Source: Online

When you are first exposed to the idea of investing, you will usually learn that in order to make money from the stock market, you will need to buy low and sell high. If your stock increases in price, you will need to sell away your stock in order to lock in the profits. And if you do not sell away your stock, the profit you see is known as unrealized profit, a paper profit which is not actual profit.

While there is a certain truth to this, but is this always the best strategy?

Afterall, we have learnt how the best value investors like Warren Buffett and Charlie Munger invest in stocks, we faced a conflict between what we have learnt and what they teach.

“Our favourite holding period is forever” quoted Warren Buffett, the Chairman and CEO of Berkshire Hathaway.

“The big money is not in the buying and selling, but in the waiting” once famously said by Charlie Munger, the Vice Chairman of Berkshire Hathaway and business partner of Buffett.

Basically, their investment philosophies are totally the opposite from what we have learnt previously.

“Holding a company forever?” If we do not sell away our stocks on hand, how can we possibly make money?

“Big money is in the waiting?” If we do not do anything and just wait, how can we possibly make money?

These are two main questions we asked when we first study about Warren Buffett and Charlie Munger. Being confused at first, but after practicing value investing, we finally understood the wisdoms of Buffett and Munger. There is a reason why they are the best value investors in the history.

Yield on Cost

This is a very important concept to understand if you really want to build your wealth through investing in stocks. And it is also one of the reasons why successful value investors is able to compound their wealth very well. Value investors focus on the business behind the stock rather than the stock price itself because they understand the power of yield on cost.

To explain the concept of yield on cost, we will use Padini as a case study.

In year 2011, Padini’s share price was RM0.88 per share and had issued RM0.04 dividend per share. Some investors back then only look at the dividend yield of 4.5%, which was just slightly higher than the fixed deposit, thinking probably not a good investment for them. And of course, there are a lot of investors who bought into Padini at RM0.88 hoping to sell at RM1.00.

However, for value investors who had bought in Padini at year 2011 and held it until today, they have made much more money. With the current dividend per share of RM0.10, new investors today will only be getting a 2.9% dividend yield. However, for those who had invested at RM0.88, their yield on cost will be 11% per year! Pure passive income by just holding the stock. Just dividends alone, investors would have collected back a total of RM0.70 per share, resulting their net purchase price of Padini to be RM0.18 per share. If you were to consider the total capital gains from this investment, which is from RM0.18 to RM3.50, that’s a 1844% return of investment! A Compounded Annual Growth Rate (CAGR) of 45% for 8 period of years! Meaning, if you have invested RM18,000 in Padini in year 2011 and held it until today, your RM18,000 will become RM350,000!

If you continue to hold Padini, you will have collected back all of your capital from its dividends moving forward, making your investment total risk free and infinite return on investment.

“Our favourite holding period is forever”, Warren Buffett.

“The big money is not in the buying and selling, but in the waiting”, Charlie Munger.

How about companies that does not pay dividend?

Some might say that if the company itself does not pay dividends, the stock must be sold in order to make money.

Is that true? Let us show you a case study called Company ABC.

Company ABC

One of the characteristics of this Company ABC is that the management do not like to pay dividends to the shareholders. If you managed to invest the shares when it was at the price of USD 300 in year 1980, you would definitely be very happy if you are able to sell away the shares at USD 900.

But what if we show you the rest?

Company ABC

The share price of this company today is USD 300,000. Yes, you heard it right, USD 300,000 per share. So, based on the earlier scenario, buying at USD 300 and selling at USD 900 does not seem to be an intelligent decision.

Company ABC in reality is Berkshire Hathaway, managed by Warren Buffett and Charlie Munger. Throughout history, they have only paid dividends to their shareholders once and they regretted doing so. Warren Buffett said that if they did not pay dividends to their shareholders, they are able to compound that amount of money much better for their shareholders.

In year 1980, Berkshire Hathaway is priced at about USD 300 per share. Today, its USD 300,000 per share, having a Compounded Annual Growth Rate of 20% for 38 years. However, the only way to enjoy such return is to invest and hold it for 38 years.

“Our favourite holding period is forever”, Warren Buffett.

 “The big money is not in the buying and selling, but in the waiting”, Charlie Munger.

Just like cash, stocks are your assets as well

Ultimately, we invest our money to build our financial wealth. Financial wealth is not just limited to cold hard cash alone, but your stocks as well. Just like cash, stocks are your assets as well. But if it is just cash alone, your net worth will not grow. Your net worth will only grow if you make use of the cash and invest in great companies that will increase in value.

And if you own stocks of great businesses which are able to grow in value, what is the rush of turning them into cash?

Remember, the big money is in the waiting.

Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. The author involved in the writing of this message has no vested interest in the companies. Please consult a professional for expert financial or other assistance or legal advice.

This article was written by Team VIC
Team VIC is formed by experienced and well-trained individuals from Value Investing College (VIC). The team has been consistently studying the latest stocks market trend in order to focus on educating the layman on investment principles and techniques.

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