WARREN BUFFETT’S LETTER – 1990-91

WB Letter 1990

Mr. Buffett mentioned that we need to thoroughly analyze earnings and accounting numbers; we should not focus on the big auditor names.

WB 1990 01

Low prices and low cost of operations for their Jewelry and furniture business creates huge volume growth. Such a low cost of operation is difficult to adopt by competitors.

While we are analyses an insurance company then we check combined ratio for the measuring profitability of the insurance company but with it, we need to check –

WB 1990 02

WB 1990 03

Mr. Buffett mentioned that the majority of the companies follows what their peers are doing though they seem foolish.

WB 1990 04

Example of PSUs & Private Bank

i) PSU Bank

PSU

ii) Private Bank

Private

We should not focus on the buying an only a cheap companies without knowing the quality of assets on which they seem cheap. We can see that PSUs banks have majorly traded at discount compare too few private banks which have a quality of books. PSUs banks seem cheap on the basis of Price to Book Value but the quality of books is questionable, which we have already experienced.

WB 1990 05

Mr. Buffett has mentioned some of the qualities of management which we also can check when we make any investment.

WB 1990 06

As an investor, we need to always focus on the Margin of Safety which is mentioned by the Ben Graham. The margin of Safety provides us a safeguard against any errors occurs by us.

WB 1990 07

WB Letter 1991

In long run, our investment returns will occur through the stock prices but stock prices are derivatives of the future earnings of the business. If a business is not performing well, earnings not grown in future then stock prices also not given us return in long run. So that we need to keep a focus on the business performance, earnings growth driver of business rather keep a focus on the stock price performance.

WB 1991 01

When we talk about the strong franchise of business then we should focus on the criterion into the business which mentioned by Mr. Buffett. All businesses do not fall under the mentioned criterion but those businesses fall under mentioned criterion those can earn a higher return on capital for the longer period of time through price it’s product/services aggressively. If business having a strong franchise then we does not require a strong management to run the business.

WB 1991 02

Liquor is a desired of people and customers does not have any close substitute (legal) of it but in India, the price of liquor is regulated so that we cannot say that liquor business has a strong economic franchise. Watching movies at the multiplex is a desired of people, no close substitute is available for it and also a price of the ticket is not regulated.

Whereas those businesses which do not have strong franchises then those businesses can only earn decent from a low-cost production of products/services or a shortage of products/services. And shortage does not stay for a longer period of time. Shortage of particular product with huge industry size invite more players into the industry which reduces the profitability. Continuously remaining low-cost producer, business needs to be run by the strong management or else business will not sustain as a low-cost producer for the long period of time.

WB 1991 03

We generally provide difference valuations to the businesses where we can foresee constant earning with the lower capital requirement and where we cannot foresee earning with cyclical business nature. Mr. Buffett has explained this concept by mentioning Media business and steel business. He mentioned that we believe that media business having a constant revenue and steel business having a cyclical business nature but when media business has started to getting deteriorate then we revise our way to value media business.

See’s Candy

Berkshire Hathway had bought See’s Candy through Bluechip stamp in the year 1972. A company owned $7 million of tangible net worth with $10 million of excess cash. A seller had asked $30 million (cash adjusted) for the 100% ownership of See’s candy. Buffett and Charlie were ready to pay only $25 million for See’s. Buffett and Charlie have been experienced a pricing power to the business and they felt lucky that seller agreed to sell See’s at $25 million to Berkshire. See’s sales grown from $29 million to $196 million and pre-tax profit has grown from $4.2 million in the year 1972 to $42.4 million in the year 1990.

H.H.Brown

Berkshire has made an investment in the H.H.Brown company, which is a shoe manufacturing business. H.H.Brown is a leading manufacturer of work shoes and boots in North America. Mr. Buffett knows that shoe business is tough to perform due to higher inventories and receivables but he has experienced that H.H.Brown has done well in the leadership of Frank and Mr. Heffernan.

