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Warren Buffett--Tap Dancing to Work
by Fortune journalist Carol Loomis
Why Stocks Beat Gold and Bonds February 27, 2012 An excerpt from Buffett’s letter to shareholders in the 2011 Berkshire Hathaway annual report (p. 321)
· Gold is a barren asset; bonds are seldom rewarding to investors; well-chosen productive assets like common stocks and land are the logical prospects to deliver superior returns. (p. 321).
· Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire Hathaway we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power— after taxes have been paid on nominal gains— in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date. (p. 322).
· From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability— the reasoned probability— of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a nonfluctuating asset can be laden with risk. (p. 322).
· Investment possibilities are both many and varied. There are three major categories,
1. Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge. Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control. (pp. 322-323).
High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments— and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label. Under today’s conditions, therefore, I do not like currency-based investments. Even so, Berkshire holds significant amounts of them, primarily of the short-term variety. At Berkshire the need for ample liquidity occupies center stage and will never be slighted, however inadequate rates may be. Accommodating this need, we primarily hold U.S. Treasury bills, the only investment that can be counted on for liquidity under the most chaotic of economic conditions. Our working level for liquidity is $ 20 billion; $ 10 billion is our absolute minimum. (p. 323).
Beyond the requirements that liquidity and regulators impose on us, we will purchase currency-related securities only if they offer the possibility of unusual gain— either because a particular credit is mispriced, as can occur in periodic junk-bond debacles, or because rates rise to a level that offers the possibility of realizing substantial capital gains on high-grade bonds when rates fall. Though we’ve exploited both opportunities in the past— and may do so again— we are now 180 degrees removed from such prospects. Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.” (p. 323).
2. The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else— who also knows that the assets will be forever unproductive— will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century. (p. 324).
The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end. (p. 324).
Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers— for a time— expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.” (p. 324).
Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard “cash is king” in late 2008, just when cash should have been deployed rather than held. Similarly, we heard “cash is trash” in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort. (p. 325).
3. My own preference— and you knew this was coming— is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM, and our own See’s Candy meet that double-barreled test. Certain other companies— think of our regulated utilities, for example— fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets. (p. 325).
People will forever exchange what they produce for what others produce. Our country’s businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial “cows” will live for centuries and give ever greater quantities of “milk” to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. (p. 325).
Berkshire’s goal will be to increase its ownership of first-class businesses. Our first choice will be to own them in their entirety— but we will also be owners by way of holding sizable amounts of marketable stocks. I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we’ve examined. More important, it will be by far the safest. (p. 326).
Buffett Takes Charge April 27, 2009 BY MARC GUNTHER (p. 289).
· Some Warren Buffett investing rules: when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is usually the reputation of the business that remains intact. You should invest in a business that even a fool can run, because someday a fool will. And perhaps most famously, Never invest in a business you cannot understand. (p. 289).
Buffett’s Big Bet June 23, 2008 BY CAROL LOOMIS (p. 279).
· The basic issue, obviously, is costs. Still pushing the theme laid out in “Cut Your Gains!” (see page 247), Buffett believes that the management and incentive fees charged by funds of funds and the hedge funds arrayed beneath them typically leave their investors earning less than a market index fund does. Protégé believes that its funds of funds will perform well enough to provide investors a net return (after fees) better than the market. p. 279).
· As for the fees that investors pay in the hedge fund world— and that, of course, is the crux of Buffett’s argument— they are both complicated and costly. A fund of funds normally charges a 1% annual management fee. The hedge funds it puts that money into charge an annual management fee of their own, which for funds of funds is typically 1.5%. (The fees are paid quarterly by an investor and are figured on the value of his account at the time.) So that’s 2.5% of an investor’s capital that continually goes for these fees, regardless of the returns earned during a year. (pp. 282-283).
· On top of the management fee, the hedge funds typically collect 20% of any gains they make. That leaves 80% for the investors. The fund of funds takes 5% (or more) of that 80% as its share of the gains. The upshot is that only 76% (at most) of the annual return made on an investor’s money accrues to him, with the rest going to the “helpers” that Buffett has written about. Meanwhile, the investor is paying his inexorable management fee of 2.5% on capital. The summation is pretty obvious. For Protégé to win this bet, the five funds of funds it has picked must do much, much better than the S& P. (p. 283
· Warren Buffett: Agree A lot of very smart people set out to do better than average in securities markets. Call them active investors. Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore the balance of the universe— the active investors— must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors. Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested. A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds. (pp. 283-284).
What Warren Thinks… April 28, 2008 BY NICHOLAS VARCHAVER (p. 272).
· The 150 students that Buffett talked to on that April day were among 2,400, from 31 different schools, who visited Berkshire in the 2007– 2008 school year. By the 2011– 2012 year Buffett had faced up to the demands on his time and cut back to around 1,450 students. But that left him still devoting one Friday a month to a crowd: 160 students, split among 8 schools each entitled to 20 slots. (p. 272).
· when people panic, when fear takes over, or when greed takes over, people react just as irrationally as they have in the past. (p. 274).
· It’s very, very hard to regulate when you get into very complex instruments where you’ve got hundreds of counterparties. The counterparty behavior and risk was a big part of why the Treasury and the Fed felt that they had to move in over a weekend at Bear Stearns. And I think they were right to do it, incidentally. Nobody knew what would be unleashed when you had thousands of counterparties with, I read someplace, contracts with a $ 14 trillion notional value. Those people would have tried to unwind all those contracts if there had been a bankruptcy. What that would have done to the markets, what that would have done to other counterparties in turn— it gets very, very complicated. So regulating is an important part of the system. The efficacy of it is really tough. (pp. 274-275).
· How do you get your ideas? I just read. I read all day. I mean, we put $ 500 million in PetroChina. All I did was read the annual report. [Editor’s note: Berkshire purchased the shares five years ago and sold them in 2007 for $ 4 billion.] (p. 275).
· What advice would you give to someone who is not a professional investor? Where should they put their money? Well, if they’re not going to be an active investor— and very few should try to do that— then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They’re not going to be able to pick the right price and the right time. What they want to do is avoid the wrong price and wrong stock. You just make sure you own a piece of American business, and you don’t buy all at one time. (pp. 275-276).
· How does the current turmoil stack up against past crises? Well, that’s hard to say. Every one has so many variables in it. But there’s no question that this time there’s extreme leveraging and in some cases the extreme prices of residential housing or buyouts. You’ve got $ 20 trillion of residential real estate and you’ve got $ 11 trillion of mortgages, and a lot of that does not have a problem, but a lot of it does. In 2006 you had $ 330 billion of cash taken out in mortgage refinancings in the United States. That’s a hell of a lot— I mean, we talk about having $ 150 billion of stimulus now, but that was $ 330 billion of stimulus. And that’s just from prime mortgages. That’s not from subprime mortgages. So leveraging up was one hell of a stimulus for the economy. (p. 276).
· The scenario you’re describing suggests we’re a long way from turning a corner. I think so. I mean, it seems everybody says it’ll be short and shallow, but it looks like it’s just the opposite. You know, deleveraging by its nature takes a lot of time, a lot of pain. And the consequences kind of roll through in different ways. Now, I don’t invest a dime based on macro forecasts, so I don’t think people should sell stocks because of that. I also don’t think they should buy stocks because of that. (p. 276).
