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"