If you think successful investing is trading in and out of stocks frequently then you'd be wrong.
If you think successful investing is buying unloved, cheap stocks then you are probably also wrong.
If you think successful investing is buying and holding a collection of stocks for the long term, you'd only be partly right.
If you haven't yet read Berkshire Hathaway's Annual report (PDF) and Warren Buffett's and Charlie Munger's included 50th anniversary letters, then you should drop everything and do it now because it contains the answer to the headline above. Don't worry, I'll still be here when you come back.
If you've read the letter already, the master investor Buffett lays it out clearly.
"The blueprint he [Charlie Munger] gave me was simple: Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices."
In other words, if you want to build a wonderful portfolio that will serve you well over many years, forget about trolling through the unloved, ugly, cheap stocks and look to buy quality companies at fair prices.
That means ignoring those companies such as Mount Gibson Iron Limited (ASX: MGX) trading at less than its net tangible assets, or super-cheap mining services companies like MacMahon Holdings Limited (ASX: MAH), Ausenco Limited (ASX: AAX), Ausdrill Limited (ASX: ASL) or Boart Longyear Ltd (ASX: BLY) trading at massive discounts to book value. Sure, you could generate some gains, but it'd likely be hard work.
It also means bypassing companies like Fairfax Media Limited (ASX: FXJ), Qantas Airways Limited (ASX: QAN), both of which are non-quality companies. (Tip: don't equate a strong brand with equally strong business performance).
It also means avoiding buying those stocks such as Woodside Petroleum Ltd (ASX: WPL) purely for the current strong dividend yield. As a capital intensive business, Woodside will need huge lumps of capital in the future to drive any sort of growth.
What it does mean is buying the high-quality companies on the ASX that generate high returns on capital, have strong brands, good management, consistent earnings growth and loads of potential at fair prices.
If you can get them at cheap prices even better – but also be aware that you want cheap or fair prices, not expensive prices.
The stocks I'm talking about are the likes of CSL Limited (ASX: CSL), Cochlear Limited (ASX: COH), Ramsay Health Care Limited (ASX: RHC), Seek Limited (ASX: SEK), REA Group Limited (ASX: REA), Woolworths Limited (ASX: WOW) and Telstra Corporation Ltd (ASX: TLS) to name but a few.
Now they aren't all cheap or fairly priced, but patient (Foolish with a capital 'F') investors will wait until the market offers them a decent price. Sometimes that's when the company has hit a small bump in the road, at other times, the whole market is on sale. In both cases, quality companies will usually come out the other end much stronger.
