Sunday, March 19, 2006

Widening the moat

Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger. If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous.

When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as "widening the moat." And doing that is essential if we are to have the kind of business we want a decade or two from now. We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted. Take a look at the dilemmas of managers in the auto and airline industries today as they struggle with the huge problems handed them by their predecessors. Charlie is fond of quoting Ben Franklin's "An ounce of prevention is worth a pound of cure." But sometimes no amount of cure will overcome the mistakes of the past.

Excerpt from "2005 Annual report of BERKSHIRE HATHAWAY INC." by Warren Buffett

Friday, March 17, 2006

Quote of the day

"When a problem exists, whether in personnel or in business operations, the time to act is now. " - Warren Buffett in his 2005 Annual Report of BERKSHIRE HATHAWAY INC.

"An ounce of prevention is worth a pound of cure." - Ben Franklin

Sunday, March 05, 2006

Quote of the day

“You can not teach a man anything; you can only help him discover it in himself.”

The investment framework

Though many people have tried to come out with their "investment strategies", I still find the principles in Ben Graham's "The Intelligent Investor" the most true and simplest:

  1. Think of a stock as a business not “things that wiggle around” (Chapter 8);
  2. let the markets serve you, not instruct you (also in Chapter 8);
  3. buy with a margin of safety (Chapter 20)

“Those three concepts are really all I know about investing,” Warren Buffett once said. “I’ve built everything on that structure. Those were the ones that applied in 1949, those are the ones that still apply today and will apply 100 years from now.”

Graham’s book was to Buffett as Buffett’s letters in his annual reports are to his shareholders: The framework.

And Graham was to Buffett as Buffett is to his followers: The teacher.

Friday, March 03, 2006

Great quotes

"Condoms aren't completely safe. A friend of mine was wearing one and got hit by a bus." Bob Rubin

"It is not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it - who look and sift the world for a mispriced bet - that they can occasionally find one. And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have odds. And the rest of the time, they don't. It's just that simple." - Charlie Munger

"It's better to be approximately right than to be precisely wrong."

"What we learn from history, is that we don't learn from history."

"Fear is a foe of the faddist, but the friend of the fundamentalist." - Warren Buffett

"There is one thing about which I am certain, and this is that there is very little about which one can be certain." - Somerset Maugham

"A committee is a group of people who keep minutes and waste hours." - Mark Mobius

"The stockmarket is a semi-psychotic creature given to extremes of elation and despair." - Warren Buffett

"The first chance you have to avoid a loss from a foolish loan is by refusing to make it; there is no second chance." - Charlie Munger

"Opportunity comes often. It knocks as often as you have a trained ear to hear it, an eye trained to see it, a hand trained to grasp it, and a head trained to use it."

"In the short-run, the market is a voting machine but in the long run, the market is a weighing machine." - Ben Graham

"We do not have an opinion about where the stock market, interest rates, or business activity will be a year from now. We've long felt that the only value of stock forecasts is to make fortune tellers look good. We believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children." - Warren Buffett

Bladder theory of corporate finance: "The more cash that builds up in the treasury, the greater the pressure to piss it away."

"The smarter side to take in a bidding war is often the losing side." - Warren Buffett

"The most dangerous words in the investment business are, "this time it's different."" - John Templeton

"If something can't go on forever, it will end." - Herb Stein

"You can fool most investors some of the time and some investors all of the time. But you can't fool most investors indefinitely." - Carol Loomis

"We have two classes of forecasters: Those who don't know - and those who don't know they don't know." - J.K.Galbraith

"This is a world inhabited not by people who have to be persuaded to believe but by people who want an excuse to believe." - J.K.Galbraith.

"You pay a very high price in the stock market for a cheery consensus." - Warren Buffett

"A fool and his money are soon invited everywhere." - Warren Buffett

"It's difficult for an empty sack to stand upright." - Ben Franklin

"Don't ask the barber whether you need a haircut." - Warren Buffett

"No matter how great the talent or effort, some things just take time: you can't produce a baby in one month by getting nine woman pregnant." - Warren Buffett

"One of the many unique and advantageous aspects of value investing is that the larger the discount from intrinsic value, the greater the margin of safety and the greater potential return when the stock price moves back to intrinsic value. Contrary to the view of modern portfolio theorists that increased returns can only be achieved by taking greater levels of risk, value investing is predicated on the notion that increased returns are associated with a greater margin of safety, i.e. lower risk." - The Partners of Tweedy Browne.