· Your OFHEO example implies you’re not too optimistic about regulation. Finance has gotten so complex, with so much interdependency. I argued with Alan Greenspan some about this at [Washington Post chairman] Don Graham’s dinner. He would say that you’ve spread risk throughout the world by all these instruments, and now you didn’t have it all concentrated in your banks. But what you’ve done is you’ve interconnected the solvency of institutions to a degree that probably nobody anticipated. And it’s very hard to evaluate. If Bear Stearns had not had a derivatives book, my guess is the Fed wouldn’t have had to do what it did. (p. 277).
· Do you find it striking that banks keep looking into their investments and not knowing what they have? I read a few prospectuses for residential-mortgage-backed securities— mortgages, thousands of mortgages backing them, and then those all tranched into maybe 30 slices. You create a CDO by taking one of the lower tranches of that one and 50 others like it. Now if you’re going to understand that CDO, you’ve got 50-times-300 pages to read, it’s 15,000. If you take one of the lower tranches of the CDO and take 50 of those and create a CDO squared, you’re now up to 750,000 pages to read to understand one security. I mean, it can’t be done. When you start buying tranches of other instruments, nobody knows what the hell they’re doing. It’s ridiculous. And of course, you took a lower tranche of a mortgage-backed security and did 100 of those and thought you were diversifying risk. Hell, they’re all subject to the same thing. I mean, it may be a little different whether they’re in California or Nebraska, but the idea that this is uncorrelated risk and therefore you can take the CDO and call the top 50% of it super-senior— it isn’t super-senior or anything. It’s a bunch of juniors all put together. And the juniors all correlate. (p. 277).
· What should we say to investors now? The answer is you don’t want investors to think that what they read today is important in terms of their investment strategy. Their investment strategy should factor in that (a) if you knew what was going to happen in the economy, you still wouldn’t necessarily know what was going to happen in the stock market. And (b) they can’t pick stocks that are better than average. Stocks are a good thing to own over time. There’s only two things you can do wrong: You can buy the wrong ones, and you can buy or sell them at the wrong time. And the truth is you never need to sell them, basically. But they could buy a cross section of American industry, and if a cross section of American industry doesn’t work, certainly trying to pick the little beauties here and there isn’t going to work either. Then they just have to worry about getting greedy. You know, I always say you should get greedy when others are fearful and fearful when others are greedy. But that’s too much to expect. Of course, you shouldn’t get greedy when others get greedy and fearful when others get fearful. At a minimum, try to stay away from that. (p. 278).
· By your rule, now seems like a good time to be greedy. People are pretty fearful. You’re right. They are going in that direction. That’s why stocks are cheaper. Stocks are a better buy today than they were a year ago. Or three years ago. (p. 278).
· But you’re still bullish about the U.S. for the long term? The American economy is going to do fine. But it won’t do fine every year and every week and every month. I mean, if you don’t believe that, forget about buying stocks anyway. But it stands to reason. I mean, we get more productive every year, you know. It’s a positive-sum game, long term. And the only way an investor can get killed is by high fees or by trying to outsmart the market.
Buffett’s Mr. Fix-It August 16, 2010 BY BRIAN DUMAINE (p. 297).
· Sokol has a formula, one that is laid out in Pleased but Not Satisfied. (He hands out the self-published book to all his executives.) The concise, 129-page treatise expounds Sokol’s six laws: operational excellence, integrity, customer commitment, employee commitment, financial strength, and environmental respect. Yes, they are management bromides, but Sokol drives them so hard and so consistently into every organization he touches— ruthlessly if need be— that time and again they get him the kind of results even a Warren Buffett could like. (p. 299).
Cut Your Gains! March 20, 2006 An excerpt from Buffett’s letter to shareholders in the 2005 Berkshire Hathaway annual report (p. 247).
· “the most that owners in aggregate can earn between now and Judgment Day is what their businesses in aggregate earn.” He then goes on, under the “Cut Your Gains!” headline that Fortune supplied for the excerpt, to lament “frictional costs” and their expensive effect on a family named Gotrocks. (p. 247).
· he advised most individual investors to head for low-cost index funds rather than to try to deal with the stock market themselves. Still later, he made the now famous bet against Protégé Partners, in which he wagered that an unmanaged and low-cost S& P index fund could over ten years beat the performance of five hedge fund of funds carefully selected for this bet. (p. 247).
· For investors as a whole, returns decrease as motion increases. (p. 249).
Buffett’s Alter Ego May 29, 2006 BY ANDY SERWER (p. 251).
· Said Charlie: “We chose our style of operation to fit our natures, which demanded that plenty of time be spent thinking and learning, while engaging in lifelong self-criticism, light contrition for every error, and much humor. Naturally this caused extreme delegation, which is what we would have wanted as recipients of trust. We knew our methods would create good financial results for us and those who relied on us. But we did not anticipate that we would draw so much more admiration than we deserved and that this would help us to be happy as we in effect became teachers who to some extent copied Warren’s mentor, Ben Graham.”— CL (p. 251).
· “Warren and I avoid doing anything that someone else at Berkshire can do better,” he tells me. “You don’t really have a competency if you don’t know the edge of it.” (p. 253).
· What’s always been maddening to me about Berkshire and Buffett and Munger is how they make both their business and the art of investing, which I find to be so complicated and bewildering, seem so simple. “Berkshire is in the business of making easy predictions,” Munger explains. If a deal looks too hard, the partners simply shelve it. But the line of Munger’s that I really remember best from this year’s meeting is this: “We have a high moral responsibility to be rational,” he says. (p. 253).
Marking to Myth September 3, 2007 BY WARREN BUFFETT (p. 270).
· Many institutions that publicly report precise market values for their holdings of CDOs and CMOs are in truth reporting fiction. They are marking to model rather than marking to market. The recent meltdown in much of the debt market, moreover, has transformed this process into marking to myth. (p. 270).
The $ 91 Billion Conversation October 31, 2005 BY DANIEL ROTH (p. 239).
FORTUNE: A few quick hits. First: best book you’ve read lately.
BUFFETT: Katharine Graham’s Personal History is sensational. I think everybody ought to read that.
GATES: There’s one called The Bottomless Well, about energy, that I love. There’s one about computer science, Ray Kurzweil’s book— I have a preprint, so I’m not sure when it’s coming out— called Singularity Is Near, about artificial intelligence. The Tom Friedman book [The World Is Flat] is supergood. Jeffrey Sachs wrote a book called The End of Poverty, the Jack Welch book Winning came out this year, and don’t forget [Jared Diamond’s] Collapse, which is the follow-on to one of the best books of all time [Guns, Germs, and Steel]. (p. 240).
America’s Growing Trade Deficit Is Selling the Nation Out from Under Us. Here’s a Way to Fix the Problem— And We Need to Do It Now. November 10, 2003 BY WARREN BUFFETT, WORKING WITH CAROL LOOMIS
Where We’re Putting Our Money Now March 17, 2003 A second excerpt from Buffett’s letter to shareholders in the 2002 annual report (p. 221).
· Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge. The aversion to equities that Charlie and I exhibit today is far from congenital. We love owning common stocks— if they can be purchased at attractive prices. In my 61 years of investing, 50 or so years have offered that kind of opportunity. There will be years like that again. Unless, however, we see a very high probability of at least 10% pretax returns (which translate to 6% to 7% after corporate tax), we will sit on the sidelines. With short-term money returning less than 1% after-tax, sitting it out is no fun. But occasionally successful investing requires inactivity. (p. 221).
· In stocks, we expect every commitment to work out well because we concentrate on conservatively financed businesses with strong competitive strengths, run by able and honest people. If we buy into these companies at sensible prices, losses should be rare. (p. 221).
The Most Powerful Businessperson: Warren Buffett August 11, 2003 BY ANDY SERWER (p. 225).
Avoiding a “Mega-Catastrophe” March 17, 2003 An excerpt from Buffett’s letter to shareholders in the 2002 Berkshire Hathaway annual report (p. 216).
· “Financial weapons of mass destruction.” That Buffett blast at derivatives— a phrase soon to become famous around the world— made its inaugural public appearance in Fortune, as we published this excerpt from Berkshire’s 2002 annual report a short time before the report itself came out. (p. 216).
· Charlie [Munger] and I are of one mind in how we feel about derivatives and the trading activities that go with them: We view them as time bombs, both for the parties that deal in them and the economic system. (p. 216).
· let me retreat to explaining derivatives, though the explanation must be general because the word covers an extraordinarily wide range of financial contracts. Essentially, these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values. If, for example, you are either long or short an S& P 500 futures contract, you are a party to a very simple derivatives transaction— with your gain or loss derived from movements in the index. Derivatives contracts are of varying duration (running sometimes to 20 or more years), and their value is often tied to several variables. Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. (pp. 216-217).
· In fact, the reinsurance and derivatives businesses are similar: Like Hell, both are easy to enter and almost impossible to exit. In either industry, once you write a contract— which may require a large payment decades later— you are usually stuck with it. True, there are methods by which the risk can be laid off with others. But most strategies of that kind leave you with residual liability. (p. 217).
· Derivatives also create a daisy-chain risk that is akin to the risk run by insurers or reinsurers that lay off much of their business with others. In both cases, huge receivables from many counterparties tend to build up over time. (At Gen Re Securities, we still have $ 6.5 billion of receivables, though we’ve been in a liquidation mode for nearly a year.) A participant may see himself as prudent, believing his large credit exposures to be diversified and therefore not dangerous. Under certain circumstances, though, an exogenous event that causes the receivable from Company A to go bad will also affect those from Companies B through Z. History teaches us that a crisis often causes problems to correlate in a manner undreamed of in more tranquil times. (p. 218).
Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one another. The troubles of one could quickly infect the others. On top of that, these dealers are owed huge amounts by nondealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the telecom industry or the precipitous decline in the value of merchant power projects). Linkage, when it suddenly surfaces, can trigger serious systemic problems. Indeed, in 1998, the leveraged and derivatives-heavy activities of a single hedge fund, Long-Term Capital Management, caused the Federal Reserve anxieties so severe that it hastily orchestrated a rescue effort. In later congressional testimony, Fed officials acknowledged that, had they not intervened, the outstanding trades of LTCM— a firm unknown to the general public and employing only a few hundred people— could well have posed a serious threat to the stability of American markets. In other words, the Fed acted because its leaders were fearful of what might have happened to other financial institutions had the LTCM domino toppled. And this affair, though it paralyzed many parts of the fixed-income market for weeks, was far from a worst-case scenario. One of the derivatives instruments that LTCM used was total-return swaps, contracts that facilitate 100% leverage in various markets, including stocks. For example, Party A to a contract, usually a bank, puts up all of the money for the purchase of a stock, while Party B, without putting up any capital, agrees that at a future date it will receive any gain or pay any loss that the bank realizes. (p. 219).
· In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal. (p. 220).
The Oracle of Everything November 11, 2002 BY ANDY SERWER (p. 204).
· In the forty-seven years that Warren Buffett has run Berkshire Hathaway, the company’s stock has fallen roughly 40 percent to 50 percent at four different times. We will identify three of those episodes--- 1973– 1974, 1987– 1988, and 2007– 2008--- and move on to the other perpetrator, the Internet bubble. (p. 204).
· You can’t do well in investments unless you think independently. And the truth is, you’re neither right nor wrong because people agree with you. You’re right because your facts and your reasoning are right. In the end that’s all that counts. And there wasn’t any question about the facts or reasoning being correct.” (p. 206).
· So what does Buffett think about the market now? Not much more than: “The bubble has popped, but stocks are still not cheap.” There is no question, however, that now is a better time to buy stocks than it was in 1999, he confirms. Buffett’s investing precepts remain unflinching as well: “Investors need to avoid the negatives of buying fads, crummy companies, and timing the market,” he says. “Buying an index fund over a long period of time makes the most sense.” (p. 206).
· First, Buffett has largely stopped buying huge blocks of stock of companies. His purchases of the Washington Post, for instance, date back to the 1970s. Why has he stopped? Simple: Stock prices have been too high to his taste for years. “I bought my first stock 60 years ago,” Buffett says. “Of those 60 years, probably 50 have been attractive to buy common stocks. In probably ten years I’ve not been able to find anything.” Many of those ten, notably, have been recent ones. (p. 207).
Warren Buffett on the Stock Market December 10, 2001 A Buffett speech that Carol Loomis converted into an article (p. 191).
· Buffett’s discussion, an exemplar of his out-of-the-box thinking, turns to several themes he feels deeply about: the resilience of the U.S. economy; the inability of investors, very much including pension funds, to ignore the rearview mirror; the importance of price in gauging when it’s time to buy. (p. 191).
· Investing is laying out money today to receive more money tomorrow. That gets to the first of the economic variables that affected stock prices in the two periods— interest rates. In economics, interest rates act as gravity behaves in the physical world. At all times, in all markets, in all parts of the world, the tiniest change in rates changes the value of every financial asset. You see that clearly with the fluctuating prices of bonds. But the rule applies as well to farmland, oil reserves, stocks, and every other financial asset. And the effects can be huge on values. If interest rates are, say, 13%, the present value of a dollar that you’re going to receive in the future from an investment is not nearly as high as the present value of a dollar if rates are 4%. So here’s the record on interest rates at key dates in our 34-year span. They moved dramatically up— that was bad for investors— in the first half of that period and dramatically down— a boon for investors— in the second half. (p. 192).
· In a flourishing country in which people are focused on making money, how could you have had three extended and anguishing periods of stagnation that in aggregate— leaving aside dividends— would have lost you money? The answer lies in the mistake that investors repeatedly make— that psychological force I mentioned above: People are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them. (pp. 194-195).
· In 1979, when I felt stocks were a screaming buy, I wrote in an article, “Pension fund managers continue to make investment decisions with their eyes firmly fixed on the rear-view mirror. This generals-fighting-the-last-war approach has proved costly in the past and will likely prove equally costly this time around.” That’s true, I said, because “stocks now sell at levels that should produce long-term returns far superior to bonds.” (p. 197).
