You don't make money when you buy a stock. And you don't make money when you sell a stock. Buying and selling are simply market motions. The way you make money in investing is, drum roll please, by waiting. Indeed, some very active traders may be able to consistently compound invested capital year after year but it doesn't happen often. The key to successful investing is determined by that time period between when you actually buy and when you actually sell. There is a very sophisticated word for that process: patience.
In 2008, Professor Gerald Martin of American University and Professor John Puthenpurackal of the University of Nevada, Las Vegas concluded a study titled "Imitation is the Sincerest Form of Flattery." The professors analyzed the Form 13Fs filed by Warren Buffett's Berkshire Hathaway (BRK.A, BRK.B) between 1976 and 2000. For the casual investor, a 13F is the quarterly filing that all investment funds with more than $100 million in assets must file with the Securities and Exchange Commission disclosing their investment holdings. The research uncovered some startling facts.
The professors determined that during that 26-year period, Buffett, perhaps the most successful value investor in the world, primarily invested in large-cap growth stocks as opposed to large-cap value stocks. Ardent followers of Buffett may not find this as surprising as one might think. In reality, the separation between growth stocks and value stocks is arbitrary: growth and value are two sides of the same coin; the biggest creator of value is growth. Furthermore, the second half of Buffett's career has been defined by focusing on paying a fair price for a great business as opposed to paying a great price for a fair business. Investments in names like Coca-Cola (KO), Wells Fargo (WFC) and, most recently, IBM (IBM) fit this classification.
Yet the most startling conclusion of the study by far is the conclusion that a hypothetical portfolio mimicking the investments made by Buffett and Berkshire Hathaway at the beginning of the following month after they are publicly disclosed in a 13F delivers an alpha of 10.75% over the S&P 500 Index. This conclusion is extremely significant when you consider that more than 75% of professional investors fail to beat the index by three percentage points.
There is one caveat to this Buffett outperformance. Once the investment is bought, it is only sold at the beginning of the following month after Berkshire has announced its sale. In other words, this study dissolves the myth that Buffett's biggest gain comes secretively. You simply bought the stock after it was publicly revealed that the stock was purchased by Buffett and then you sold after it was revealed that Buffet sold the stock.
Even after Buffett become well known in the 1980s and 1990s and many people were piggybacking on his investment ideas, no one that outpaced the S&P 500 by such a wide margin. The reason was simple: Buffett is willing to hold investments for years, if not decades, before selling. Very few investors are. Buffett's biggest investment gains come because he waits, not because he extracts a price unavailable to us mere mortals. All one has to do is exercise patience.
This particular market is going to put an investor's patience to the ultimate test. If you believe, as I do, that financials offer some of the best bargains today, let me do you a favor and tell you that to benefit from an investment in financials is going to require patience. In fact, that's the trick in investing: buy something you understand at a fair price and sit on it. Let time and compounding work their magic. Otherwise, the friction and expense caused by excessive investment activity will leave you stuck in the pack, not ahead of it.