"Money is a good servant and a poor master."

"Chains of habit are too light to be felt until they are too heavy to be broken." - Warren Buffett

"It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently." - Warren Buffett

"If past history was all there was to the game, the richest people would be librarians."

"Rule No.1: Never lose money. Rule No.2: Never forget rule No.1."

"Someone's sitting in the shade today because someone planted a tree a long time ago."

"Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway."

"Risk comes from not knowing what you're doing."

"Go for a business that any idiot can run - because sooner or later, any idiot probably is going to run it."

"It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."

"The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell."

"If you have trouble imagining a 20% loss in the stock market, you shouldn't be in stocks."

Master classes -Buffett & Munger

Every year a handful of Australian investors make the trek to Omaha, Nebraska, to hear Warren Buffett and Charles Munger at the Berkshire Hathaway annual meeting.

Mark Nelson of Caledonia Investments has made the trip for the past 11 years. Why does he bother? "That's easy," he says. "We need to go. Put simply, this is the annual refresher course in common sense investing that we all need."

Tape recorders weren't allowed into the Berkshire or Munger's Wesco Financial meetings so Mark Nelson and his colleague Robert Luciano had to scribble fast.

Here are some of Buffett's and Munger's edited thoughts.

Shareholder: I was wondering how it was that you got interested in investing, and what advice you might give to a young person interested in investing?
Buffett: I got interested when I was about seven years old . . . when I was about 19, I read The Intelligent Investor by Benjamin Graham. My advice is to start young, and read everything you can. If you do that you'll always do well. There are no secrets in this industry that are only available to the priesthood. There are no temples, or secret tablets; it's all public information. You don't need a massive intellect but you do need the right temperament, and then constantly look for opportunities that fit your framework. If you enjoy the game then you'll do well.

Shareholder: My question concerns rising raw material prices and import costs.

Buffett: We love companies that haven't fully recognised their pricing power; where it's still untapped. You can measure a business over time by the agony they go through in raising prices. You're not in a great business if you have to have intense management debates and a prayer session before you raise prices.

Shareholder: What are your investment strategies if we do go into a prolonged bear market?

Buffett: If the market gets cheaper then we'll be able to buy a lot more. I'm always looking to buy stocks, just as I buy groceries every week. And obviously I prefer lower grocery prices. We're not good at predicting markets, and we spend little or no time talking or thinking about it. If you can buy very good companies at a good price, then it's crazy to not buy any stock, just because it might get a bit cheaper next year after a catastrophe. We pay very little attention to macro factors.

Shareholder: Corporate boards have been in the news recently due to both action and inaction. What responsibilities do directors now have? What do you look for?"

Munger: We're completely out of step with modern practices which try to get one director from each diverse discipline, and they all tend to need the money. We don't do that.

Buffett: It's a tough job to be a director, especially when you have to deal with mediocrity. It's very difficult for a director who needs $100,000 per year, and wants to get on new boards, to try and push for meaningful changes in a company. But independence is a state of mind, and you need to challenge the ideas of executives if they don't make sense.

You can't be truly independent though if 50 per cent of your income comes from board fees. You don't want to upset the applecart.

All Berkshire directors have a significant amount of wealth tied up in Berkshire. Their income from board fees is inconsequential to them. They are all very smart and hand picked. However, those who wish to use checklist approaches may not view the Berkshire board as favourable.

Shareholder: Berkshire hasn't really invested in technology stocks before. With Bill Gates on board as a director, will that change?

Buffett: No. Charlie and I still want to understand the companies we invest in. We need to believe that we know what the economics will look like in 20 years' time. The fact that some other person has a wider circle of competence doesn't really matter. Mind you, I'll listen to what he says. I still wish I'd bought Microsoft when I first met him.

Shareholder: What other approved criteria do you have apart from financial criteria, when you are analysing your businesses?

Buffett: The financial returns being achieved in a way that we want them to be achieved is still the key for us. If a business becomes permanently flawed, then we will sell it. If it has been merely disappointing but still has potential, we will continue to hold it. We don't like to participate in what I call gin-rummy investing, where you keep discarding your least attractive investment of the moment in favour of something else.