· Now, if you had read that article in 1979, you would have suffered— oh, how you would have suffered!— for about three years. I was no good then at forecasting the near-term movements of stock prices, and I’m no good now. I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two. But I think it is very easy to see what is likely to happen over the long term. Ben Graham told us why: “Though the stock market functions as a voting machine in the short run, it acts as a weighing machine in the long run.” Fear and greed play important roles when votes are being cast, but they don’t register on the scale. (p. 198).
· The tour we’ve taken through the last century proves that market irrationality of an extreme kind periodically erupts— and compellingly suggests that investors wanting to do well had better learn how to deal with the next outbreak. What’s needed is an antidote, and in my opinion that’s quantification. If you quantify, you won’t necessarily rise to brilliance, but neither will you sink into craziness. (p. 201).
The Value Machine February 19, 2001 BY CAROL LOOMIS (p. 181).
· In the 36 years that Buffett has run the company, Berkshire’s per-share book value— the performance statistic that best describes the success of an insurance company— has grown, on average, by more than 23% a year. (p. 181).
· The real story is what was going on in the company, not the stock. In a grand sweep of allocating capital— which has been his greatest talent— Buffett completed or initiated the purchase of no fewer than eight companies. We’re not talking stocks here (though some of the lot were publicly owned) but rather entire companies. One of the acquisitions, U.S. Liability of Wayne, Pa., adds to Berkshire’s insurance empire. The others contribute new swatches to the Berkshire crazy quilt, being in businesses as ludicrously diverse, and as old economy, as bricks and boots (Justin Industries of Fort Worth) and fine jewelry (the Ben Bridge chain, headquartered in Seattle) and carpets (Shaw Industries of Dalton, Ga.). The purchase price, in total, was $ 8 billion. That’s an amount dwarfed by the $ 22 billion in stock that Berkshire paid for reinsurer General Re in 1998. But the $ 8 billion paid for the pieces of eight was almost all cash. That’s a lot of cash— more than five times as much, for example, as the $ 1.5 billion that Berkshire put some years ago into its biggest stock investment ever, American Express. None of the $ 8 billion, furthermore, was borrowed. Buffett just reached into the big bucket of cash equivalents he’s been patiently sitting with, and handed over the money. (p. 182).
· he likes to buy businesses that generate healthy earnings and leave them alone. (p. 183).
· He was, however, a net seller of stocks in 2000, and in each of the four years before as well. This retreat fits his well-known opinion that future returns from stocks can’t begin to match those that investors earned in the 1980s and ’90s. Among the stocks he’s known to have chopped in the past few years are McDonald’s and Disney. (p. 183).
· As for what he buys: Buffett likes companies at sensible prices— which leaves him avoiding the auctions investment bankers run— that throw off cash and have capable, honest, and trustworthy people running them. He wants substantial earnings, for sure, but cares not at all whether they are consistent: “I’d rather have a lumpy 15% return on capital,” he has often said, “than a smooth 12%.” And he wants businesses that he can understand and that are not subject to major change. It is the rapid change in technology that has kept him away from tech investments. He feels that he cannot be sure how much cash flow a tech company will be producing ten years from now, so he stays away. (pp. 183-184).
Mr. Buffett on the Stock Market November 22, 1999 A Buffett speech that Carol Loomis converted into an article (p.166)
· Buffett was absolutely right in his general bearishness about the market, so much so that he says today, “I wouldn’t change a word of what I said.” He was speaking at a time when investors had grown used to average annual total returns of 12 percent on their holdings. He expected instead that 7 percent was a reasonable estimate as to what investors— before inflation— could earn annually in total returns over the seventeen years from 1999 to 2016 (the article explains why he selected that oddball number of years). And that was a gross figure, before the heavy transactional costs that investors bear— commissions, sales loads, and management fees, for example. After these costs, Buffett thought that a reasonable expectation for the return would be about 6 percent annually. (p. 167).
· Investors in stocks these days are expecting far too much, and I’m going to explain why. That will inevitably set me to talking about the general stock market, a subject I’m usually unwilling to discuss. But I want to make one thing clear going in: Though I will be talking about the level of the market, I will not be predicting its next moves. At Berkshire we focus almost exclusively on the valuations of individual companies, looking only to a very limited extent at the valuation of the overall market. Even then, valuing the market has nothing to do with where it’s going to go next week or next month or next year, a line of thought we never get into. The fact is that markets behave in ways, sometimes for a very long stretch, that are not linked to value. Sooner or later, though, value counts. So what I am going to be saying— assuming it’s correct— will have implications for the long-term results to be realized by American stockholders. Let’s start by defining “investing.” The definition is simple but often forgotten: Investing is laying out money now to get more money back in the future— more money in real terms, after taking inflation into account. (p. 167).
· To understand why that happened, we need first to look at one of the two important variables that affect investment results: interest rates. These act on financial valuations the way gravity acts on matter: The higher the rate, the greater the downward pull. That’s because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate that they can earn from government securities. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line. Conversely, if government interest rates fall, the move pushes the prices of all other investments upward. The basic proposition is this: What an investor should pay today for a dollar to be received tomorrow can only be determined by first looking at the risk-free interest rate. Consequently, every time the risk-free rate moves by one basis point— by 0.01%— the value of every investment in the country changes. People can see this easily in the case of bonds, whose value is normally affected only by interest rates. In the case of equities or real estate or farms or whatever, other very important variables are almost always at work, and that means the effect of interest rate changes is usually obscured. Nonetheless, the effect— like the invisible pull of gravity— is constantly there. In the 1964-81 period, there was a tremendous increase in the rates on long-term government bonds, which moved from just over 4% at year-end 1964 to more than 15% by late 1981. That rise in rates had a huge depressing effect on the value of all investments, but the one we noticed, of course, was the price of equities. So there— in that tripling of the gravitational pull of interest rates— lies the major explanation of why tremendous growth in the economy was accompanied by a stock market going nowhere. (pp. 167-168).
· By 1981, though, the trend was headed toward the bottom of that band, and in 1982 profits tumbled to 3.5%. So at that point investors were looking at two strong negatives: Profits were sub-par and interest rates were sky-high. And as is so typical, investors projected out into the future what they were seeing. That’s their unshakable habit: looking into the rear-view mirror instead of through the windshield. What they were observing, looking backward, made them very discouraged about the country. They were projecting high interest rates, they were projecting low profits, and they were therefore valuing the Dow at a level that was the same as 17 years earlier, even though GDP had nearly quintupled. (p. 169).
· The inescapable fact is that the value of an asset, whatever its character, cannot over the long term grow faster than its earnings do.
· Bear in mind— this is a critical fact often ignored— that investors as a whole cannot get anything out of their businesses except what the businesses earn. (p. 172).
· Move on to failures of airlines. Here [says Buffett in his speech, waving a piece of paper] is a list of 129 airlines that in the past 20 years filed for bankruptcy. Continental was smart enough to make that list twice. As of 1992, in fact— though the picture would have improved since then— the money that had been made since the dawn of aviation by all of this country’s airline companies was zero. Absolutely zero. (p. 174).
