All of us want our stock picking to produce superior returns to the S&P/ASX 200 Index (ASX: XJO). If this wasn't the objective, then an index-based exchange-traded fund (ETF) would be all we'd need in an investment portfolio.
Over the past 20 years, the Australian benchmark has delivered an 8.1% per annum return. There's certainly no shame in being satisfied with such a performance. It still blows the socks off a savings account and pips the hottest rate of inflation we've witnessed in more than 30 years.
However, if you're like me and have an insatiable appetite for finding the best companies that money can invest in, I believe there are a few investing parables worth inscribing on your mind.
There's a lot of information out there in the world. Not all of it is worth listening to, while some of it bears repeating again and again. It is knowledge imparted by those far more experienced than I that can be instrumental in successfully building wealth.
So, here are three valuable lessons to help outperform the ASX index over the next decade (or more).
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Simple and strong companies can survive ineptitude
The first lesson is one I was reminded of recently while listening to the annual shareholders' meeting of a major London-based investment company known as Fundsmith.
While perhaps not as well-known as Warren Buffett, Fundsmith CEO and founder Terry Smith applies similar principles to investing and is a success in his own right.
During the meeting, Smith explained a mantra that his fund operates by, stating:
Always invest in businesses that can be run by an idiot, because sooner or later they all are.
It's fairly self-explanatory. Companies often experience changes in leadership. To lessen the risk posed by careless management, pick businesses that are simple to run and have a strong foundation.
The original quote was shared by Buffett many years ago. Yet, the crux of the statement still rings true today and likely will remain so into the future.
You won't beat the ASX index by overpaying
Generosity is praised in many aspects of life. Though, gratuity won't do you any favours when attempting to outperform the benchmark.
In a 2012 fund manager letter, Peter Kinney of Kinsale Capital Management shared his own investment philosophy. One of the cornerstone tenets described was the notion of never overpaying for a company. He called it 'the margin of safety'.
The price I pay for a company is one of the few things I can control as a minority shareholder.
Peter Kinney, portfolio manager Kinsale Compass Fund
In true value-investing fashion, Kinney wrote that he required at least a 50% discount on what he believed was the company's intrinsic value. Doing so removed the need for extensive diversification as a risk management strategy.
How'd it work out for Kinney? Well, three out of the fund's top five holdings at that time (11 years ago) were Microsoft Corp (NASDAQ: MSFT), Sartorius Stedim Biotech SA (EPA: DIM), and Nakanishi Inc (TYO: 7716).
Safe to say, those were some ASX index-beating investments…
A key trait of a serial compounder
So, you've spotted a company that is well-established, simple, and trading at a considerable discount — surely that is enough. Well, not quite… don't forget to check for pricing power.
It wouldn't be a summary of investing lessons without a Buffett quote. As the Oracle of Omaha has said before:
The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business.
In other words, to beat the ASX index, you want companies that hold such a strong customer attraction that price rises don't put a dent in demand. This pricing power can take shape as a monopoly, strong brand, technical excellence, patented technology, etc.
If you want to find ASX shares with pricing power, look for companies that have been able to sustain growth through difficult economic periods.
