WARREN BUFFETT’S LETTER – 2004 – 2006

Warren Buffett’s Letter 2004

Mr.Buffett has explained why many of the investors do not able to create wealth by investing into the equities.

When we trade extensively then we incurred an additional cost which reduces our return. Also, many of us follow tips of others and rely on others which also reduces investment return. Many of people start investing when market continuously moving into upward direction with the fear of losing an opportunity to earn and get exit from the market when the market starts moving downward with the fear of losing investment. Rather we should increase our investment when the market is continuously moving downward.

Mr.Buffett has been explained that one of the ways to survive into the commodity-like business is to become a low-cost producer. Commodity business generally does not have pricing power and prices of a particular commodity are decided based on the demand & supply of a particular commodity so that they have to focus on the costs.

Warren Buffett’s Letter 2005

Investment + Cash per share at Berkshire Hathaway –

Per share value of non-insurance business –

During January – 2006, the price of a share of Berkshire Hathway – A was traded at $90,000.

Mr.Buffett’s thought on Moat –

The strong moat can result in a strong flow of float. If the company having a moat then the company has the ability to raise prices, getting the float, higher return ratios, raising market shares, etc.

Indian Companies Examples

One of the two-wheelers and commercial vehicle manufacturing company of India

One of the four-wheeler manufacturing company of India

We can see that float is also getting compound over a period of time which benefits to the company to survive for the long-term and to create wealth.

Why investors are not able to make money through the company can earn well –

Warren Buffett’s Letter 2006

Warren Buffett answer for his currency derivatives position –

We need to focus on avoiding mistakes which can spoil out our wealth. If we focus on avoiding mistakes then half of the battle, we won.

Mr.Buffett on Walter Schloss –

Mr.Buffett on people who clone others’ portfolio –

Mr.Walter Schloss is one of the investors who have an influence on my investment decisions. I keep his advice always with me. (Published at Safal Niveshak –

https://1icz9g2sdfe31jz0lglwdu48-wpengine.netdna-ssl.com/wp-content/uploads/2015/01/Walter-Schloss-16-Rules-to-Make-Money-in-Stock-Market.pdf )

Warren Buffett’s Letters 1957 – 2012

WARREN BUFFETT’S LETTER – 2001 – 2003

Warren Buffett’s Letter 2001

We need to analyze financial statements and notes to accounts with huge care so that we can identify flaws which management wants to hide.

Indian companies Examples – Companies having growing sales but the majority of sales from related parties.

The company engaged in manufactures pumps, motors, valves, and custom-built power systems/manifold blocks.

The company is a travel management company.

Warren Buffett’s Letter 2002

Acquisitions

Berkshire has made a five investments in the year 2002 which are Albecca (U.S. leader in custom-made picture Frames), Fruit of the Loom (the producer of about 33.3% of the men’s and boy’s underwear sold in the U.S. and of other apparel as well),CTB (a worldwide leader in equipment for the poultry, hog, egg production and grain industries), Garan (a manufacturer of children’s apparel, whose largest and best-known line is Garanimals) and The Pampered Chef – Founder Doris Christopher (in a business of manufacturing kitchen tools, food products, and cookbooks for preparing food in the home).

John Holland who is managing Fruit has Rescue Company from the disastrous path. We can see that if the management of the company is capable enough then he can run the business in a good manner rather than spoil it.

Two company from the same segment one has survived under the worst period and other has made a disaster.

The company has a sales growth, growth in cash balance, free cash flow for the cumulative period, a major portion of the assets side of the balance sheet is Net Block as a company is into the capital-intensive industry but investors of the company do not lose money.

Second company which has made a disaster 

Another company from the same segment where the company has does not have a sales growth, reduced cash balance, no free cash flow for the cumulative period, a major portion of the assets side of the balance sheet is other assets and investors of the company has lost money.

We can see that the management of the company plays an important role in making a company successful and survive during the worst period also.

Berkshire has made an investment into MidAmerican Energy Holdings in the year 1999 for $35.05/per share and per-share earnings of MidAmerican Energy Holdings in the year 1998 was $2.01 (P/E 17.44x, Earning yield of 5.73% – US interest rates during the year 1999 was similar to earning yield).

View on Derivatives

We should wait for the opportunity which is falling under our criteria and till that time we should be inactive. We should work for staying into the game rather than try to hit on each and every ball thrown to us.

I will be going to make a detail explanation regarding weak earning quality later on. But I learn from my Guru that we need to start analyzing every company by considering it as a “Chor” so that we will not be biased about the company. If our process proves that the company has not a weak quality of financial then only need to consider the company as a clean company.

Warren Buffett’s Letter 2003

Mr. Buffett has again mentioned waiting for an opportunity which matches our criterion.

Director of the company should have the freedom to make an independent decision and they also should be an owner of the company so that their interest and interest of shareholders will not have any kind of conflict.

One of the lesson if there is a bubble scenario and we know that the price at the business traded is much higher than what actually an intrinsic value of the business then we need to sell out our position.

Indian example

One of the wealth creator from IT segment. If we have sold out shares during an IT bubble period year 2000 at half price Rs.140 from the high price Rs.279. then we have lost return of 9% CAGR since the year 2000 (current price Rs.650). Now, we have bought Nifty Bees from those sold amounts then we have earned 13% CAGR till now.

Warren Buffett’s Letters 1957 – 2012

What can be a probable return from SENSEX in coming 10 years?