· The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors. (pp. 174-175).
A House Built on Sand October 26, 1998 BY CAROL LOOMIS (p. 152).
· the collapsing hedge fund Long-Term Capital Management (LTCM). (p. 152).
· For most of the month, the huge hedge fund hung on the edge of bankruptcy and was finally saved only by a $ 3.6 billion infusion from a consortium of 14 banks and brokerage firms— all creditors who feared what the bankruptcy of a fund that owed upwards of $ 100 billion would do to their own finances. Very much in the act also was the Federal Reserve Bank of New York, which wished to avert the domino effects that a fast liquidation of the fund’s holdings might have exerted on an already reeling global securities market. So the New York Fed played godfather to the rescue deal, bringing the creditors together at its own offices and overseeing their negotiations. (p. 153).
· The disaster that befell this brain trust recalls the first line of Allen Ginsberg’s beatnik poem “Howl”: “I saw the best minds of my generation destroyed by madness…” At LTCM the best minds were destroyed by the oldest and most famously addictive drug in finance, leverage. Had the fund not grievously overextended itself, it might still be trucking along, doing its thing, working those brain cells. But now its strategists have swapped their laurels for the booby prize of the financial markets, which is the ignominy of being largely wiped out and viewed as bumbling losers. (p. 153).
· Meriwether, now 51, was a vice chairman of Salomon, with responsibility for fixed-income trading and also “proprietary trading,” which is a firm’s investment of its own money. Meriwether was a huge money-maker for the firm, and was liked and admired to the point of reverence by the people who worked for him. “British Guiana actually comes to mind,” said a former Salomon Brothers executive recently. “John had a kind of cultlike following.” Then came Salomon’s Treasury bond scandal, precipitated by Paul Mozer, one of Meriwether’s senior people. In the chain of disclosure, Mozer admitted to Meriwether in April 1991 that he had falsified bids for Treasury securities; Meriwether immediately went to his bosses, John Gutfreund and Thomas Strauss, with the news; everybody concluded that the Fed must be told; and then nobody did the telling. When the scandal finally erupted in August, Mozer was fired, and Gutfreund and Strauss resigned under pressure. To the rescue came Buffett, head of Salomon’s biggest shareholder, Berkshire. (pp. 154-155).
HOW BUFFETT RATED AMEX A BUY OCTOBER 30, 1995 A Sidebar by Linda Grant (p. 129)
· Just about everyone knows that Warren Buffett is a zealous disciple of value investing, the approach championed by Wall Street legend Benjamin Graham in the 1930s and 1940s. Value investors buy stocks only when they believe the market is temporarily— and irrationally— valuing a company at far below what they call its intrinsic value. (p. 129).
· But many are mystified by Buffett’s purchase of roughly $ 2 billion of American Express shares. Wall Street has shunned the stock in recent years as Amex began losing market share and suffered from problems at its former brokerage subsidiary, Shearson Lehman. But maybe it’s all the bad news that attracted Buffett in the first place. After all, a primary Graham tenet is to think for yourself and understand the difference between price and value. He also counseled followers to rake the market for bargains. (p. 130).
· Value investor Robert G. Hagstrom Jr., author of The Warren Buffett Way and portfolio manager of Philadelphia’s Focus Trust, points out that to understand any Buffett investment, investors must start with his philosophy, stated in his 1989 letter to shareholders of Berkshire Hathaway. Buffett wrote that the value of any business today is “calculated by taking all future cash flows— in and out— and discounting them at prevailing interest rates. So valued, all businesses, from manufacturers of buggy whips to operators of cellular telephones, become economic equals.” In other words, Hagstrom believes that Buffett determines a stock’s value as if it were a bond. He starts with “net owner earnings,” which is reported earnings plus depreciation and amortization minus capital investments. (p. 130).
How We Got Here (p. 134).
· How I got here is pretty simple in my case. It’s not IQ, I’m sure you’ll be glad to hear. The big thing is rationality. I always look at IQ and talent as representing the horsepower of the motor, but that the output— the efficiency with which that motor works— depends on rationality. A lot of people start out with 400-horsepower motors but only get a hundred horsepower of output. It’s way better to have a 200-horsepower motor and get it all into output. So why do smart people do things that interfere with getting the output they’re entitled to? It gets into the habits and character and temperament, and behaving in a rational manner. Not getting in your own way. (p. 134).
· They say success is getting what you want and happiness is wanting what you get. (p. 136).
· BUFFETT: I don’t do a lot of innovating in my work. I really have just two functions: One is to allocate capital, which I enjoy doing. And the second one is to help 15 or 20 senior managers keep a group of people enthused about what they do when they have no financial need whatsoever to do it. At least three-quarters of the managers that we have are rich beyond any possible financial need, and therefore my job is to help my senior people keep them interested enough to want to jump out of bed at six o’clock in the morning and work with all of the enthusiasm they did when they were poor and starting. If I do those two things, they do the innovation. (p. 139).
· A financial asset means, by definition, that you lay out money now to get money back in the future. (p. 144).
· A generally buoyant market tends to encourage mergers, because everybody’s currency is more useful in those circumstances. (p. 146).
· GATES: In my case, I’d have to say my best business decisions have had to do with picking people. Deciding to go into business with Paul Allen is probably at the top of the list, and subsequently, hiring a friend— Steve Ballmer— who has been my primary business partner ever since. It’s important to have someone who you totally trust, who is totally committed, who shares your vision, and yet who has a little bit different set of skills and who also acts as something of a check on you. Some of the ideas you run by him, you know he’s going to say, “Hey, wait a minute, have you thought about this and that?” The benefit of sparking off somebody who’s got that kind of brilliance is that it not only makes business more fun, but it really leads to a lot of success.(p. 148).
· How do you see yourselves as leaders in facets of human experience other than business?
· GATES: You have to be careful, if you’re good at something, to make sure you don’t think you’re good at other things that you aren’t necessarily so good at. I come in every day and work with a great team of people who are trying to figure out how to make great software, listening to the feedback and doing the research. And it’s very typical that because I’ve been very successful at that, people come in and expect that I have wisdom about topics that I don’t. I do think there are some ways that we’ve run the company— the way we’ve hired people, and created an environment and used stock options— that would be good lessons for other businesses as well. But I always want to be careful not to suggest that we’ve found the solutions to all problems.
· BUFFETT: You can learn a lot by studying Microsoft and Bill. And you can learn the most by studying what it is he does year after year. But if he devoted 5% or 10% to what he’s now doing, and then spread the remainder of his attention over a bunch of other things, well, society would be worse off, in my view. Bill’s right, occasionally there are things— like campaign finance reform— that he may want to take a position on. But you still don’t want to say that the whole world ought to follow you on it. I’m very suspect of the person who is very good at one business— it also could be a good athlete or a good entertainer— who starts thinking they should tell the world how to behave on everything. For us to think that just because we made a lot of money, we’re going to be better at giving advice on every subject— well, that’s just crazy. (p. 151).
