Two of the greatest investors in history, Warren Buffett
and Peter Lynch
, are renowned for one trick that helped them develop investing records of 20% to 30% compounded over long stretches of time. Buffett summed it up in the acronym "Kiss", which stands for "Keep it simple, stupid!" When you truly understand what it means, it can have big ramifications for your portfolio
and help you make sense of a turbulent market.
The One-Paragraph Test
The test that these two men applied was roughly the same. According to sources, Peter Lynch used to start an egg timer when on the telephone with financial analysts and traders, for forcing them to explain the basic premise of an investing idea in less than a minute. Buffett recommends that you write out a short paragraph saying something along the lines of, “I am buying $10,000 shares of Company XYZ at $25 per share because I believe (insert reason here such as profit will grow twice as fast as the current price-to-earnings ratio
, hidden assets are on the balance sheet
, there was a management change for the better, valuation is too low, etc.) Then, monitor the situation, always mindful of your basic thesis.
The practical result is the meat, or substance, of your argument of the matter is separated from the water down nonsense. Too often, stockbrokers and financial journalists spew dozens of facts they have regurgitated from a 10k or annual report. So many facts obscure the truly important figures such as sales growth, profit margins, expected capital expenditures, expected depreciation, and return on equity. Investors instead become bogged down in reading about a $12 million transaction at a firm generating $20 billion in sales. In a vast majority of cases, information of that kind isn’t particularly or necessarily relevant.
Avoiding Multiple Break Points
Another major advantage of the “Kiss” approach is that you factor in basic probability theory into your decisions. Which would you rather have: a stock that has a 65% change of doubling in the next five years or a stock that has a chance of quadrupling if eight different events all take place (perhaps a business license in a new state, a new factory built, etc.), each event having a 90% probable success rate? The latter, believe it or not, has an approximate 43% chance of coming true – much worse odds than the former option! With more links in a chain, you have a greater probability of something going wrong. If a stock could go up 1,000% but for it to do so, the labor unions must drop demand, fuel supplies must collapse, a bankruptcy court must force a competitor to pay its promised pension obligations, and new management to come in and cut stock option expenses, you are probably going to be disappointed.