How To Use The 2023 Recession To Build Wealth

Despite the 2023 economy looking pretty shaky, with high inflation, the Federal Reserve raising rates, and the stock market suffering over the past 12 months or so, many of the world's best investors have been busy buying into the market. While most other investors, on balance, have been selling, Warren Buffett, for example, dumped a huge chunk of money into the market in 2022 after being heavily criticized for staying too much on the sidelines in recent years.

This is not an isolated incident. In the crash of 2020, the super investors were buying in; in 2008, they were buying in; and in 2001, yep, exactly the same thing happened. They were buying in that as well. In hindsight, this strategy of investing heavily during weak economic periods has worked incredibly well. But there are three fundamental rules to remember to make sure you come out on top. Luckily for us, Warren Buffett disciple Monish Pabrai, who is very good friends with Charlie Munger himself and actually once paid $605,000 to have lunch with Warren Buffett, recently took the time to explain these three investing rules.

So let's talk about them. The first, which is particularly relevant in times of high inflation and economic weakness, is looking for companies with a durable competitive advantage. Let's say you have some small city in England, and it has no Thai restaurant, for example. Someone looks at it and says, "I think my restaurant will do really well here," and they open a Thai restaurant. They do really well, they're full all the time, and they can charge premiums versus London and other cities. That is going to attract more people and entrepreneurs to open Thai restaurants.

Eventually, the economics of the Thai restaurants in that small city may be no different from other parts of England. The nature of capitalism is such that if someone builds a better mousetrap, which grows their company and generates high returns on equity and is very profitable, they have a target on their back. In general, that will attract a lot more competitors to enter your space, and they'll try to chip away at whatever advantage is there.

This is an important point: being first at something might work for a while, but it doesn't work forever. You know Snapchat was first with Stories, but they lost. Atari was first in video games, and they lost. Motorola made the first mobile phones, and they lost. Being a first mover is nice and all, but what you need to look for is an intrinsic characteristic of a business that permanently sets it apart from its competitors—something that another company can't replicate, no matter how hard they try. That's what we call the moat.

We see this a lot these days. There's one type of moat that is always impossible to replicate, and it's one that Monish talks about in this next clip. Now, sometimes, what happens in capitalism is we get aberrations. When the pharmacist started the Coca-Cola Company, he had no idea what he was on to, and no one could have imagined that Coke would end up being the brand it is today.

Quite frankly, there's nothing particularly magical about Coke in the sense that they say they have the formula locked up in some bank vault in Atlanta, but it is really easy to clone Coke, and several companies have done that. When Pepsi introduced the Pepsi challenge in the 1980s, they basically gave people two colas to drink with no brands on them and said, "Tell us which one is better." Most people preferred Pepsi because it was a little sweeter. Then after they took the test, they would tell them, "Oh, by the way, you preferred Pepsi."

But if they presented the two drinks to most people with the brands Coke and Pepsi, most people would prefer to take Coke. So Coke's moat is, if you look at it objectively, it really doesn't make any sense. They have a product that can be very easily cloned; they have competitors who, in many cases, have better products.

But a brand got built, and yes, we see it time and time again. The most powerful moats tend to be the brand moats. Monish is right: Coke was objectively proven to be less popular than Pepsi if you took away the label, but with the label on, Coke is the number one drink in the world, without question.

So businesses with very desirable stickers, despite being slightly counter-intuitive, actually have the strongest moats and are some of the best businesses to own as an investor in tough economic times. Think about it: essentially, having a moat means people are coming back to your product or service and won't switch to an alternative. That's handy because when people are tight on cash, it means they won't buy the cheaper product; they'll still buy yours.

Another example of a company with a brand moat is Ferrari. You know there are cheaper cars out there, and there are cheaper hypercars out there, but Ferrari's demand just never drops. You know, Louis Vuitton—you actually reckon their products are high quality? Of course not; they're made out of the same stuff that everything else is made out of. But what people buy is the brand; they want the design, they want the logo, and what that represents.

But even with that said, no moat is forever. So on top of identifying, we also need to keep tabs that the moat endures through the years. The nature of capitalism is that moats are very likely eventually to get filled in.

If we go back in history, you look at businesses that have survived and thrived for a long time. Very few businesses that are founded make it past their first year; a few will make it past their fifth year, and even fewer will make it past their tenth year, twentieth year, thirtieth year. It just keeps going down.

When we look at businesses that may look dominant today, our job as investors is to project what these businesses may look like 5, 10, 20 years from now. That is a very difficult exercise because you have all these marauding intruders who want to take away your moat, who want to take away those profits, and they're continuously coming at you.

That's what makes this a fun and exciting endeavor, from my point of view, because trying to figure those things out is not that straightforward. So, while Apple is a ridiculously strong company with a big brand moat and a big switching moat, you always need to keep tabs on the strength of the moat as an investor.

So how do you spot them out? Well, remember Phil Town's exercise: look at the long-term track record of revenue, earnings per share, free cash flow, and equity. Just have a look at whether they're consistently growing at over 10% per year.

In the case of Apple, their chart looks pretty good. Remember that equity can get thrown off due to all the share repurchases, but generally, they seem like they have a moat because they've been able to grow uninterrupted for a very long period of time.

On the flip side, if we saw declining sales or declining margins, or maybe there's been a lot of negative media sentiment, or they're closing stores—stuff like that—these can all be signs that a moat is, in fact, being crossed.

But yes, anyway, looking for businesses with moats is really the first big lesson to successful value investing in tough economic times. But let's now turn our attention to another key element that Monish describes next.

So one of the arrows in our quiver as value investors is patience. In general, we don't really have—or for the most part—an information edge. So if I'm looking at a business, there's not much I'm going to be able to come up with about that business that a lot of other people haven't figured out or are capable of figuring out.