WB 1991 04

If we got a good business which is run by a good manager in the bad industry then we should check such business as an investment candidate.

Berkshire Hathway earns from holding policyholders fund which Mr. Buffett called as “Float”.

WB 1991 05

WB 1991 06

Berkshire Hathway has beat government bond in 20 years from 25 years till the year 1991 and cost of the fund remains satisfactory which help Berkshire Hathway to grow well. Insurance business of the company sustain well, increases float. Lower cost of float and Berkshire has compound it in a good manner which is a major strength of the company for being an out-performer.

Mr. Buffett has mentioned that they don’t like to trade business to business. He considers that He & Charlie are not as much smart to earn well by buying and selling businesses for a longer period of time. He likes to buy a business which has a long-term economic characteristic, run by quality people and available at a sensible price.

Mistake Du Jour

In this section, Mr. Buffett has written about the mistakes which he has incurred. He believes that people cannot able to see mistakes incurred by Berkshire, that does not reduce the cost associated with mistakes. Berkshire has missed few opportunities such as esoteric invention (such as Xerox), high-technology (Apple), or even brilliant merchandising (Wal-Mart) but they do not consider it as their mistake. Such type of the businesses does not fall under their competence area to understand so they have missed it. Few mistakes which they have occurred from their competence area.

In the year 1988, they decided to purchase 30 million shares of Federal National Mortgage Association (Fannie Mae). They owned stocks since earlier years and also understand the business. But when they have bought 7 million shares and the stock price has started moving upside and they have stopped buying it. They do not want to repeat mistakes which they occurred while buying shares of Coca-Cola, they have to keep on buying shares of Coca-Cola though the price has moving upward. But here, they sold 7 million shares which they hold due to a small position. Such a mistake has cost to Berkshire is about $1.40 billion.

Warren Buffett’s Letters 1957 – 2012

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “INVESTING DEFENSIVELY”

ID 01

Whenever someone asks us for an investment advice, then our first step must be an understanding his attitude towards the risk and return. We need to ask a question to him that what his choice – making money or avoiding losses is.

We cannot able to do both the things simultaneously in each and every situation.

If we provide an advice or we make an own investment without knowing attitude towards risk and return then we will not able to provide a proper solution. This is as similar as an asking for a cure from a doctor without disclosing our diseases to him. Investing is a full of bad bounces, uncertainty and random events which challenge us every time. So that such uncertainty requires knowing our risk-reward attitude for long-term survival into the market.

While we hit fewer losers then our probability to win the game is much higher. We need to choose how to play the game of investment – Offensive or Defensive.

ID 02

We just need to do is to protect our wealth by not picking wrong opportunities. In investing, only avoiding losers is in our control, not everything else. We do not know what will happen in the future, our best investment can be turnout as the worst investment. But we have to be ready for it. We have to focus on missing wrong shots so that can protect game if our best turnouts as a worst.

ID 03

If we look at the sports, many a time we need to protect our wicket rather play aggressively to make scores. Staying on a pitch provide us an opportunity for making a score while we get a good hitting opportunity. Investing also having many points which are similar to the game either positive or negative. As in cricket, Dhoni, Sachin, Rahul Dravid, Virat all having a different style to play a game. Some play defensive, some play aggressive and some make the balance of it. We cannot able to judge any players by looking towards his one match. Successful players perform well over a longer period of time with consistency.

ID 04

Sometimes even a good players overestimate short-term success and forget to focus on the consistency of performance over a longer period of time.

ID 05

As all players cannot be a Sachin, Dhoni, Dravid. As similarly, all investors cannot be a Warren Buffett, Charlie Munger, Howard Marks, etc. We just need to focus on our game in our comfort zone.

We are not able to know what will the result of the game we played, any uncertainty can affect it. We cannot only focus on one single investment ideas, we need to work on a selective group of ideas.

Negative side – If we keep on playing an aggressive investment game then we might not able to stick for the longest period of time in the game. Many uncertain events work as bounces for us.