Shareholder: What about benchmark risk?

Munger: If you're an investment manager and you're going to get fired if you don't beat your benchmark, then you'll do some strange things to make sure that doesn't happen. We are in a benchmarking world right now. You often get investors who are really closet indexers, in which case you're being played for a sucker. These guys have 85 per cent of their assets linked to the index, and they charge big fees.

Shareholder: Do you have a book recommendation for us this year?

Munger (earlier in the meeting): You really should read Fiasco, a book about the Morgan Stanley bond traders by Frank Partnoy. It'll make your stomach turn. The other book, Conspiracy of Fools, by Kurt Eichenwald, about the collapse of Enron, is also excellent. The most sickening aspect of it all is the description of the investment banks' behaviour. I always think that every now and then it's good to rub your nose in the worst aspects of human civilisation; it certainly improves your judgement going forward.

Shareholder: With Wal-Mart-type businesses now growing so large, is that a danger to our economic way of life?

Munger: I think that the country is way better off by having Wal-Mart. It's a fabulous enterprise that adds a lot of value to the customer. I also think that McDonald's is one of the great educational institutions in the world. Working there teaches young people to come to work on time, how to earn a wage, and then they go on to another, better job. I think it often does more good work, for a lot more people, than Harvard.

Shareholder: You've said previously that 15 or so great investments have made the difference for Berkshire. What have been some of their common characteristics?

Munger: Well, they all worked. But they have been very different. It does emphasise just how few great investments you really need in a lifetime. Patience and aggressive opportunism are part of our game. People who have to make an acquisition every month, will eventually crater.

Excerpt from "DeepWealth"

How Buffett does it

The book, "How Buffett Does It", is a step-by-step guidebook for investing like Buffet in any market environment. This book presents 24 ideas Buffet has followed from day one:

1. Choose Simplicity over Complexity
When investing, keep it simple. Do what's easy and obvious. If you don't understand a business, don't buy it.

2. Make Your Own Investment Decisions
Don't listen to the brokers, the analysts, or the pundits. Figure it out for yourself. Become a value investor. It's proven to be a very rewarding technique over the long term.

3. Maintain Proper Temperament
Let other people overreact to the market. To succeed in the market, you need only ordinary intelligence. But in addition, you need the kind of temperament to help you ride out the storms and stick to your long-term plans. If you can stay cool while those around you are panicking, you can surely prevail.

4. Be Patient
Think 10 years, rather than 10 minutes. Don't dwell on the price of stocks. Instead, study the underlying business, its earnings capacity and its future. If the question is, "How long will you wait?" ¨C "If we're in the right place, we'll wait indefinitely" says Buffet.

5. Buy Business, Not Stocks
Once you get into the right business, you can let everyone else worry about the stock market. Business performance is the key to picking stocks. Study the long-term track record of any company that is on your buy list. Buffet looks for following five main things before investing in a company.
(i) Business he can understand
(ii) Companies with favorable long-term prospects
(iii) Business operated by honest and competent people
(iv) Businesses priced very attractively
(v) Business with free cash flow
Don't think about "stock in the short term." Think about "business in the long term".

6. Look for a Company that is a Franchise
Some businesses are "franchises". Franchise generates free cash flows.

7. Buy Low-Tech, Not High-Tech
Successful investing is rarely a gee-whiz activity. It's less often about rockets and lasers and more often about bricks, carpets, paint, shaving blades and insulation. Do not be tempted by get-rich-quick deals involving relatively complex companies (e.g., high-tech companies). They are the most unpredictable in the long run. Look for the absence of change. Look for the business whose only change in the future will be doing more business, e.g Gillette Blades.

8. Concentrate Your Stock Investments
A the "Noah's Ark" style of investing ¨C that is, a little of this, a little of that. Better to have a smaller number of investments with more of your money in each. Portfolio concentration ¨C the opposite of diversification ¨C also has the power to focus the mind. If you're putting your eggs in only a few baskets, you're far less likely to make investments on impulse or emotion.

9. Practice Inactivity, Not Hyperactivity
There are times when doing nothing is a sign of investing brilliance. Be a decade's trader, not a day trader.

