Some nuggets from the sage of Omaha, all in his own words
• From the Noah principle and the need to adapt, to what really counts in investing
The lockdown provides a unique, albeit somewhat unwelcomed, opportunity to do some alwaysmeant-to-do-but-never-gotaround-to-doing reading.
What follows are selected extracts from Warren Buffett’s letters to Berkshire Hathaway shareholders written between 1980 and 2000. Except for a few words, the content is all Buffett.
The reason for not inserting additional comments is twofold: it seems unnecessary, and the interference could be annoying given Buffett’s unique style of communicating. Here, then, are some untainted thoughts from the sage of Omaha on:
The Noah principle: Predicting rain doesn’t count, building arks does. (1981)
The need to adapt: While investors and managers must place their feet in the future, their memories and nervous systems often remain plugged into the past. It is much easier for investors to utilise historic price:earnings ratios or for managers to utilise historic business valuation yardsticks than it is for either group to rethink their premises daily. When change is slow, constant rethinking is actually undesirable; it achieves little and slows response time. But when change is great, yesterday’s assumptions can be retained only at great cost. And the pace of economic change has become breathtaking. (1981)
A too-high price: The market, like the Lord, helps those who help themselves. But unlike the Lord, the market does not forgive those who know not what they do. For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favourable business developments. (1982)
The institutions: You might think that institutions, with their large staffs of highly paid and experienced investment professionals, would be a force for stability and reason in financial markets. They are not: stocks heavily owned and constantly monitored by institutions have often been among the most inappropriately valued. (1985)
Reported earnings: As long as investors — including supposedly sophisticated institutions — place fancy valuations on reported “earnings” that march steadily upward, you can be sure that some managers and promoters will exploit GAAP (Generally Accepted Accounting Principles) to produce such numbers, no matter what the truth may be. (1988)
What counts: It’s true that in the long run the scoreboard for investment decisions is market price. But prices will be determined by future earnings. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard. (1991)
The long and the short of it: We do not see this long-term focus as eliminating the need for us to achieve decent short-term results as well. After all, we were thinking long-range thoughts five or 10 years ago, and the moves we made then should now be paying off. If plantings made confidently are repeatedly followed by disappointing harvests, something is wrong with the farmer. (Or perhaps with the farm: investors should understand that for certain companies, and even for some industries, there simply is no good longterm strategy.) Just as you should be suspicious of managers who pump up short-term earnings by accounting manoeuvres, asset sales and the like, so also should you be suspicious of those managers who fail to deliver for extended periods and blame it on their long-term focus. Even Alice, after listening to the Queen lecture her about “jam tomorrow”, finally insisted, “It must come sometimes to jam today.” (1992)
Financial innovations: As citizens, Charlie [Munger, Berkshire vice-chair] and I welcome change. Fresh ideas, new products, innovative processes and the like cause our country’s standard of living to rise, and that’s clearly good. As investors, however, our reaction to a fermenting industry is much like our attitude towards space exploration: we applaud the endeavour but prefer to skip the ride. (1996)
How to invest: To invest successfully you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects.
In our view though, investment students need only two well-taught courses: how to value a business, and how to think about market prices. Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, 10 and 20 years from now. If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes. (1996)
Growth versus value: Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent [that] they provide clues to the amount and timing of cash flows into and from the business.
Indeed, growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years. Market commentators and investment managers who glibly refer to “growth” and “value” styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component — usually a plus, sometimes a minus — in the value equation. (2000)
IN INVESTING, AS IN BASEBALL … ONE MUST WATCH THE PLAYING FIELD, NOT THE SCOREBOARD
GROWTH IS SIMPLY A COMPONENT — USUALLY A PLUS, SOMETIMES A MINUS — IN THE VALUE EQUATION