Many a time, short-term investment success can become a reason to ignore the durable and consistent track record of investors. And few get attracted towards shine without checking its durability.

When opponents try to keep on throwing bounces then referee blows the whistle to give warning sign to opponents but in investing, there is no one who blows the whistle, we cannot able to get protected. Also in sports, we get notifications for the change of turn from our to opponents. But in investing, there is no notifications are available to us. We have to decide ourselves for changing the game from offensive to defensive.

We need to focus on the outperform into the bad time rather focus on outperforming into the good & best time. In good time, everyone can able to generate a good return but skill comes when we can able to outperform into the bad time. Doubled your Money in Last 3 Years? Skill or Luck?

Every player can able to play well against a weak team but a good player who can able to play well against strong opponents.

ID 06

We should focus on either making more score or stay on the pitch for a longer period of time. We cannot say that only one way is the right way and we just need to select it. Selection of way can be based on our experience, learning, market environments in which we operate, etc.

ID 07

We require a different kind of mindset for doing a right thing and avoiding doing the wrong thing.

Defense is focused on avoiding bad outcomes. It can help us to generate a higher returns but more through avoiding bad outcomes, through missing bounces, through managing risk.

If we bought an asset at Rs.100 and it falls to Rs.50; it falls by 50% but for reaching to Rs.100, that asset has to rise by 100% to just reach break-even.

ID 08

When we play offensive and if it works then it will add additional returns to our investment. BUT if not works then it creates a damage to our investment and to our wealth.

Defensive game help us to stay in the game during a tough time also, it helps us to survive for a longer period of time.

Majority of a time, financial markets works in an average manner but it shows one abnormal day which has reason to destroy our financial health. We need to prepare for that worst day. We just can prepare for the worst day but cannot predict how worst it can be or when that worst day will come. But it’s sure that worst day will come.

ID 09

It is hard to say in investing that whether our investment becomes successful or not and it works in the future as we have expected, economy /industries / Companies moves in a certain way and we prove to be right every time. We need to take care of the unforeseen future events which can go against us and can meltdown us. Warren Buffett has given concept which can protect us from such unforeseen events that called “Margin of Safety”.

ID 10

When we buy Rs.100 worth of an investment for Rs.90 then we have a chance to gain. But when we buy that same thing at Rs.70 then we have very less chance of loss and if odds will be in our favor then we can able to make a good return. So that buying cheaper provide us a “Margin of Safety” when our assumptions go wrong.

In the over-optimistic scenario, people buy Rs.100 worth of investment avenue for more than its worth (I.e. Rs.150, Rs.160) and then find a greater fool who will buy at the higher price from him.

ID 11

ID 12

When we need an above-fixed returns then we need to go for more uncertainty but how to balance the defensive game with the inclusion of offense is the key area to focus. We cannot get higher returns with the exclusion of offensive game. We cannot able to win the match by just keep on making a single run. We need to hit 4 & 6 but with also focus on not losing a wicket.

Our first focus is to play a defensive game for staying on the pitch and then the inclusion of offense to the game for generating higher returns. Such approach provides us a consistency for a longer period of time.

ID 13

If we take out a history of investment managers, investors then we will come to know that very few get survival for the longer period of time. Not due to their inability to make a 4 & 6 but to lose wickets in many matches. Many investors come and performed well in a good time but worst time make them disappears.

The managers who do not get survived for a longer period, the majority of them have built up their portfolio on based of favorable scenario and with the hope of likelihood of outcomes without keeping a room for the occurrence of an error.

ID 14

Aggressive investors require competitive technical skills with fortitude, patient mindset, and capital. The investment might have potential to work well in a long-term but above quality provides a support to stay in a game for a long term.

ID 15

We should focus on controlling risk, avoiding losses rather than try to focus on gaining again and again.

ID 16

Simply defensive investing means being scared while making an investment decision. Worrying about losses, bad luck, worrying about something we don’t know, bounces etc.

ID 17

Read for more detail: The Most Important Thing Illuminated by Howard Marks