10. Don't Look at the Ticker
Tickers are all about prices. Investing is about a lot more than prices. It is about value. It is about wealth. Abstain from looking at share prices every day. Study the playing field and not the scoreboard. Know the value of something rather than the price of everything.

11. View Market Downturns as Buying Opportunities
Market downturns aren't body blows; they are buying opportunities. Change your investing mind-set. Reprogram your thinking. Learn to like a sinking market because it presents great buying opportunity. Pounce when the three variables come together. When a strong business with an enduring competitive advantage, strong management, and a low stock price come onto your investment screen.

12. Don't Swing at Every Pitch
What if you had to predict how every stock in the Standard & Poor's (S&P) 500 would do over the next few years? In this scenario you have very poor chance of being correct. But if your job was to find only one stock among those 500 that would do well? In this revised scenario you have a good chance. A few good investments are all that is needed.

13. Ignore the Macro; Focus on the Micro
The big things ¨C the large trends that are external to the business ¨C don't matter. It's the little things, the things that are business-specific, that count. It's possible to imagine a cataclysm so terrible that the markets would collapse and not bounce back. Externalities don't matter ¨C and you can't predict them, anyway. And what can you do about them? Focus on what you can know: the workings of a good business.

14. Take a Close Look at Management
The analysis begins ¨C and sometimes ends ¨C with one key question: Who's in charge here? Assess the management team before you invest. A investing in any company that has a record of financial or accounting shenanigans, (creative accounting, accounting jugglery). Weak accounting usually means weak business performance. Strong companies do not have to resort to tricks.

15. Remember, The Emperor Wears No Clothes on Wall Street
Wall Street is the only place where people go to in Rolls Royce to get advice from people who take the subway. Ignore the charts. A value investor is not concerned with charts. Invest like Benjamin Graham. Graham told investors to "search for discrepancies between the value of a business and the price of small pieces of that business in the market." This is the key to value investing, and it's far more productive than getting dizzy studying hundreds of stock charts. Offer documents of most mutual funds say ¨C in small print ¨C that past performance is no guarantee of future success. Buffet says the same thing about the market: If history revealed the path to riches, librarians would be rich.

16. Practice Independent Thinking
When investing, you need to think independently. Make independent thinking one of your portfolio's greatest assets. Being smart isn't good enough, says Buffet. Lots of high-IQ people fall victim to the herd mentality. Independent thinking is one of Buffet's greatest strengths. Make it one of your own.

17. Stay within Your Circle of Competence
Develop a zone of expertise, operative within that zone. Write down the industries and businesses with which you feel most comfortable. Confine your investments to them.

18. Ignore Stock Market Forecasts
Short-term forecasts of stock or bond prices are useless. They tell you more about the forecaster than they tell you about the future. Take the time you would spend listening to forecasts and instead use it to analyze a business's track record. Develop an investing strategy that does not depend on the overall movement of the market.

19. Understand "Mr. Market" and the "Margin of Safety"
What makes for a good investor? A good investor is one who combines good business judgment with an ability to ignore the wild swings of the marketplace.

When the emotions start to swirl, remember Ben Graham's "Mr.Market" concept, and look for a "margin of safety". Make sure that you also understand Buffet's concepts of Mr. Market and the margin of safety.

Like the Lord, the market helps those who help themselves. But, unlike God, the market doesn't forgive those who "know not what they do".

Bide your time, and wait for Mr. Market to get depressed and lower stock prices enough to provide a margin-ofsafety buying opportunity.

20. Be Fearful when Others Are Greedy and Greedy When Others Are Fearful
You can safely predict that people will be greedy, fearful, or foolish. Trouble is you just can't predict when or in what order. Buy when people are selling and sell when people are buying.

21. Read, Read Some More, and Then Think
Mr. Warren Buffet spends something like six hours a day reading and an hour or two on the phone. The rest of the time, he thinks. He therefore advises to get in the habit of reading. The best thing to start is to read Buffett's annual reports and letters. Finally, restrict your time only to things worth reading.

22. Use All Your Horsepower
How big is your engine, and how efficiently do you put it to work? Warren Buffett suggests that lots of people have "400 ¨C horsepower engines" but only 100 horsepower of output. Smart people, in other words, often allow themselves to get distracted from the task at hand and act in irrational ways. The person who gets full output from a 200-horse-power engine, says Buffett, is a lot better off. Make sure that you have the right role models. Strive for rational behaviour, good habits, and proper temperament. Write down the habits, practices and philosophies that you want to make your own. Then be sure to keep track of them and eventually own them. Financial success is a "matter of having the right habits".

