Value Investing

Breaking Down Buffett

From GDS Investments

On February 24, Warren Buffett made his annual letter public and although it didn’t contain any new insight into CEO succession, it did contain its usual trove of investment (and life) wisdom. Here are a few highlights, starting with this paragraph about how to think about common stocks:

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Page 9: “Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of media pundits.”
Page 9: “Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure longterm growth in value. For the last 53 years, the company has built value by reinvesting its earnings and letting compound interest work its magic. Year by year, we have moved forward. Yet Berkshire shares have suffered four truly major dips. Here are the gory details:

March 1973-January 1975: High 93, Low 38 (Decrease of 59.1%)
10/2/87-10/27/87: High 4,250, Low 2,675 (Decrease of 37.1%)
6/19/98-3/10/2000: High 80,900, Low 41,300 (Decrease of 48.9%)
9/19/08-3/5/09: High 147,000, Low 72,400 (Decrease of 50.7%)

This table offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.”
Page 11: “Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period – or even to look foolish – is also essential.”

Glenn’s bottom line: A winning investment strategy is one that ignores short term noise and instead, evaluates and emphasizes the long term fundamentals of a business. Act only when business value comfortably exceeds stock value.

Page 12: “I want to quickly acknowledge that in any upcoming day, week or even year, stocks will be riskier – far riskier – than short-term U.S. bonds. As an investor’s investment horizon lengthens, however, a diversified portfolio of U.S. equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates.

"It is a terrible mistake for investors with long-term horizons – among them, pension funds, college endowments and savings-minded individuals – to measure their investment “risk” by their portfolio’s ratio of bonds to stocks. Often, high-grade bonds in an investment portfolio increase its risk.”

Excellent point he makes about risk and time horizon. Risk is tied to valuation, a point that seems lost on many bond investors today. Adding overvalued assets into a diversified portfolio doesn’t decrease the overall risk of the portfolio – it does the opposite!

 

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