From “Why Warren Buffett’s Betting Big on American Express” October 30, 1995 Excerpts and a sidebar from an article by Linda Grant
· Warren Buffett loves to tell a parable about the stock market’s irrationality. It was 1963, and a scandal involving fake inventories of salad oil at a small subsidiary of American Express drove down the price of Amex shares. How bad a problem was this? To find out, Buffett spent an evening with the cashier at Ross’s Steak House in Omaha seeing if people would stop using their green cards. The scandal didn’t seem to give any of the diners indigestion, so Buffett seized the opportunity to buy 5% of the company for $ 13 million. He later sold his holding for a $ 20 million profit. (p. 128).
· Always the patient investor, Buffett— worth $ 14.2 billion at last count— believes the latest troubles are little more than a distraction. What he likes is exactly what has made him rich before: a mighty brand coupled with a healthy cash flow. After all, American Express, according to London marketing group Interbrand, is still one of the ten most-recognized brands in the world. Buffett believes the name remains “synonymous with financial integrity and money substitutes around the world.” As he explained to Berkshire Hathaway shareholders at last spring’s annual meeting: “By far the most important factor in [Amex’s] future for a great many years to come will be the credit card. We think American Express’s management thinks well about… how to keep the card special.” Buffett probably isn’t particularly concerned about the company’s loss of market share. More likely, he’s gambling that Amex, even if it fails to grow dramatically, will become a very profitable niche player in the card market. (p. 129).
Gates on Buffett February 5, 1996 BY BILL GATES (p. 121).
· Buffett: The Making of an American Capitalist (Random House, 1995) will join the growing ranks. Lowenstein’s book is a straightforward account of Buffett’s remarkable life. (p. 121).
· The author describes Buffett’s secretiveness about the stocks he picked for the partnership, and his contrasting openness about his guiding principle, which is to buy stocks at bargain basement prices and hold them patiently. As Warren once explained in a letter to his partners, “This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.” (p. 121).
· Warren stays away from technology companies because he likes investments in which he can predict winners a decade in advance— an almost impossible feat when it comes to technology. (p. 123).
· Warren is great with numbers, and I love math too. But being good with numbers doesn’t necessarily correlate with being a good investor. Warren doesn’t outperform other investors because he computes odds better. That’s not it at all. Warren never makes an investment where the difference between doing it and not doing it relies on the second digit of computation. He doesn’t invest— take a swing of the bat— unless the opportunity appears unbelievably good. (p. 124).
· His affinity for routine extends to his investment practices too. Warren sticks to companies that he is comfortable with. He doesn’t do much investing outside the U.S. (p. 124).
· Lowenstein is a good collector of facts, and Buffett: The Making of an American Capitalist is competently written. (p. 125).
How Buffett Views Risk April 4, 1994 An excerpt from Buffett’s letter to shareholders in the 1993 Berkshire Hathaway annual report (p. 116)
BUFFETT AND COCA-COLA (p. 113).
How I Goofed April 9, 1990 An excerpt from Buffett’s letter to shareholders in the 1989 Berkshire Hathaway annual report (p. 103).
· If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit. (p. 103).
· Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original “bargain” price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces— never is there just one cockroach in the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $ 8 million that can be sold or liquidated for $ 10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $ 10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre. (pp. 103-104).
· I could give you other personal examples of “bargain purchase” folly but I’m sure you get the picture: It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie [Munger] understood this early; I was a slow learner. But now, when buying companies or common stock, we look for first-class businesses accompanied by first-class managements. (p. 104).
· I’ve said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. (p. 104).
· After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers. The finding may seem unfair, but in both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult. (p. 104).
· My most surprising discovery: the overwhelming importance in business of an unseen force that we might call “the institutional imperative.” In business school, I was given no hint of the imperative’s existence and I did not intuitively understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn’t so. Instead, rationality frequently wilts when the institutional imperative comes into play. For example: (1) As if governed by Newton’s first law of motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting compensation, or whatever, will be mindlessly imitated. (p. 105).
From “Now Hear This” April 5, 1993 (p. 112).
From “Are These the New Warren Buffetts?” October 30, 1989 An excerpt from an article by Brett Duval Fromson (p. 100).
· Wouldn’t you like to become partners with someone who would double your money every three to four years ad infinitum? To put it another way, wouldn’t you like to invest with the next Warren Buffett? Riches come to investors who, early in their lives, find great money managers. Buffett is certifiably one of the greatest. (p. 100).
· Buffett himself starts with “high-grade ethics. The investment manager must put the client first in everything he does.” At the very least, the manager should have his net worth invested alongside of his clients to avoid potential conflicts of interest. Those profiled here have put the bulk of their assets with their customers. Buffett says he would invest only with someone who handled his mother’s money too (as he did). (pp. 100-101).
· Says Buffett, “You don’t need a rocket scientist. Investing is not a game where the 160 IQ guy beats the guy with the 130 IQ.” The size of the investor’s brain is less important than his ability to detach the brain from the emotions. “Rationality is essential when others are making decisions based on short-term greed or fear,” says Buffett. “That is when the money is made.” (p. 101).
· Like all master craftsmen, Buffett prizes consistency. Marshall Weinberg of the brokerage firm Gruntal & Co. recalls going to dinner with him in Manhattan. “He had an exceptional ham-and-cheese sandwich. A few days later, we were going out again. He said, ‘Let’s go back to that restaurant.’ I said, ‘But we were just there.’ He said, ‘Precisely. Why take a risk with another place? We know exactly what we’re going to get.’ And that,” says Weinberg, “is what Warren looks for in stocks too. He only invests in companies where the odds are great that they will not disappoint.” (p. 102).
A Warm Tip from Warren Buffett: It’s Time to Buy Freddie Macs December 19, 1988 BY BRETT DUVAL FROMSON (p. 92).
· Buffett testified that he’d met with Brendsel several times and found him unwisely striving for double-digit earnings gains— of, say, 15 percent. Gains like that don’t come naturally for financial companies, Buffett said, and managements reaching for them can “start making up the numbers.” (p. 92).
· Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised. (p. 93).
· Freddie Mac, is just such an opportunity. A quasi-public corporation like its older cousin Fannie Mae (the Federal National Mortgage Association), it earns an impressive 23% return on equity and sells for less than eight times estimated 1988 earnings. “Freddie Mac is a triple dip,” says Buffett. “You’ve got a low price/ earnings ratio on a company with a terrific record. You’ve got growing earnings. And you have a stock that is bound to become much better known to equity investors.” (p. 93).
From “How to Live with a Billion” September 11, 1989 Excerpts from an article by Alan Farnham (p. 97).
· I would rather have a smart, well-intentioned, high-grade person looking at the problems of the day through eyes that are open, not through my eyes that are in a coffin. I found in running businesses that the best results come from letting high-grade people work unencumbered. Stick around. If you’re young enough, you’ll see how it all works out.” (p. 97).
From “Now Hear This” October 23, 1989
· Warren Buffett, 59, billionaire investor and chairman of Berkshire Hathaway, on why he borrowed $ 400 million and put the cash into Treasuries: “The best time to buy assets may be when it is hardest to raise money.” (p. 98).
