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Learning from Warren Buffet Series – Part 5

Berkshire Hathaway Shareholder letter – 1983-85

Key Takeaways from the letters (in no particular order)

Learning 1

Allocation of capital is the key – Allocation of capital is the key factor to judge a business management or a fund manager. It is one of the most crucial factors which decide the fate of the business or fund. We as investors need to keep an eye on the capital allocation decisions of management. We often see management retaining large sums of the business earnings and reinvesting it in lower return of investment projects, unrelated businesses, just so that management can expand their empire or at times we see companies having a high dividend payout ratio when they actually need to deploy capital in their business. Both these circumstances are alarming. Market in general rewards management which has a history of good capital allocation decisions.

This is true for businesses and individuals alike as capital is not free, every decision we as individuals take to save, spend or invest capital matters.

Learning 2

Become a learning machine – To be successful one need to keep learning and updating oneself. To become a learning machine one has to voraciously read, think and aim to become little wiser every day. This concept been beautifully captured in an article on the Buffet formula in the widely read and followed blog “Farnam Street”. I strongly suggest that you read the full article here.

The biggest difficulty in life is not learning new things; it is to unlearn the old. Keynes articulated the problem crisply when he said: “The difficulty lies not in the new ideas but in escaping from the old ones.”

Learning 3

Invest in management who eat their own cooking – Buffet in his 1983 annual letter to shareholders lists down the major business principles which he follows and one of the most important one is that he has an ownership orientation instead of thinking like a manager. He and other directors are all major shareholders of Berkshire Hathaway. This is one of the key takeaways for us as investors – look for companies with high Promoter holdings or mutual funds where the fund managers have their own funds invested.

Learning 4

Study your failures rather than your success – Buffet emphasizes that both in life and other aspects of life studying and learning from your mistakes is of great importance. He embodies it by giving a full detailed account of his reason of shutting down the textile business and the loss in earnings caused by the delay in taking this decision.

Learning from our mistakes has one added advantage we tend to not repeat them again in future (hopefully). As Charlie Munger says “All I want to know is where I’m going to die so I’ll never go there.”

Learn more from Warren Buffet through previous parts of our series:

Part 1 | Part 2 | Part 3 | Part 4

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Learning from Warren Buffet Series – Part 4

This time, I have combined the key takeaways from 3 letters. Because, while Warren Buffet writes these letters with a gap of one year, we are trying to bring up these articles every month. So we need to avoid being repetitive. But, most of the knowledge imparted by him is so timeless and relevant, that we are forced to write about them again and again.

Berkshire Hathway Shareholder letter – 1980-82

Key learning from the letters (in no particular order)

Learning 1

Buy right and sit tight – If your purchase price is sensible, some long-term market recognition of the accumulation of retained earnings almost certainly will occur. If you are confident about your investment, you need to wait patiently. Pascal’s observation seems apt: “It has struck me that all men’s misfortunes spring from the single cause that they are unable to stay quietly in one room.” If there is ever a chart which can speak, I believe the below chart of BSE Sensex would just say “shut up and remain invested”.

Sensex journey and growth

Learning 2

Forecasting folly – Forecasts are useless especially in stock markets. Investors need to avoid falling for forecasts at any costs.   “Forecasts”, said Sam Goldwyn, “are dangerous, particularly those about the future.” Read why here.

Learning 3

Invest when there is blood on street – Investors need to be patient and invest when there is fear in the market, because it is during these market corrections that you will get handsome opportunities.

Learning 4

Avoid business in industries producing un-differentiated products – Businesses in industries with both substantial over-capacity and a “commodity” product (undifferentiated in any customer-important way by factors such as performance, appearance, service support, etc.) are prime candidates for profit troubles. Investors need to be wary of businesses in industries where there is no difference in products like sugar, textile, paper etc.

PayPal founder, Peter Thiel in his ground breaking book “Zero to One” says “All failed companies are the same: they failed to escape competition.”, and it is very difficult to escape competition if the product you are producing is undifferentiated.

Learn more from Warren Buffet through previous parts of our series:

Part 1 | Part 2 | Part 3

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LEARNING FROM WARREN BUFFET SERIES – PART 3

After a long cooling off period, here is our third part of the much liked series from Mr. Kshitiz Jain. This one should be read by everyone as the takeaways are extremely relevant for Indians.

Do participate in sharing the knowledge. Comment / Share / Like.

