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.
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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