BUFFETT AND SALOMON (p. 77).
· Buffett notes in his annual report that the economics of investment banking are far less predictable than those of most businesses in which he has major commitments. (p. 77).
· In his 1982 annual report he derided the inclination of investment bankers to provide whatever advice would bring in the most income. “Don’t ask your barber whether you need a haircut,” he said. (p. 78).
Warren Buffett’s Wild Ride at Salomon October 27, 1997 BY CAROL LOOMIS (p. 79).
· Sunday, Aug. 18, 1991— in which the U.S. Treasury first banned Salomon from bidding in government securities auctions and then, because of Buffett’s efforts, rescinded the ban. In the four hours of suspense between the two actions, Buffett struggled passionately to ward off a tragedy he saw threatening to unfold. In Buffett’s opinion, the ban put Salomon, this company now being priced at $ 9 billion, in sure danger of having immediately to file for bankruptcy. Even more important, he believed on that day, as he does now, that the collapse of Salomon would have shaken the world’s financial system to its core. (p. 79).
· Over the years, Buffett had derided investment bankers, deploring their enthusiasm for deals that provided huge fees but that were turkeys for their clients. (p. 79).
· management and its lawyers worried that too much disclosure would threaten the firm’s “funding”— its ability to roll over the billions of dollars of short-term debt that became due every day. So Salomon’s plan was to tell its directors and regulators that management had known of Mozer’s misconduct, but to avoid saying this publicly. Munger didn’t like it, finding this behavior neither candid nor smart. But not considering himself an expert on “funding,” he subsided. (p. 82).
· It is not good for any securities firm to lose the world’s confidence. But if the firm is “credit dependent,” as Salomon was to an extreme, it cannot tolerate a negative change in perceptions. Buffett likens Salomon’s need for confidence to a mortal’s need for air: When the required good is present, it’s never noticed. When it’s missing, that’s all that’s noticed. (p. 83).
· . . .unlike commercial banks, whose creditors can look to the FDIC or to the “too big to fail” doctrine, securities firms have no declared “Big Daddy” whose mere presence is a deterrent to runs. So on that Thursday, Salomon began to experience a run. (p. 84).
· He predicted that a Salomon bankruptcy would be calamitous, having domino effects that would reach worldwide and play havoc with a financial system that subsists on the idea of prompt payments. (p. 88).
· the interim CEO reduced leverage by vastly shrinking the balance sheet, haggled with banks about money Salomon badly needed, and hoped above all else that Mozer’s wrongdoing (which cost him nearly four months in prison after he pleaded guilty to lying to the Fed) would not entrap Salomon itself in criminal charges. In the end, the company settled for $ 290 million, an outcome mainly reflecting the extraordinary cooperation Buffett decreed should be given both regulators and the law in getting things cleaned up. (p. 89).
The Inside Story of Warren Buffett April 11, 1988 BY CAROL LOOMIS (p. 64).
· As a manager he disregards form and convention and sticks to business principles that he calls “simple, old, and few.” (p. 64).
· Buffett’s intellectual power is totally focused on business, which he loves and knows incredible amounts about. Says Goldberg: “He is constantly examining all that he hears: ‘Is it consistent and plausible? Is it wrong?’ He has a model in his head of the whole world. The computer there compares every new fact with all that he’s ever experienced and knows about— and says, ‘What does this mean for us?’” For Berkshire, that is. Buffett owns a few stocks personally but spends little time thinking about them. Says he: “My ego is wrapped up with Berkshire. No question about that.” (pp. 64-65).
· The investor sees the chance to buy portions of a business in the stock market at a price below intrinsic value— that is, below what a rational buyer would pay to own the entire establishment. The manager sees the chance to buy the whole business at no more than that intrinsic value. (p. 65).
· The kind of merchandise that Buffett wants is simply described also: “good businesses.” To him that essentially means operations with strong franchises, above-average returns on equity, a relatively small need for capital investment, and the capacity therefore to throw off cash. That list may sound like motherhood and apple pie. (p. 65).
· But Buffett has been consistently shrewd as a buyer— he simply will not overpay— and patient in waiting for opportunities. (p. 66).
· There, in early 1950, while a senior, he read Benjamin Graham’s newly published book, The Intelligent Investor. The book encouraged the reader to pay attention to the intrinsic value of companies and to invest with a “margin of safety,” and to Buffett it all made enormous sense. To this day there is a Graham flavor to Buffett’s only articulated rules of investment: “The first rule is not to lose. The second rule is not to forget the first rule” (p. 67).
· Basically, Graham looked for “bargains,” which he rigidly defined as stocks that could be bought at no more than two-thirds of their net working capital. Most companies, he figured, could be liquidated for at least their net working capital; so in buying for still less, he saw himself building in the necessary margin of safety. Today few stocks would meet Graham’s standards; in the early 1950s, many did. (p. 68).
· Buffett wrote a line that has become famous: “With few exceptions, when a manager with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.” (p. 69).
· he has tended to buy good managements and stick with them, he has worked over the years with an unusually large number of older executives and treasured their abilities. “My God,” he says, “good managers are so scarce I can’t afford the luxury of letting them go just because they’ve added a year to their age.” (p. 72).
· He spends hours at a stretch in his office, reading, talking on the phone, and, in the December to March period, agonizing over his annual report, whose fame is one of the profound satisfactions of his life. (p. 74).
· Murphy tunes in for advice also. “I talk to him about all the important aspects of my business,” says Murphy. “He’s never negative and always supportive. He’s got such a massive mind and such a remarkable ability to absorb information. You know, we’re supposed to be pretty good managers around here, but his newspaper outdoes ours.” (p. 75).
Early Fears about Index Futures December 7, 1987 A warning letter sent by Warren Buffett to Congressman John Dingell Jr. (p. 58).
· Dingell asked the younger Buffett to explain in a letter why he thought trading in stock index futures was a bad idea. Said Buffett, as he wound up his carefully reasoned letter: “We do not need more people gambling in nonessential instruments identified with the stock market in this country, nor brokers who encourage them to do so.” (p. 58).
· I see a logical risk-reducing strategy that involves shorting the futures contract. I see no corresponding investment or hedging strategy whatsoever on the long side. (p. 59
· The propensity to gamble is always increased by a large prize vs. a small entry fee, no matter how poor the true odds may be. That’s why Las Vegas casinos advertise big jackpots and why state lotteries headline big prizes. In securities, the unintelligent are seduced by the same approach in various ways, including: (a) “penny stocks,” which are “manufactured” by promoters precisely because they snare the gullible— creating dreams of enormous payoffs but with an actual group result of disaster, and (b) low margin requirements through which financial experience attributable to a large investment is achieved by committing a relatively small stake. (pp. 59-60).
· We have had many earlier experiences in our history in which the high total commitment/ low down payment phenomenon has led to trouble. (pp. 59-60).
· The ability to speculate in stock indexes with 10% down payments, of course, is simply a way around the margin requirements and will be immediately perceived as such by gamblers throughout the country. (p. 60).
· And the more the activity, the greater the cost to the public and the greater the amount of money that will be left behind by them to be spread among the brokerage industry. . (p. 60).
