Warren Buffett’s track record in the stock market is nothing short of exceptional. Over the last 60 years, he’s generated a return of about 20% a year for his investors (for a total return of more than 5,000,000%).
Here, I’m going to explain how I’m using his winning formula in my Stocks and Shares ISA and Self-Invested Personal Pension (SIPP) today. I reckon this strategy can help me grow my retirement savings significantly over the next few decades.
The secret to his success
Buffett started off as a value investor. But over time, he evolved into more of a ‘quality’ investor. Ultimately, he realised he could generate higher long-term returns from high-quality companies (those with wide economic moats, strong profits and balance sheets, and significant growth potential) even if they were trading at higher valuations than value stocks.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price“, he once said.
The power of compounding
Why was he able to generate better long-term returns with high-quality companies? It comes down to compounding.
Companies that have wide economic moats and strong levels of profitability are often able to get much bigger over time (and generate huge returns for investors in the process) by compounding their growth. They generate strong profits, reinvest most of these earnings, and then generate a return on the reinvested profits (and do it all again).
With a low-quality company (ie one that has a low level of profitability and minimal long-term growth prospects) that’s trading cheaply, this compounding cycle’s often not possible, meaning long-term returns won’t probably won’t be as strong. Investors may be able to generate a one-off 20% or 30% gain if the company’s valuation improves, but the long-term returns most likely won’t be huge.
Holding for the long term
It’s worth noting that Buffett’s long-term investment horizon played a huge role in his returns. By holding on to stocks like Coca-Cola and American Express for decades, he was able to generate prolific returns as these companies compounded their growth and got much bigger.
Our favourite holding period is forever
Warren Buffett
A recent buy
Today, I’m following Buffett and snapping up high-quality stocks (compounders) for my ISA and SIPP. My plan is to hold onto them for many years as they compound their way to growth.
One stock I bought recently (and I think is worth considering today) was Wise (LSE: WISE). It’s one of the biggest international money transfer companies, currently moving about 5% of the world’s money crossing borders.
I see a lot of quality in this company. It’s founder-led, has rapidly rising revenues, is now very profitable, and has a strong balance sheet.
As for an economic moat, Wise has spent years establishing networks of bank accounts in the countries it operates in. This allows it to offer very low fees and super-fast money transfers to its customers.
Of course, payments is a competitive space. And looking ahead, competitors could compete aggressively for market share. Right now though, this company appears to have significant long-term investment potential. Even if it does trade at an above-average valuation.