I have written on this topic is due to current market fall and fear into the mind of an investor. We are seeing many uncertainties hindering the growth of the economy, rising crude oil prices, commodity prices, fiscal deficit, banks NPA, government expenditure, rising interest rate, the success of GST, structural changes into the economy. All such events will impact the growth of business positively or negatively. If we try to put all such events into different scenarios then we can come to know what can be a probable return from SENSEX in coming 10 years.

For the calculation of probable return, I have taken a formula which is given by John P. Hussman. John P. Hussman is the U.S.A stock market analyst and owner of the hedge fund.

Formula –

Annualized Return (%) = (1+g)(future PE or P/BV / current PE or P/BV)^(1/T) – 1 + dividend yield (current PE or P/BV / future PE or P/BV + 1) / 2

G = Business earning growth,       P/E = Price to Earnings ratio,          P/BV = Price to Book Value ratio

Return of our investment is based on –

Business Earning Growth – Our investment return will grow if particular business earning will grow. Investment return is directly related with the earning of a business. If business survives for the longer period of time with generating the higher return on invested capital with earnings growth then we will able to earn a decent return from particular business.

Dividends – Dividends comes from the earning of the company. If a company distributes dividends to shareholders with growing earnings, the dividend is an additional return for the shareholders with the appreciation of business value. As per Mr.Buffett, if the company does not have a reinvesting opportunity available or business does not able to generate a higher return than the cost of capital then management should distribute earnings in form of dividends.

Changes in the valuation – the Stock price of the particular business is also affected by the changes in the valuation such as changes into the P/E, P/BV, P/S (Price to Sales) or Market Cap to Sales, etc.

Assumptions –

• Dividend yield (%) is assumed to be 0.50% to 1.00%.
• Business Earning Growth (%) is assumed 3.50% (a rate, which is half of the current GDP growth), 7% (current GDP growth rate) and 14% (twice of current GDP growth rate). Assuming average earnings growth of various businesses comprises SENSEX.
• Future P/E taken as 19x (Historical average of last 20 years since the year 1998), 21x (10% premium on historical average P/E) and 23x (20% premium on historical average P/E).
• Future P/BV taken as 3.29x (Historical average of last 20 years since the year 1998), 3.62x (10% premium on historical average P/BV) and 3.95x (20% premium on historical average P/BV).

We can use a similar kind of valuation matrix for the particular business itself. Here, I have also shown valuation calculation of an air cooler manufacturing company of India, I have calculated as I was at the year 2012 and what can be a probable return from particular business till the year 2022.

If we consider actual business performance then sales of the company have been grown by 17% CAGR since the year 2012 to the year 2018. But the stock price has been increased to Rs.2209 (high price and the current price is Rs.967) from Rs.130. This entire return is come to the stock only because of valuation multiple expansion such as P/E, P/BV, EV/EBITDA etc. Similar period has P/E increased to 85x (high P/E and current P/E is 46x) from 23.63x and P/BV increased to 33x (high P/BV and current P/BV is 11x) from 5.84x.

Disclosure – I am not using this valuation matrix in my investment journey till now. This is only one of the valuation matrix and we need to use a different appropriate valuation matrix for reaching to a value range.

Learn matrix from –

http://hussmanfunds.com/wmc/wmc050222.htm

https://www.gurufocus.com/stock-market-valuations.php

SIMPLE IS BETTER – ISSUE -12 – FUND FLOW ANALYSIS

We have seen in the previous simple is better to issue regarding profit and loss account in Issue-8, balance sheet in Issue-9, Relationship between balance sheet and profit & loss account in Issue-10, and Cash flow statement in issue-11. Analysis of balance sheet is essential for a better understanding of the financial strength of the company. Balance sheet majorly focuses on the sources from where we have brought the fund and at where we have deployed that fund.

Equity and liability side shows us a source of funds and assets side show us an application of the funds which we have brought.

We have to check in detail that does fund get proper utilization which company has to bring or not. For proper understanding, we need to prepare and analysis fund flow statement. Using fund flow analysis, we can come to that fund is effectively utilized by the management or not. This analysis also helps us to know where the fund is going and from where the fund is coming to the business. Does fund utilize to the wrong places or does fund brings from the sources which can be not favorable for the owners of the company?

For Detail Issue, Click here —> SIMPLE IS BETTER – ISSUE -12 – FUND FLOW ANALYSIS

WARREN BUFFETT’S LETTER – 1999 – 2000

Warren Buffett’s Letter 1999

Accepting mistakes – Mr. Buffett has accepted mistake of poor equity performance during the year 1999. Though they have a wonderful track record, they do not get trapped with the overconfidence, does not show any excuses, stay down to earth and stick with the reality.

Example of Management Quality

Example of Indian Companies

One of the footwear company in India

One of the diagnostic chain company of India

Mr. Buffett has given his view on Tech Companies –

We should have to define and written own investment philosophy and need to follow it strictly. If some of the investment opportunity does not fall under our investment philosophy then we should avoid it, though everyone else wants to capture a particular investment opportunity.

Business with a valuation –

Warren Buffett’s Letter 2000

Mr. Buffet has mentioned that line between speculation and investment is not clear and blur so we have to identify the investment process according to our course of action. The definition given by Mr. Benjamin Graham can be useful to us for identifying investment process – “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operation not meeting these requirements are speculative.”

Example of the Indian companies which have a higher related party transaction

One of the Cable manufacturing company

One of the spirit company of India

We have seen into the current scenario that when people have started believing that investing/speculating to the equities provides them a higher return (no one remembers what Ben Graham said for return – should expect reasonable return) then only bubble started to build up.

Warren Buffett’s Letters 1957 – 2012