23. Learn from the Costly Mistakes of Others
This is self explanatory and need no comments!

24. Become a Sound Investor
Buffet says that Ben Graham was about "sound investing". He wasn't about brilliant investing or fads and fashions, and the good thing about sound investing is that it can make you wealthy if you are in not too much of a hurry, and it never makes you poor. To become a sound investor, you need to develop sound investing habits. Always fight the noise to get the real story. Always practice continuous improvement. It's about finding and stepping over "one-foot hurdles" rather than developing the extraordinary skills needed to clear sevenfoot hurdles.

Excerpt from "deepwealth"

Thursday, February 23, 2006

Charlie Munger on The importance of reading

"In my whole life, I have known no wise people (over a broad subject matter area) who didn't read all the time -- none, zero... You'd be amazed at how much Warren reads -- at how much I read. My children laugh at me. They think I'm a book with a couple of legs sticking out." by Charlie Munger (May 9, 2003)

Charlie Munger's Investing mental models

"You need a different checklist and different mental models for different companies. I can never make it easy by saying, 'Here are three things.' You have to derive it yourself to ingrain it in your head for the rest of your life." by Charlie Munger (May 15, 2002)

"You must know the big ideas in the big disciplines, and use them routinely -- all of them, not just a few. Most people are trained in one model -- economics, for example -- and try to solve all problems in one way. You know the old saying: to the man with a hammer, the world looks like a nail. This is a dumb way of handling problems." by Charlie Munger (May 15, 2000)

Charlie Munger on How to get rich

A young shareholder asked Munger how to follow in his footsteps, and Munger brought down the house by saying, "We get these questions a lot from the enterprising young. It's a very intelligent question: You look at some old guy who's rich and you ask, 'How can I become like you, except faster?'" (May 9, 2003)

Munger's reply was: "Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts... Slug it out one inch at a time, day by day, at the end of the day -- if you live long enough -- most people get what they deserve." (May 9, 2003)

Stock Market Predictions

“I don't know if we'll ever see stocks in general at mouthwatering levels that we saw in 1973-4 or 1982 even. I think there's a very excellent chance that neither Warren or I will see those opportunities again, but that's not all bad. We'll just keep plugging away.” by Charlie Munger (2003 Annual Meeting)

“It's not out of [the realm of] possibility though. You can never predict what markets will do. In Japan, a 10 year bond is yielding 5/8 of 1%. [Who could have ever imagined that?]” by Warren Buffett (2003 Annual Meeting)

Happiness and Success

“I tell college students, when you get to be my age you will be successful if the people who you hope to have love you, do love you. Charlie and I know people who have buildings named after them, receive great honors, etc., and nobody loves them -- not even the people who give them honors. Charlie and I talk about wouldn't it be great if we could buy love for $1 million. But the only way to be loved is to be lovable. You always get back more than you give away. If you don't give any you won't get any. Everybody loves Don Keough [former senior executive and Board member of Coca Cola]. There's nobody I know who commands the love of others who doesn't feel like a success. And I can't imagine people who aren't loved feel very successful.” by Warren Buffett (2003 Annual Meeting)

“You don't want to be like to motion picture exec who had so many people at his funeral, but they were there just make sure he was dead. Or how about the guy who, at his funeral, the priest said, "Won't anyone stand up and say anything nice for the deceased?" and finally someone said, "Well, his brother was worse."” by Charlie Munger (2003 Annual Meeting)

Warren Buffett on Preparing for the future

"Imagine that you had a car and that was the only car you'd have for your entire lifetime. Of course, you'd care for it well, changing the oil more frequently than necessary, driving carefully, etc. Now, consider that you only have one mind and one body. Prepare them for life, care for them. You can enhance your mind over time. A person's main asset is themselves, so preserve and enhance yourself."


