The annual letter to the shareholders from Warren Buffett and Charlie Munger (published in Feb’19) is one of the things that the investment community watches out for — many things to learn therefrom. We have pulled out some excerpts and our takeaway on the same.
1. Certainty of gains with uncertainty of time
“Focus on operating earnings, paying little attention to gains or losses of any variety. My saying is that in no way diminishes the importance of our investments to Berkshire. Over time, Charlie and I expect them to deliver substantial gains, albeit with highly irregular timing.”
Despite being an investor from more than 76 years, an investor like Buffet too is uncertain on the timing. But his confidence in the gains in the investments is intact. There is a very important lesson for all the investors out here who intend to time the market by entering and exiting the market “at the right time”.
Berkshire in 16 years out of 54, has recorded underperformance over S&P 500 index but still managed to outperform the index by ~11% CAGR.
What is important here is substantial gain and not the timing.
2. Corporate Governance
“Over the years, Charlie and I have seen all sorts of bad corporate behavior, both accounting and operational, induced by the desire of management to meet Wall Street expectations. What starts as an “innocent” fudge in order to not disappoint “the Street” – say, trade-loading at quarter-end, turning a blind eye to rising insurance losses, or drawing down a “cookie-jar” reserve – can become the first step toward full-fledged fraud. Playing with the numbers “just this once” may well be the CEO’s intent; it’s seldom the end result. And if it’s okay for the boss to cheat a little, it’s easy for subordinates to rationalize similar behavior.”
In last one year, in the Indian market as well, the corporate governance has become one of the prime importance and any company with some question on the governance is immediately reflected in the market price of the stock. Going forward, it is likely that it will remain as one of the important parameters for the selection of a particular company for investment. But clearly the integrity of the management in the business is becoming rarer and more invaluable.
In Buffet’s own words; “in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you.
3. Focus on value investing and not predicting near term stock price movements
“My expectation of more stock purchases is not a market call. Charlie and I have no idea as to how stocks will behave next week or next year, Prediction of that sort have never been a part of our activities. Our thinking, rather is focused on calculation whether a portion of an attractive business is worth more than its market price.”
Find a business whose market value is lower than its intrinsic value and consider buying the equity of such business. One should avoid getting into predicting the movement in the market price of the stock in the shorter run.
Although everyone knows it (that they don’t know) but everyone wants to (predict). That is the hard irony!
4. De-focus on the short-term
“For 54 years our managerial decisions at Berkshire have been made from the viewpoint of the shareholders who are staying, not those who are leaving. Consequently, Charlie and I have never focused on current-quarter results. Berkshire, in fact, may be the only company in the Fortune 500 that does not prepare monthly earnings reports or balance sheets.”
Quarterly results and daily news are just a distraction for the long term investors. They should focus on where the business is moving and whether this business or this company is likely to do well in the future and the valuations at which one has entered is likely to improve or not.
5. Debt can become fatal at unpredictable intervals
“At rare and unpredictable intervals, however, credit vanishes and debt becomes financially fatal. A Russian roulette equation – usually win, occasionally die…. Rational people don’t risk what they have and need for what they don’t have and don’t need.”
While the view of our and his matches in this context the Russian quote is worth looking at which says Usually Win; occasionally die! That one period (occasion) can kill the entire company and there are enough examples available in our Indian stock market which proves that such situations have proved fatal.
Rational people don’t risk what they have and need – for – what they don’t have and don’t need. A trade-off here is clearly a lesson not only in the investments but in routine life if we can digest this fact then it will give us a winning edge over others. And in this world where there is a very thin line of difference between need and luxury and the availability of finance making that line thinner; clearly states the importance of that statement.
6. Upward Averaging
“Berkshire made an offer to buy the remaining 50% of the company for $2.3 billion, about 50 times what we had paid for the first half (and people say I never pay up!).”
After 17 years of 1st investment, he paid 50 times price of what he paid for the first time buying the shares of that same very company. So the message is that not only there is a concept of downward averaging but there is also a concept of upward averaging in investment when your view is long term and you are there to make a big buck!
What we all do is downward averaging and especially in the time of falling prices with the intention to bring down the average cost so that we can exit early at a better profit! However, it’s very difficult to do the same thing in the times of rising prices – which we have termed it as “Upward averaging” and this is something we believe only an investor with true conviction with a strong will can do it. It’s surely not an easy thing for a regular investor.
7. Don’t listen to preachers of doom, if your outlook is long-term
“Those who regularly preach doom because of government budget deficits (as I regularly did myself for many years) might note that our country’s national debt has increased roughly 400-fold during the last of my 77-year periods. That’s 40,000%! Suppose you had foreseen this increase and panicked at the prospect of runaway deficits and a worthless currency. To “protect” yourself, you might have eschewed stocks and opted instead to buy 31⁄4 ounces of gold with your $114.75.”
Every now and then especially in this year, there have been discussions about the fiscal deficit being out of control and people getting worried for the economy. We believe India is a country with great potential for growth and clearly such macro numbers would likely to underrate the growth that this country is likely to provide.
8. Substance over form
“A new GAAP rule requires us to include (loss from mark-to-market in investment holdings) in earnings. As I emphasized in the 2017 Annual report, neither Berkshire’s vice chairman, Charlie Munger nor I believe that rule to be sensible. Rather, both of us have consistently thought that at Berkshire this mark-to-market change would produce “wild and capricious swings in the bottom line”.
“For example, management sometimes assert that their company’s stock-based compensation shouldn’t be counted as an expense. (What else could it be – a gift from shareholders?)”
Change in reported earnings due to mark to market profit/loss arises due to fluctuation in price. An investor should check whether this fluctuation is because of a change in business or mere market speculation. In contrast, treating stock-based employee compensation as the expense is important to arrive at the true profitability of the company.
One has to see and watch out for the real effect in the books rather than purely going on the reported numbers. Reporting happens according to the accounting rules which may or may not be the right way to look at a particular set of numbers. A quote from Abraham Lincoln on the subject further proves the point – ‘If you call a dog’s tail a leg, how many legs does it have? The answer will still remain Four, because calling a tail a leg doesn’t make it one’.
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