The 2 Most Important Things to Focus On As an Investor

The United States Federal Reserve is one of the most powerful forces to be reckoned with in the global financial markets. So, it’s perhaps no surprise to find that market participants have an unrelenting focus on what the Fed has been and is going to do with regard to issues like its Quantitative Easing programme and the level of benchmark borrowing rates in the U.S.

This chart below, which comes from the Fed’s own research and looks at how U.S. long-term stock market returns are affected by Fed policy meetings (held by the organisation’s Federal Open Market Committee), says it all:

S&P500 and US Fed

Buffett: Not bothered by the Fed

But if you were to ask Warren Buffett how the Fed might affect his investment decision making, you might be surprised to know that he basically couldn’t care less. Buffett has built up a formidable reputation as an investor since the late 1950s (he’s arguably the best investor of our generation) and so when he speaks, it might pay for investors to listen.

The following words, which appeared in a recent interview he gave at CNBC, give us valuable insights on how macroeconomic factors – such as the Fed’s actions – influence his thoughts on investing:

“We’re not making any judgement on where the market’s going or we’re not looking at any macro factors. My partner Charlie Munger and I have been working together now 55 years. We’ve talked about every business you can imagine – and stocks. We’ve never had one decision that involved a macro factor. This doesn’t come up. I mean if I talked to Charlie about [unclear] or something we’re going to buy up in Alberta, or just anything, we don’t get into macro – it just doesn’t make any difference.

We do decide whether we think where the business will be in 10 years or 20 years, and we know what we’ll pay in terms of valuation. But we really don’t care whether the Fed is going to increase interest rates a hundred basis points or 200 basis points next week [emphasis mine].”

Buffett’s nonchalance about what the Fed does and the central bank’s influence on market returns (as per the chart above) might seem contradictory. But when you peel back the onion’s layers, you would realise that the American economy and its businesses had improved tremendously too – between 1994 and 2011, corporate earnings in the U.S. had tripled after accounting for inflation and economic output per person there increased by more than a quarter. So while the FOMC meetings might be important, they are far from being the only key driving force behind long-term U.S. stock market returns.

The key things to focus on

This thus brings me to the two most important things an investor should really focus on, which were also mentioned by Buffett:

1) The long-term future of the business you’re interested in.

2) The price you pay for the business in relation to its future prospects.

To give some real-life examples of why the above two factors are so important for investors, let’s consider the experience of the shipping outfit Cosco Corporation (Singapore) Limited (SGX: F83) and the healthcare provider Raffles Medical Group Ltd. (SGX: R01).

At the start of 2008, the two companies were valued at 38 and 22 times trailing earnings respectively. Those aren’t low valuations. But today, with Cosco’s profit having fallen by 90%, its shares are 88% lower in price. Meanwhile, Raffles Medical’s 140% jump in earnings had helped propel its share price close to 160% higher.

Over the past six-plus years since the start of 2008, the U.S. Fed has been busy keeping the country’s benchmark borrowing rates low and implementing three different iterations of its QE programme. These actions – and its ripple effects – are widely thought to be a boon to the prices of financial assets in many parts of the world. But like we’ve seen with Cosco, all of the Fed’s actions couldn’t affect the gravitational pull of the company’s corporate performance (and its unsustainable high valuation) on its eventual share price movement.

So like my colleague Morgan Housel once said, “Keep your eye on high-quality businesses, not government policy changes.” Bear this in mind when you invest – and forget about the Fed.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Raffles Medical.