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Seven Investment Lessons from the Greatest Investment Mind

Published on March 6, 2008

Seven Investment Lessons from the Greatest Investment Mind

March 6, 2008

Mr Warren Buffet’s latest shareholder’s letter has been recently released and if you haven’t read it yet, download a copy and read it. His letters are no less than an investment book which is available for free for the general public. Pay close attention to what he says and what are his investment philosophies and I am sure you will be able to find some insights.

Let’s begin with the results first:

In the 43 Years he has been leading the club, Berkshire Hathaway has grown its book value from $19 to $78,008 a rate of 21.1% CAGR which is more than twice the returns that one would have gotten from S&P over the same period.

Here are my seven take-aways from the recent shareholder’s letter. There are many more nuggets, it depends on how you interpret the letter and below is in no way meant to capture all.
Know Your Business: Although thousands of books have been written on this, but I think without really understanding the essence of it, one can’t understand what does this mean. Read the letter to see how much he knows about the business he is in, the people who runs it and how he values the business for a long time to own. Just like previous letters, this letter is full of examples. If I were to interpret in my own way, even at this age, in his sleep he can talk to you about that business, can tell you the economics and why this business has a long term future. It amazes me how much he knows about the people who run the show.

“I think our rare and hard-to-replicate managerial structure gives Berkshire a real advantage”

Sure he has his own share of mistakes that he has called out in the letter, but he was more right than wrong and the magnitude of right was more that that of loss which is what makes him a winner. He sums-up business categories this way “Think of three types of “savings account”. The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on the deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappoint returns”. He has explained “Moat” in such a simple way that I would like you read and won’t write here. He is very good story-teller and ha good sense of humor. I am sure you will enjoy reading Mamon acquisition story.

Being In touch with the trends: Although, underlying investing philosophy remains the same, He has stayed in touch with the changes in the industry dynamics. An example is given that during the past two decades more emphasis has been given to the development of earnings from the non-insurance business. For 14 year period, compounded annual gain in per-share investment has declined from 42.8% to 25.6% to 14.3% for insurance business while it has increased from 11.1% to 19.1% to 23.5% for non-insurance business.

The Party is over. It’s a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008”

Higher education does not mean Smart: Business are run by people and the best people are not the only one with greatest resumes (pointing to MBAs). He points to Susan Jacques who came to Borsheims 25 years ago as a $4-an-hour sales woman. She was appointed as CEO in 1994 because “She is smart, she loves the business and she loves her associates”. Another example if of Cathy Baron Tamraz (Busienss Wire) who began her career as cab driver. He focuses on brain, passion and integrity while choosing managers for his businesses.

Sell when price is ahead of True Value: I think he has learned his lessons from CocaCola when it was priced way too high in the $75s 10 years ago and he didn’t sell it even though it was way above true value at that time, as it was part of permanent holding. He cashed out of Petrochina last year when Petrochina was flying high netting eight times in 5 years (US$ 4billons vs $488million investment). Now this cash can be used for other attractive opportunities. Of course the key is to know when your business is “ahead of true value”. To know how, there are two things which every investor must be aware of before investing.

  • Know the business and
  • Know how to Value the business
  • Just to share how Mr Buffett values business once they are part of BH. Rather then valuing those businesses by market value (share price X number of shares), he values it by a) Improvement in earnings and b) widening of the “moats”- a metaphor for the superiorities the business possess to make life difficult for their competitors.

    Accept Facts, Develop a big picture to develop new opportunities: The house prices will fall and as move downward “a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out and what are we are witnessing today at some of our largest financial institutions is an ugly sight”. I found another comment to be quite interesting where he quoted John Stumpf of Wells Fargo as saying “it is interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine”. As I was reading this, it was reminds me of Nouriel Roubilni’s article “12 steps to economic disaster”. Just in case if you don’t know, Mr Buffet has taken premiums worth US$4.5billion from investors who bought insurance from hm against four major stock markets (S&P 500 and 3 major foreign indices) heading lower in 15-20 years. The puts in these contracts are exercisable only at their expiration which will occur between 2019 and 2027. Talk about value investing? Probably the biggest option trader on the planet isn’t it and he knows how to charge premium on increased IV aka catastrophic insurance?

    Get the house in order first: He has painted a very clear picture of the Sovereign Wealth Funds (SWF).

    This is our doing, not some nefarious plot by foreign governments. Our trade equation guarantees massive foreign investment in the US. When we force-feed $2 billions daily to the rest of the world, they must invest in something here. Why should we complain when they choose stocks over bonds?

    The U.S.needs to adopt policies that reduces deficit and lower dollar in the not the cure. He has given several example of increasing trade deficit even thought dollar has fallen vs several currencies. Separately, to understand more about currencies, read his perspective on a) Brazilian real and b) Euro vs. US$ in an Amazon bond investment scenario.

    Don’t confuse memo with reality- Fanciful figures : This is rather a long story but Mr Buffett hits at the core of accounting. During the 20th century, the Dow advanced from 66 to 11,497. This is a 5.3% CAGR. In order to generate similar amounts in the 21st century, the Dow needs to close at about 20,000,000 on December 31, 2099!! We are now in the eighth year and have racked only 2000 points of the 1,988,000 Dow points to generate 5.3%.

    You expect 10% per annum from equities this century do the math yourself or read the letter.

    Beyond many soft points, the above were my key takeaways from the latest letter. Read it, digest it, and then re-read it time to time. It’s straight from the biggest investment wizard of the past 100 years. I am happy to have had sometime with him, Q&Ad and have him paid for my lunch.

    Adopted from the latest letter and written for the interest of the OP Blogreaders for free.

    Profitable trading, OP

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