Is Investing Simple? It Depends…

Warren Buffet said investing is simple but not easy. Since it is simple one can explain it, and he has done so over decades. This goes something like buy good businesses and hold them for the long term. Ignore noise and volatility.

But investing is simple only if return expectations are around index returns. If you expect to make around 13 to 16% returns, which is somewhat more than index returns, investing can be quite simple.

First, let us step back and try to understand two versions of Buffet.

Buffet version 2

This is the avatar we have known for the last few decades. In this phase, he was handling very large sums of money and making index like returns. Most of his teachings pointing at the simple nature of investing are from this phase.

Buffet version 1

This is not a commonly known version of Warren Buffet. This is the early part of his career. Here he used to make much higher returns, but he managed smaller sums of money. He even has claimed recently that if he was managing such kinds of money now, he could make even 50%. But there is not much material from him on how he would have done that.

So what we know about the simplicity of investing is from version 2 of Buffet, where he also made index like returns only.

For making 25 to 30% kind of returns, investing is not simple

Not lay person simple. There are a number of prolific, but relatively smaller number of investors, who have made such returns. They have done so over long periods of time, so it is not a fluke. There should be a method. Most of these people do not speak to the public in the same detail and length as Buffet and Munger have done over the years. One reason is that it is not easy to explain. But some of the people who do speak publicly are not as simple to follow for a lay person, like it is with Buffet, again because the subject is complex now.

If you follow their work over time and work on your own skills (accounting, business patterns, market psychology and so on), and do real practice, you can start to understand their process and method better. Since these practitioners have not been able to simplify this, this piece will not attempt to either. The aim here is only to explain why it is not simple.

Why is holding a good company for longer periods not adequate?

There are so many 20 to 30 year multi-baggers like HDFC Bank, Bajaj Finance, Infosys, Titan and so on, so why is this not a good strategy?

Making large returns, for long periods of time, at the portfolio level is very different from having 1 or 2 multi-baggers like above. Even if one has 1 or 2 stocks like above in a portfolio of 15 to 20 stocks, that doesn’t translate into making such returns at the portfolio level. This means many other stocks in the portfolio also need to fire at the 20 to 25% level, for long periods.

Take a rough example. Say you have a 20-stock equal-weight portfolio. One stock compounds at 30% and the other 19 compound at the index, call it 13%. The blended return is (1 × 30% + 19 × 13%) ÷ 20 = 13.85%, which is barely above the index. For the portfolio to reach 25%, the remaining 19 stocks would have to average roughly 24.7%, so the single 30% holding is not what gets you there.

Maybe there are people like that, but investors who make 25 to 30% returns just by picking a lot (much more than 1 or 2) of stocks and holding them for long periods of time are hard to find.

Why is high returns investing not simple?

Making such high returns requires incorporating other factors into buy, sell and hold decisions. There are two distinct paths to 25-30% returns: re-rating, and high underlying business growth. Of the two, re-rating is the more tractable one for most investors, and cycles are what drive it.

Cycles

Most businesses, sectors, and economies go through cycles. Very broadly one has to play these cycles to their advantage. Roughly getting them right is the key, as precision cannot be achieved in spotting these cycles. There can be a world of difference in roughly getting them right versus not paying any attention to these cycles at all and holding through cycles.

In the “investing is simple” world view, this has a bad name which people call market timing. Trying to time the market with no fundamental basis is indeed a pointless, rather negative impact, exercise. But a deeper understanding of the topic will reveal that there are real factors behind these cycles and understanding them can be quite beneficial. Here is one recent example.

Formal and large hotels are doing well since 2023 because Covid destroyed this business and supply went off because many didn’t survive. When Covid got over this supply is coming back but it takes 2 to 3 years to set up a new hotel. During this period supply will remain constrained, giving a pricing advantage to these large hotels. These hotel chains are going through a positive cycle today but when supply catches up the cycle will turn.

Since most businesses are cyclic, one should pay attention to them. Why do cycles exist? It is a very interesting phenomenon that is explained well in the book Mastering the Market Cycle. The book explores various types of cycles.

Re-rating

Cycles lead to re-rating and de-rating of PE ratios. Due to smaller size, or lack of understanding of tailwinds, or other reasons in a sector or business, stocks may trade at a lower PE ratio. But sooner or later the broader market starts understanding the business potential and prices them right. Pricing them right is another way of saying that going forward it is going to give returns in the vicinity of index returns. In other words there is no alpha available anymore. This process is also called re-rating. Re-rating is the process in which a business with the same growth potential gets a higher price to earnings ratio.

During the period of re-rating the investor makes returns from re-rating as well as from the profit growth. After re-rating one makes money only from profit growth. It is important to appreciate that even a company growing at 10% can give you 25% returns while it is getting re-rated. Re-rating is a one-time repricing though, so once the market has fully valued the business, returns fall back to the underlying profit growth.

High Growth

The second path is to find a business growing earnings at 25 to 30% and hold it. At a stable PE your returns track the earnings growth directly, with no re-rating needed.

Businesses sustaining 25 to 30% earnings growth for 10 or more years are rare, and identifying one before the market has priced in the growth is the hard part, because by the time the growth is obvious the PE has already expanded and much of the return is behind you. Doing that requires deep understanding of the business model, the competitive dynamics, and the size of the addressable market relative to where the company currently sits.

Holding is its own problem, because any business growing that fast will go through stretches that feel alarming, whether from a competitive threat, a macro headwind or a bad quarter. The conviction needed to hold through those periods comes from the analytical work done upfront, and an investor who has not done that work tends to sell at the worst possible time.

Finally, high growth does not last forever. At some point the business runs out of runway and the growth rate moderates, and recognising that inflection and acting on it is a separate skill from identifying the business in the first place.

What this means is that neither path, re-rating through cycles or identifying high-growth compounders, is something a lay person can execute without significant work. Simply buying good businesses and holding onto them for many years is not adequate. Selling, entry points, understanding cycles, and deeply understanding business growth trajectories all become important, and each adds complexity.