Berkshire Hathway Shareholder letter – 1979

Learning 1

Buffet explains that for investors to judge a good company the measure that should be focused on is Return on Capital Employed (ROCE). But, investors need to be careful of the factors like leverage, accounting measures etc. which can distort the ratios.

Learning 2

Buffet in his letter brings out two of the most important factors that impact the returns of individual investors i.e. Inflation and Taxation.

 “For the inflation rate, coupled with individual tax rates, will be the ultimate determinant as to whether our internal operating performance produces successful investment results – i.e., a reasonable gain in purchasing power from funds committed – for you as shareholders”

Learning 3

In my view, the below lines is what made Buffet so successful as an investor. It clearly brings out Buffet from the shadow of his teacher Benjamin Graham, who is widely known as the “father of value investing”. Quality of company should be the first criteria for an investor, only if this criterion is met, investor should look at prices.

“ Both our operating and investment experience cause us to conclude that “turnarounds” seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price.”

Learning 4

Buffet in this letter touches upon another common investment instrument i.e. Bonds. He suggests that investors should avoid investing in long tenor bonds, especially in an inflation-ridden world. According to him, fixed price contracts like bonds are nonexistent in virtually all other areas of commerce. Parties to long-term contracts now either index prices in some manner, or insist on the right to review the situation every year or so. Similarly, fixed rate bonds for long tenors, does not make sense as it is difficult to predict interest rate and inflation scenario for such a long term.

My two cents

Firstly, an important lesson which Buffet talks about is that investors should avoid instruments like fixed deposits (FD) which due to lower returns than inflation end up destroying the purchasing power of the investors. Investors should focus on the real return (Nominal return – inflation) generated by an instrument of company instead of the nominal return generated.

Secondly, taxation is another important factor that impacts an investor’s return. Inflation adjusted post tax return is actually what an investor will earn. For an investor’s money to grow, the post-tax return from an instrument should be more than inflation.

Equity is the only asset class which is known to give real returns over a long period of time. So for investors looking to create wealth over a long term, equity exposure is necessary.

Also read our LEARNING FROM WARREN BUFFET SERIES – PART 2 & PART 1

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Learning from Warren Buffet Series – Part 2

warren buffet investing

Here is the second in our Warren Buffet Series. (Refer Part 1). This one is quite interesting and relevant.

Do participate in sharing the knowledge. So do Comment / Share / Like.

Berkshire Hathaway Shareholder letter – 1978

Learning 1

Buffet warns investors against forecasting folly that prevails in the stock market. He clearly communicates to his shareholders his philosophy of investing for the long term. It helps him to align his shareholders expectation with his thinking.

“We make no attempt to predict how security markets will behave; successfully forecasting short term stock price movements are something we think neither we nor anyone else can do.  In the longer run, however, we feel that many of our major equity holdings are going to be worth considerably more money than we paid, and that investment gains will add significantly to the operating returns of the insurance group.”

Learning 2

Buffet highlights some of the characteristics of certain industries that need to be avoided by investors, by using his investment in Textile as an example. Again clearly admitting his mistakes head on.

  1. Slow capital turnover
  2. Low profit margins on sales
  3. Highly competitive landscape
  4. Capital intensive industry with low differentiation in goods

“The textile industry illustrates in textbook style how  producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage.  As long as excess productive capacity exists, prices tend to reflect direct operating costs rather than capital employed.  Such a supply-excess condition appears likely to prevail most of the time in the textile industry, and our expectations are for profits of relatively modest amounts in relation to capital.”

Learning 3

Buffet describes two facets of his highly successful investing style, which he feels is going to reap benefits for him and his shareholders over the years. Buffet and his partner Charlie Munger has been two of the best known proponents of this style of investing. i.e. Concentrated value investing. A concentrated value investor looks for a company where he can see more value than the market price and when he finds such an opportunity, he will invest a significant amount of his portfolio in that company.

My two cents

As investors in equity market or mutual funds, the 3 biggest learning from the letter are:

  1. Ignore the short term noise and focus on the long term. So markets will be volatile but as long term investors, all you need to know is that you are invested in the right funds and have some patience
  2. Avoid stocks or Mutual funds with portfolio of companies having bad quality businesses
  3. Invest only after making sure that there is margin of safety or to put it simply, invest at a price cheaper than its value and when you are convinced about the attractiveness, you need to invest a large percentage of your portfolio. For Mutual funds investors you can look for mutual fund managers playing by this style. Word of caution here, this is just one of the successful investing style and there are various other styles which have been highly successful.