"I agree. We took an $88 million loss to get out of Gen Re's derivative business. Many companies have similar problems, but don't want to face up to them. You're seeing the unwinding of a derivative book in the Enron debacle. You couldn't devise a worse system. It's like hell." by Warren Buffett (2002 Annual Meeting)

“Charlie and I think that there is a low but not insignificant probability that at some time -- I don't know when; it could be three years, it could be 20 years -- derivatives could lead to a major problem. The problem grows as derivatives get more complex. We hoped to give a mild wakeup call to the financial world that there's a problem. In the energy sector, derivatives destroyed or almost destroyed institutions that shouldn't have been destroyed. [He mentioned Enron.]” by Warren Buffett (2003 Annual Meeting)

“In engineering, people have a big margin of safety. But in the financial world, people don't give a damn about safety. They let it balloon and balloon and balloon. It's aided by false accounting. I'm more pessimistic than Warren. I'll be amazed if we don't have some kind of significant blowup in next 5-10 years.” by Charlie Munger (2003 Annual Meeting)

Warren Buffett on Feedback mechanisms

"Having a good partner is key. Charlie will not accept anything I say because I say it. It's great to have a partner who will tell you when you're thinking is wrong."

"Having good feedback mechanisms is terribly important. We have a very good system."

Warren Buffett on Index funds

"Just pick a broad index like the S&P 500. Don't put your money in all at once; do it over a period of time. I recommend John Bogle's books -- any investor in funds should read them. They have all you need to know."

Warren Buffett on Shorting stocks

"It's an interesting item to study. It's ruined a lot of people. You can go broke doing it."

"You'll see way more stocks that are dramatically overvalued than dramatically undervalued. It's common for promoters to cause a stock to become valued at 5-10 times its true value, but rare to find a stock trading at 10-20% of its true value. So you might think short selling is easy, but it's not. Often stocks are overvalued because there is a promoter or a crook behind it. They can often bootstrap into value by using the shares of their overvalued stock. For example, it it's worth $10 and is trading at $100, they might be able to build value to $50. Then, Wall Street says, "Hey! Look at all that value creation!" and the game goes on. [As a short seller,] you could run out of money before the promoter runs out of ideas." (2001 Annual Meeting)

"Charlie and I have agreed on around 100 stocks over the years that we thought were shorts or promotions. Had we acted on them, we might have lost all of our money, every though we were right just about every time. A bubble plays on human nature. Nobody knows when it's going to pop, or how high it will go before it pops." (2002 Annual Meeting)

"I had a harrowing experience shorting a stock in 1954. I wouldn't have been wrong over 10 years, but I was very wrong after 10 weeks, which was the relevant period. My net worth was evaporating."

Warren Buffett on How to avoid fraud

"There's no short answer on how to avoid fraud. But there are whole fields where there's too much fraud, so we avoid them."

"We've been defrauded very infrequently over the years. If we do get defrauded, it'll be by someone carrying [Ben Franklin's] Poor Richard's Almanac under his arm."

"Crooks are often obvious. For example, Robert Maxwell's nickname was 'The Bouncing Check,' yet Salomon was trying to lend him money until three weeks before he went under. Wall Street has no filter, as long as there's profit."

Warren Buffett on Turnarounds vs. One-Foot Hurdles

"A further related lesson: Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers."

"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."

Warren Buffett on Losing and Regaining Competitive Advantage

“There aren't many examples of companies that lose and then regain competitive advantage. I have a friend who likes taking over lousy businesses and trying to turn them into great businesses [I wonder whether he was referring to Jack Byrne of White Mountains Insurance?]. I asked him for examples of this [bad businesses turning into good businesses] over the past 100 years [and he couldn't name very many].”

“One example: Pepsi lost its edge post-WW II when costs went up, but they successfully changed. To some extent Gillette lost its competitive edge in the 1930s to penny blades, but then regained it.”

“But generally speaking, when a company loses its edge, it's very difficult to regain. Packard [cars] went downscale one year and never regained its upscale image. Department stores have done this. You can always juice sales by going down market, but it's hard to go back up market.”

