 150, almost 30 times in the 13 years.
Try to extrapolate this figure for Amazon, Meta (formerly Facebook), Nvidia, and Microsoft, and you will come to the same conclusion: the growing earnings and cash flow deliver the gain for the stock price – in the long run.
Do not confuse with Tesla, if A then B not always B then A. When the stock price of a certain company rises – even in the long term – it does not mean that the company has solid earnings and cash flow.
Chapter 2: Another way to win the Game
Buy at discount is one of the basic investing strategies but can’t be efficient in the long run.
Another way to invest is to find a company at discount. A company that below, you know, the “proper value”. This is a strategy that was exploited by Benjamin Graham and become the starting point of value investing.
Honestly, this strategy makes sense. If you find something that is offered at its usual price, you could buy it and sell it if the price back to normal. In the stock market, you can buy an oil or coal company whose market cap is below their cash in hand. Or you can buy a real estate company whose market cap is below its land bank value.
The problem with this approach is the stock price is not always back to normal value. Some of them really go bankrupt or never back to normal value. And these circumstances are testified by Warren Buffett himself before he turns to our first strategy. Therefore, you read the popular quote:
Pick a wonderful business at a fair price instead of buying a fair business at a wonderful price.
The wonderful company is our first strategy, a company with growing earnings and cash flow. The second strategy is the ordinary company that is offered at discount by the market.
The title of this chapter should be another way to lose the game.
We deal with this topic deeper in this post: https://investingdeck.com/investing-in-growth-stock-redefining-value/
Chapter 3: The Wonderful, The Winner
It gets bigger and better over time.
Because investing in the long term is much easier (please read this)
So, we need to pick companies that grow over that time.
To be more specific, our investing task is simple: pick the company that grows its revenue, earnings, and cash flow. But to find this kind of company is not easy. The next chapter will focus on finding this kind of company.
Chapter 4: Economic Moat
The basic investing strategy is to make your investment grow as long as possible
We repeat what we’ve said before. Because you invest in the long term, you need to pick a company that grows through time. And due to the nature of business competition, this will not be easy. So, to be more specific, our task is to find a company that can defend its market share against its competitors.
This is why Warren Buffett introduces the concept of the economic moat(1)(2). A trench that filled with water to prevent invaders attack the castle. Our preference should be like that, find a business that could make the competitors still at bay.
To get a better understanding, we have the following examples:
- Amazon with economies of scale and scope make competitors and new player difficult to compete with and offer lower cost and services for the customer.
- Microsoft (its Office and OS product) with switching costs prevent the customer to switch to another platform due to high migration data cost, risk of failure, convenience, and training cost. This is also true for Adobe and Autodesk.
- Visa that connected with a huge amount of merchants and other platforms make it easier to distribute the cost and offer more convenience for the customer.
- Apple and Disney simply have no meaningful rival in terms of the ecosystem. Also, they could cast premium prices for their product.
- Warren said about the economic moat in the letter to shareholder 19xx.
- This also becomes our reason for always including competitive advantage analysis for almost any company we cover.
Chapter 5: Return on Invested Capital
The basic investing strategy is not about how fast, or how quick, but how long.
Some investing gurus recommend ROIC as the ultimate precursor of the superiority of business. Since it measures how much return with respect to the invested capital (the debt and retained earnings). Nothing wrong with this, but because our focus is on investing in the long run, the pace of growth becomes secondary. The most important is how long it could preserve the pace, the market share, and the customer.
ROIC is a good indicator, it is essential. But the more essential is the economic moat. It will be useless to have a high ROIC but only last 2 years. It is much better to invest in a business with low ROIC but could be preserved in the long – forever if possible.
Furthermore, it is always better to keep walking – as long as possible – to reach the destination, instead of sprinting at full speed, then exhausted.
TL, DR for Analysis of Nvidia stock 2022:
- Even under the company’s plan to transform into an AI platform provider, the gaming sector still becomes the backbone of the business.
- AI still offers massive opportunities. We have metaverse awaiting along with more AI adoption.
- Nvidia’s competitive advantage is solid, especially after the Mellanox acquisition.
- The most powerful edge of Nvidia is the connection with another big name, making it the most compatible chip manufacturer in terms of gaming, AI, auto, and design.