When we invest in equity markets our chances of making good returns depend on our strategy. When I say strategy it means that predefined set of rules which we made for our investing based on various factors like risk appetite, time horizon of investment, return expectation from the market etc. One such strategy is the coffee can investing. Here we will discuss this approach in detail with its pros and cons.
Coffee can investing is a simple and effective long-term investment strategy that has been around for decades. The basic idea is to invest in high-quality companies and hold onto them for an extended period, usually 10 years or more, regardless of market fluctuations or short-term trends.
One of the main benefits of coffee can investing is its simplicity. It’s a strategy that can be implemented with minimal effort and expertise, making it a great option for passive investors who don’t have the time or desire to actively manage their portfolio.
Another benefit is the potential for long-term growth and compounding returns. By holding onto high-quality companies for an extended period, you can benefit from their earnings growth and potentially see significant returns over time.
Why We Call it Coffee Can Investing
The term “coffee can investing” originated from an old practice where investors would buy shares of companies they liked and put the stock certificates in a coffee can. They would then leave the can untouched for years, allowing their investments to grow and compound over time.
This approach to investing was particularly popular in the 1950s and 1960s, when stock ownership was becoming more widespread and investors were looking for ways to grow their wealth. The idea was to invest in high-quality companies and hold onto the shares for an extended period, regardless of market fluctuations or short-term trends.
Today, the term “coffee can investing” is still used to describe a long-term investment strategy that emphasizes investing in high-quality companies and holding onto the shares for an extended period. While the practice of storing stock certificates in a coffee can is less common, the principles of the strategy remain relevant for passive investors who are looking to grow their wealth over the long term.
Why Coffee Can Investing performs well?
Studies have shown that the coffee can investment strategy often delivers above-average returns with below-average risk. Below are the summarized features of coffee can investing:
- No frequent changes which could remove valued stocks
- Compounding over a long term
- Impact of low transaction cost
Key Principle of Coffee Can Investing
- Invest in high-quality companies: Focus on companies with strong fundamentals, such as a track record of consistent earnings growth, low debt-to-equity ratios, and a competitive advantage in their industry.
- Buy and hold for the long-term: Once you have identified high-quality companies, buy shares and hold onto them for at least 10 years, regardless of market fluctuations or short-term trends.
- Don’t try to time the market: Trying to predict short-term market movements is often a losing game. Instead, focus on the long-term potential of the companies you invest in.
- Review Portfolio periodically: While the idea is to hold onto your investments for the long term, it’s still important to periodically review your portfolio and rebalance it if needed. You can say goodbye to those stocks whose fundamentals have changed.
- Stay diversified: While it’s important to invest in high-quality companies, it’s also important to stay diversified across different sectors and industries to minimize risk.
How to find High-Quality Companies
- Market cap: In the Indian stock market there are more than 5000 companies. Here we will take only those companies for analysis who has a market cap >= ₹500 Crores. Avoiding too small companies, as data provided by them is less reliable.
- ROCE and ROE: ROCE and ROE >= 15%, This 15% is derived from the logic that in India we get 8% risk-free return and equity investing premium is around 6-7% which adds to 15%.
- Revenue Growth: Revenue Growth >= 10% every year for ten consecutive years. This number is derived from the nominal GDP growth rate. It is expected from the companies to grow their revenue at least with a GDP growth rate.
- Free Cash Flow: FCF >0, Companies that generate positive cash flow will have the power to expand as they will have enough capital for capex.
- Debt-Equity Ratio: Debt-Equity-Ratio < 1, High debt can be a concerning factor as it indicates that the company is facing financial distress or can default on the debt obligation.
- Companies with governing Issues: It is very important to ignore those companies that have corporate governing or whose management is not reliable by looking at past litigation on them.
Words of Wisdom
“A man always has two reasons for what he does–a good one, and the real one.” ― J.P. Morgan
Key Takeaways
Long-Term Horizon: Coffee can investing involves a long-term perspective, where investors buy stocks and hold them for an extended period without frequent trading.
Minimal Portfolio Churn: The strategy emphasizes minimal portfolio turnover, reducing transaction costs and potential capital gains taxes.
Quality Stock Selection: Focuses on selecting high-quality stocks with strong fundamentals and the potential for long-term growth.
Reduced Market Timing: This avoids the need for frequent market timing decisions, as the focus is on the overall strength of the chosen stocks.
Risk Mitigation: Aim to mitigate risks associated with market volatility by holding a diversified portfolio of fundamentally sound stocks.
Steady Compounding: Aims to benefit from the compounding effect of long-term stock ownership, allowing investments to grow steadily over time.
Missed Opportunities: This investing style can lead to missed opportunities if an investor fails to adjust their portfolio to changing market conditions.
Holding onto underperformed: This approach can lead to losses if an investor holds onto underperforming assets for too long.
Conclusion
The coffee can investing style is an investment strategy where an investor buys stocks or other assets and holds onto them for a long time without making any changes or adjustments to the portfolio. This strategy is named after the practice of storing valuables in a coffee can for safekeeping.
The main advantage of the coffee can investing style is its simplicity. By investing in a diversified portfolio of high-quality assets and holding onto them for a long time, investors can avoid the costs and risks associated with frequent trading and market timing.
However, there are some drawbacks to this strategy. The coffee can investing style can lead to missed opportunities if an investor fails to adjust their portfolio to changing market conditions. In addition, it can also lead to losses if an investor holds onto underperforming assets for too long.
References
– Coffee Can Investing The Low-Risk Road to Stupendous Wealth by Saurabh Mukherjea
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