Warren Buffett on The Borsheim Advantage

“The Borsheim selections are sent all over the country, some to people no one at Borsheim's has ever met. (They must always have been well recommended, however.) While the number of mailings in 1990 was a record, Ike has been sending merchandise far and wide for decades. Misanthropes will be crushed to learn how well our "honor-system" works: We have yet to experience a loss from customer dishonesty. At Borsheim’s, we attract business nationwide because we have several advantages that competitors can't match. The most important item in the equation is our operating costs, which run about 18% of sales compared to 40% or so at the typical competitor. (Included in the 18% are occupancy and buying costs, which some public companies include in "cost of goods sold.") Just as Wal-Mart, with its 15% operating costs, sells at prices that high-cost competitors can't touch and thereby constantly increases its market share, so does Borsheim's. What works with diapers works with diamonds.”

Warren Buffett talks about his Purchase of Nebraska Furniture Mart

“One question I always ask myself in appraising a business is how I would like, assuming I had ample capital and skilled personnel, to compete with it. I’d rather wrestle grizzlies than compete with Mrs. B and her progeny. They buy brilliantly, they operate at expense ratios competitors don’t even dream about, and they then pass on to their customers much of the savings. It’s the ideal business - one built upon exceptional value to the customer that in turn translates into exceptional economics for its owners.”

Warren Buffett on Inevitables

“Of course, Charlie and I can identify only a few Inevitables, even after a lifetime of looking for them. Leadership alone provides no certainties: Witness the shocks some years back at General Motors, IBM and Sears, all of which had enjoyed long periods of seeming invincibility. Though some industries or lines of business exhibit characteristics that endow leaders with virtually insurmountable advantages, and that tend to establish Survival of the Fattest as almost a natural law, most do not. Thus, for every Inevitable, there are dozens of Impostors, companies now riding high but vulnerable to competitive attacks. Considering what it takes to be an Inevitable, Charlie and I recognize that we will never be able to come up with a Nifty Fifty or even a Twinkling Twenty. To the Inevitables in our portfolio, therefore, we add a few "Highly Probables."”

Wednesday, February 22, 2006

Warren Buffett talks about his Purchase of Wells Fargo

“Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled - often on the heels of managerial assurances that all was well - investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.”

Tuesday, February 21, 2006

Warren Buffett on Investing expectations

"We think people whose expectations were set from 1982 - 1999 will be disappointed [with future investment returns]. But there's nothing wrong with earning 6% annually on your money, in a world of low inflation."

Munger: "One of the smartest things a person can do is dampen investment expectations, especially with Berkshire. That would be mature and responsible. I like our model and we should do nicely."

"The problem is the starting point in predicting modest returns for equity investors. [Expectations were too high.] In 1999, a Gallup poll showed people expected 15% [returns from stocks] in a low inflation environment. In a low inflation environment, how much will GDP grow? If there's 2% inflation and 3% [real] growth, that's 5%. This will be the rate of corporate growth, so if you add dividends, you get 6-7% [annualized returns] before frictional costs -- and investors incur high frictional costs (they don't have to, but they do) -- which adds up to 1.5%. [This 4.5-5.5% is] not bad."

Warren Buffett on Capital Expenditure

“Such an attitude is clearly delusional. At 95% of American businesses, capital expenditures that over time roughly approximate depreciation are a necessity and are every bit as real an expense as labor or utility costs. Even a high school dropout knows that to finance a car he must have income that covers not only interest and operating expenses, but also realistically-calculated depreciation. He would be laughed out of the bank if he started talking about EBDIT.”

“Capital outlays at a business can be skipped, of course, in any given month, just as a human can skip a day or even a week of eating. But if the skipping becomes routine and is not made up, the body weakens and eventually dies. Furthermore, a start-and-stop feeding policy will over time produce a less healthy organism, human or corporate, than that produced by a steady diet. As businessmen, Charlie and I relish having competitors who are unable to fund capital expenditures.”

Warren Buffett on Acquisitions

"GEICO is a great business. Over the past 20 years, they've done three acquisitions to get into new businesses and they've all been disasters. Why when you have a wonderful business would you want to get into an inferior business? It happens time after time after time. Charlie and I have no such inclinations."

“In making acquisitions, Charlie and I have tended to avoid companies with significant post-retirement liabilities. As a result, Berkshire's present liability and future costs for post-retirement health benefits - though we now have 22,000 employees - are inconsequential. I need to admit, though, that we had a near miss: In 1982 I made a huge mistake in committing to buy a company burdened by extraordinary post-retirement health obligations. Luckily, though, the transaction fell through for reasons beyond our control. Reporting on this episode in the 1982 annual report, I said: "If we were to introduce graphics to this report, illustrating favorable business developments of the past year, two blank pages depicting this blown deal would be the appropriate centerfold." Even so, I wasn't expecting things to get as bad as they did. Another buyer appeared, the business soon went bankrupt and was shut down, and thousands of workers found those bountiful health-care promises to be largely worthless.”

