Warren Buffett and Charlie Munger's annual sessions at the Berkshire Hathaway AGM are, of course, legendary. It's because they are so filled with pearls of investment wisdom that such hordes make the trek to Omaha each year. One idea that stands out amongst the many is their emphasis of using opportunity cost as a filter. As Munger observes in Poor Charlie's Almanack: "Intelligent people make decisions based on opportunity costs - in other words, it's your alternatives that matter".
When Opportunity Knocks
The central idea is that the real cost of any purchase you make isn’t the actual dollar/pound cost. Rather, it’s the opportunity cost — the value of the investment you didn’t make, because you used your funds to buy something else. To illustrate this, in the 1998 Shareholder Meeting, Buffett explained that, the first question he & Munger ask themselves when looking at a potential investment is:
"Would we rather own this business than buying more Coca-Cola or more Gillette?".
Buffett calls businesses like Coca-Cola and Gillette the Inevitables because, not only do they have superior economics and growth prospects far into the future, but also their prospects are highly certain - if you do your homework, you can develop rational conviction about their future. "No sensible observer.. questions that Coke and Gillette will dominate their fields worldwide for an investment lifetime".
Because you have the opportunity to purchase these kinds of investments, they argue that you can use this as a filter to automatically eliminate the other 98%. We should want companies which get as close to perfection as possible, or we should figure we'd be better off buying more Coke. Buffet notes that, if every management, before they bought a business, said - "is this better than buying in our own stock or even buying Coca-Cola stock?", there'd be a lot less unsound deals done.
Introducing the fastest way to compare stocks on the Web....
It is with exactly that kind of thinking in mind that we're now released our new Stock Comparison Tool. Too often, it seems that investors get caught up by a stock idea they may have stumbled upon, without taking the time to examine the opportunity cost of that investment, versus others that may be available in the market.
Struggling to decide if one company is a better investment than another? Is there something better out there? Are you backing the right horse? The Stock Comparison Tool allows you to easily compare side by side up to 5 companies across all the key financial statement metrics and investment ratios. It's now quick, easy and painless to assess a company's relative strengths and weaknesses.
Are you backing the right horse?
To start off with, we've chosen 30 key ratios across the following categories, and it takes just seconds to compare a company stacks up on these measures against its sector peers, comparables or any listed benchmark you choose:
Of course, this is a quantitative view of a stock and it ignore important qualitative factors (e.g. a new CEO) that may over-ride the purist quant conclusion based on fundamental analysis. Equally, it doesn't take into account industry-specific drivers (e.g. reserves information in the Oil & Gas sector) where we simply don't have the data, but nevertheless we find that it gives a very instructive and helpful picture of a stock that may be worth building into your process.
We think that this tool is useful not just on the way in, but also a way to constantly re-examine a given investment's opportunity cost. All too often, investors fall foul of confirmation bias, ignoring disconfirming evidence and anything that suggests that they may have made a mistake. Have you noticed that, as soon as you buy a stock, you start looking for reasons why you are right? Once a stock is bought, we tend ONLY to look for anecdotal information that confirms the investment decision was a good one. By using the Stock Comparison tool, we can now force ourselves to face up to the opportunity cost of past mistakes, as well as being a lot smarter on the buy.
Try it out. You can see a sample comparison of BP vs. Tullow Oil vs. Royal Dutch Shell. And by signing up to the two-week trial of Stockopedia PRO, you can analyse any set of stocks you like across the London market. You won’t find this essential tool anywhere else!
We welcome any feedback!