Common Stocks and Common Sense

1 MY APPROACH TO INVESTING

Note: Most of the contents of this chapter will not be new to the majority of experienced investors. I wrote this chapter to bring less experienced investors up to speed with the principles of value investing.

In my opinion, good investing largely is common sense, made somewhat difficult by the behavioral imperfections of man. We can start with the straightforward concept that, over the longer term, common stocks are an unusually attractive investment vehicle, even for an investor whose returns only equal the stock market’s returns. During the 50-year period 1960 through 2009, the average U.S. common stock provided an average annual total return (capital gains plus dividends) of 9 to 10 percent. In addition to providing this favorable return, common stocks are highly marketable and therefore can be purchased and sold easily without high frictional costs. Also, and importantly, if selected properly, common stocks offer considerable protection against risks of permanent loss. What could be better: favorable returns, high liquidity, and relative safety! That is a home-run combination, and that is why I am a great fan of common stocks.

The 9 to 10 percent average annual return provided by common stocks over the 50-year period makes economic sense. During the period, if adjustments are made for a few outlier years,¹ the U.S. economy grew at roughly a 6 percent annual rate: about 3 percent from real growth (unit output) and about 3 percent from inflation ...