Warren Buffett on Growth

“We face another obstacle: In a finite world, high growth rates must self-destruct. If the base from which the growth is taking place is tiny, this law may not operate for a time. But when the base balloons, the party ends: A high growth rate eventually forges its own anchor.”

“Carl Sagan has entertainingly described this phenomenon, musing about the destiny of bacteria that reproduce by dividing into two every 15 minutes. Says Sagan: "That means four doublings an hour, and 96 doublings a day. Although a bacterium weighs only about a trillionth of a gram, its descendants, after a day of wild asexual abandon, will collectively weigh as much as a two days, more than the sun - and before very long, everything in the universe will be made of bacteria." Not to worry, says Sagan: Some obstacle always impedes this kind of exponential growth. "The bugs run out of food, or they poison each other, or they are shy about reproducing in public."

"We don't want people focusing on growth. It's suicide [in the insurance business]."

Warren Buffett on Stock Options

“Shareholders should understand that companies incur costs when they deliver something of value to another party and not just when cash changes hands. Moreover, it is both silly and cynical to say that an important item of cost should not be recognized simply because it can't be quantified with pinpoint precision. Right now, accounting abounds with imprecision. After all, no manager or auditor knows how long a 747 is going to last, which means he also does not know what the yearly depreciation charge for the plane should be. No one knows with any certainty what a bank's annual loan loss charge ought to be. And the estimates of losses that property-casualty companies make are notoriously inaccurate.”

“Does this mean that these important items of cost should be ignored simply because they can't be quantified with absolute accuracy? Of course not. Rather, these costs should be estimated by honest and experienced people and then recorded. When you get right down to it, what other item of major but hard-to-precisely-calculate cost - other, that is, than stock options - does the accounting profession say should be ignored in the calculation of earnings?”

“Moreover, options are just not that difficult to value. Admittedly, the difficulty is increased by the fact that the options given to executives are restricted in various ways. These restrictions affect value. They do not, however, eliminate it. In fact, since I'm in the mood for offers, I'll make one to any executive who is granted a restricted option, even though it may be out of the money: On the day of issue, Berkshire will pay him or her a substantial sum for the right to any future gain he or she realizes on the option. So if you find a CEO who says his newly-issued options have little or no value, tell him to try us out. In truth, we have far more confidence in our ability to determine an appropriate price to pay for an option than we have in our ability to determine the proper depreciation rate for our corporate jet.”

“It seems to me that the realities of stock options can be summarized quite simply: If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?”

Warren Buffett on Selling Policy

“Sometimes, of course, the market may judge a business to be more valuable than the underlying facts would indicate it is. In such a case, we will sell our holdings. Sometimes, also, we will sell a security that is fairly valued or even undervalued because we require funds for a still more undervalued investment or one we believe we understand better.”

“We need to emphasize, however, that we do not sell holdings just because they have appreciated or because we have held them for a long time. (Of Wall Street maxims the most foolish may be "You can't go broke taking a profit.") We are quite content to hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business.”

“Selling, however, is a different story. There, our pace of activity resembles that forced upon a traveler who found himself stuck in tiny Podunk's only hotel. With no T.V. in his room, he faced an evening of boredom. But his spirits soared when he spied a book on the night table entitled "Things to do in Podunk." Opening it, he found just a single sentence: "You're doing it."”

“Interestingly, corporate managers have no trouble understanding that point when they are focusing on a business they operate: A parent company that owns a subsidiary with superb long-term economics is not likely to sell that entity regardless of price. "Why," the CEO would ask, "should I part with my crown jewel?" Yet that same CEO, when it comes to running his personal investment portfolio, will offhandedly - and even impetuously - move from business to business when presented with no more than superficial arguments by his broker for doing so. The worst of these is perhaps, "You can't go broke taking a profit." Can you imagine a CEO using this line to urge his board to sell a star subsidiary? In our view, what makes sense in business also makes sense in stocks: An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.”