Then there can be another edge, which is an analytic edge, where two individuals have the same information but one person is able to look at that data and come to conclusions that are different from the other person. An analytic edge can be a real edge, but even that is difficult because there are a lot of smart people looking at a lot of companies.

The one edge that is probably the strongest is the time horizon. Even Jeff Bezos says that a lot of his competitors are focused on the next one, two, or three years. He said that Amazon always took the approach of looking out longer—looking out five, seven, or ten years. He said that when they looked out longer and invested with their longer time horizon, they got an edge.

They were willing to make investments where they knew that the payoff was not going to come in three years. Now, this applies to companies themselves, but it also applies to us investors. I can't stress enough how important this is: having a long-term outlook is hands down our biggest advantage as value investors.

We manage our own money; no one will ever tap us on the shoulder and kick us out because we haven't made a 20% return by next Tuesday. But that is the game being played by the active funds on Wall Street, and it traps them into thinking incredibly short-term—literally quarter to quarter.

But, as Monish says, long-term value investing is a game of patience. We buy great companies at favorable times, and then all we have to do is wait. That's really it; it's boring. It's a game of patience and a game of relative inaction. We wait until the crisis blows over and the recovery kicks in.

This might take one year, might take three, might take five, but the point is we can wait. When we're patient for great opportunities and focus on holding these businesses for the long term, that's when we profit.

So I think, yes, the ability of an investor to think longer term. This is one of the reasons why the index does so well. The index is too dumb to know that it owns Microsoft; it's too dumb to know that it owns Alphabet, and it's too dumb to sell these things.

It keeps these things endlessly forever. We look at the S&P 500 index, for example, which consists of, for the most part, great businesses. Every year, they might take one or two businesses out and replace them with one or two new ones. But usually, the ones they take out are not the ones that are climbing.

Recently, they removed General Electric from the Dow Industrial Average. If you look at the Dow Jones Industrial Average over time, in general, you get rising stars going in and you get companies that have passed their prime being taken out.

The S&P 500 would hold an Apple, a Microsoft, an Amazon, or an Alphabet for 20 years, 30 years. That type of holding period on these great businesses can be a great edge. And isn't it crazy that the index, the S&P 500, beats over 90% of active fund managers over the long run?

It's a pretty good example of just how much a short-term mindset can impair you as an investor. So we stay around businesses that have proven moats, and we always look to hold them for a very long period of time.

If you can do those two things, a lot of your long-term risk of loss is taken care of, even if you make a mistake with your valuation. The second approach is where you identify a great compounder that, because of people not willing to look at the right time horizon, you can look around the corner.

You could pay what would be either reasonable or even an expensive looking price and end up with a great result. I think you could have paid any multiple for Microsoft when it went public in the 80s, almost any multiple for Walmart when it went public in the 70s, and you would have still done extremely well.

So if we have a crystal ball that can tell us what a company might look like 50 years from now, 30 years from now, then we could buy something at a billion-dollar market cap, and it might become $200 billion. That's the big advantage with this type of strategy.

If you're ultra long-term focused and buy high-quality businesses with big moats, you can accidentally buy them expensive, and they can still be worth a hell of a lot more in 10 to 15 years from now. No, that doesn't mean you throw valuation out the window, but it is nice to know that if you're buying a high-quality business, you can buy it at a fair price as opposed to just buying it at a bargain basement price, and you can still do very, very well.

That's what Warren Buffett did with Coca-Cola; that's what he did with Apple. There are countless examples. But with that said, Monish also raises one more very important point that you absolutely must remember once you've found that big winner.

So have a listen to this: there are very few businesses in the universe of listed companies that would qualify as great businesses. Probably, I would say less than five percent or three percent of listed companies would qualify as great businesses. If you find yourself in the very happy situation of fractional ownership of one of those businesses, hang on for dear life.

This is one of the biggest mistakes I've made over time. The guy owns a stake in Ferrari, thanks to Monish. Thank you, Monish, for giving me that insight. And Monish doesn't own Ferrari. When I made the investment in Fiat Chrysler in 2012, when the market cap was $5 billion, and their sales were $140 billion, Fiat Chrysler was trading at less than four percent of revenue.

Eighty percent of Ferrari was inside that $6 billion. Plus, there were all the Jeeps, RAM, Maserati, and everything else in there. At that time, O'Bri funds owned something like 1.1 percent of Ferrari. When I looked through the Ferrari stake, we made a lot of money on the investment.

One of the dumbest things I did was that Ferrari looked optically expensive to me, and I sold. We would probably have three times that amount of money if I just kept the position. Like Charlie says, "All too soon and why it's too late."

That's really the final puzzle piece: once you find the business that has the wide moat, once you've committed to owning it for a long period to let it compound, and once you've bought it at a fair price, then don't let that go. If nothing fundamental changes, it's better just to keep holding, unless it's egregiously overpriced.

Actually, let that business do what you thought it would do over a decade or two; let it compound over 20 years like Amazon has, like Google has, like Tencent has. That's the key to getting the big multi-baggers—resisting the temptation to cut the flowers and then water the weeds.

We need to do the opposite: we water the flowers and we cut the weeds. That's really the not-so-secret formula that value investors use to profit during tough economic times.

Number one: find the companies that have the intrinsic characteristic that sets them apart, that sets them ahead. Number two: look to hold them for the long term. And three: just don't get caught panicking and selling them before they have been able to compound for you.

But overall, guys, those are the three lessons from Monish to help you come out on top investing in a time of economic crisis. Remember: always, always, always stay rational.

Anyway, guys, leave a like if you enjoyed. Subscribe to the channel if you'd like to see more. But that will do us for today. Thanks very much for watching, and we'll see you in the next video.