· In my judgment, a very high percentage— probably at least 95% and more likely much higher— of the activity generated by these contracts will be strictly gambling in nature. . (p. 60).
Guess Who’s Bought Whoops Bonds April 29, 1985 BY KENNETH LABICH (p. 49).
· Investors, Buffett stressed, need to think about the prices of securities— or more precisely, the mispricing that an investor hopes to identify and exploit. Said the letter, “Charlie [Munger] and I judged the risks at the time we purchased the bonds and at the prices Berkshire paid (much lower than present prices) to be considerably more than compensated for by prospects of profit.” (p. 49).
· “We feel that if we can buy small pieces of businesses with satisfactory underlying economics at a fraction of the per-share value of the entire business, something good is likely to happen to us.” (p. 49).
· Buffett’s forte is buying shares in companies whose values he believes have been underestimated by the stock market. (p. 50).
· American Express’s liability turned out to be far less than originally suspected, the stock skyrocketed and Buffett’s contrariety triumphed. “Things aren’t right just because they are unpopular,” Buffett says with a chuckle, “but it is a good pond in which to fish. You pay a lot on Wall Street for a cheery consensus.” (p. 50).
· Buffett says that occasions to buy bonds in the future are likely to be few. He is concerned that the federal budget deficit will lead to substantially higher inflation and surging interest rates— a disastrous situation for bondholders. “In runaway inflation,” says Buffett, “what you’ve bought is wallpaper.” While Buffett has been making news lately, he doesn’t make a lot of investments. “My problem is I don’t get 50 great ideas a year;” he says. “I’m lucky if I get one or two.” But when he does decide to plunge, he bets big. In the latest annual report, Buffett warns shareholders that betting heavily on a few ideas is bound to produce a bad year once in a while. That may be, but so far the shareholders have had plenty to whoop about. (p. 52).
From “Now Hear This” April 28, 1986 (p. 53).
· . . saying that most of the gain was simply the effect of Berkshire’s issuing shares during the year to make acquisitions (principally NetJets and General Re) at a time when its stock was selling at a large premium over book value. It was no accident, of course, that Buffett was issuing Berkshire stock in a year when its price related to a more important indicator, intrinsic value, was also high. He would regard it as sinful to hand out Berkshire shares when they are the opposite—“ cheap,” so to speak. (p. 53).
From “Should You Leave It All to the Children?” September 29, 1986 Excerpts from an article by Richard I. Kirkland Jr.
· To him the perfect amount to leave children is “enough money so they would feel they could do anything, but not so much that they could do nothing.” (p. 55).
From “Beating the Market by Buying Back Stock” April 29, 1985 An excerpt from an article by Carol Loomis
· Fortune found that, on average, large benefits accrued to the stockholders of companies buying in significant quantities of their own stock. This article also presented many pro and con opinions, some of them Buffett’s, about repurchases. Buffett was then, as now, a fan of managements who bought in stock for the right reason— because they knew their stocks to be undervalued. Conversely, he has always disdained managers who buy because they are trying to prop their stock or counteract the effects of stock options, which tend to shovel new shares into the market. “The only reason for a company to repurchase its stock,” Buffett has often said, “is because it is selling for less than it’s worth.” (p. 47).
· “All managements say they’re acting in the shareholders’ interests,” he observes. “What you’d like to do as an investor is hook them up to a machine and run a polygraph to see whether it’s true. Short of a polygraph, the best sign of a shareholder-oriented management— assuming its stock is undervalued— is repurchases. A polygraph proxy, that’s what it is.” (p. 48).
From “Buffett to Disney: All Thumbs Up” April 1, 1996 BY CAROL LOOMIS (p. 45).
· Buffett had the option of taking the standard package, which was Disney stock plus cash, or requesting all stock, or all cash. (p. 45).
· For a time, true, Buffett liked Disney, even adding shares to the large Disney stake that Berkshire received when the deal closed. But then Disney went through a period of management turmoil— Frank Wells died, Michael Ovitz failed as a manager— and Buffett turned thumbs down on the investment. By 1999, Berkshire was completely out of Disney. CL (pp. 45-46).
From “Can You Beat the Stock Market?” December 26, 1983 An excerpt and a sidebar from an article by Daniel Seligman (p. 40).
· investors should search for discrepancies between the value of a business and the price of small pieces of that business in the market. (p. 40).
· Most people interested in the stock market fall into one of three categories: (1) academic scholars who doubt anybody really knows how to beat the market; (2) professional investors who indignantly reject this view of the matter; and (3) amateur investors who also believe that you can beat the market but don’t realize how controversial this assumption is. (p. 41).
· It seems fairly clear that some superior investors are out there beating the market systematically….(p. 41).
· Buffett. . . believes that there are exploitable “pockets of inefficiency” in the market, (p. 41).
· Buffett, Ruane, and Schloss all studied under Graham, and all four have been influenced by his classic Security Analysis, written with David L. Dodd and first published in 1934. Graham’s core idea: look for companies that for some reason are undervalued and hold the stocks for as long as it takes the market to see the values. (p. 42).
Letters from Chairman Buffett August 22, 1983 BY ANDREW TOBIAS (p. 38).
· Although Graham and Buffett did not agree in all things, their common perception was to buy assets so cheaply that, over time, they could hardly fail to profit. This approach calls for a level head and hard work. “The market, like the Lord,” Buffett writes, “helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do.” (p. 38).
How Inflation Swindles the Equity Investor May 1977
· He remains convinced, however, that high rates of inflation are sure to swindle the equity investor, and he cites evidence from the years when inflation was out of control. (pp. 9-10)
· It is no longer a secret that stocks, like bonds, do poorly in an inflationary environment. We have been in (p. 10)
· conventional wisdom insisted that stocks were a hedge against inflation. (p. 10).
· To raise that return on equity, corporations would need at least one of the following:
(1) an increase in turnover, i.e., in the ratio between sales and total assets employed in the business;
(2) cheaper leverage;
(3) more leverage;
(4) lower income taxes;
(5) wider operating margins on sales. (p. 13).
· High rates of inflation generally cause borrowing to become dearer, not cheaper. (p. 14).
· As a common stockholder you will have more dollars, but you may have no more purchasing power. Out with Ben Franklin (“ a penny saved is a penny earned”) and in with Milton Friedman (“ a man might as well consume his capital as invest it”). The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. (p. 19).
· If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker— but not your partner. (p. 19).
· Endowment funds are earning nothing until they have outpaced the inflation treadmill. At 7 percent inflation and, say, overall investment returns of 8 percent, these institutions, which believe they are tax-exempt, are in fact paying “income taxes” of 87 1/ 2 percent. . (p. 19).
· stocks are probably still the best of all the poor alternatives in an era of inflation— at least they are if you buy in at appropriate prices.”— CL (p. 22).
A Small College Scores Big in the Investment Game December 18, 1978 BY LEE SMITH (p. 25)
· Buffett is at heart a disciple of Benjamin Graham, under whom he studied at Columbia, and as such he believes in seeking out an undervalued company and investing in it heavily. (p. 25)
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