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Buffett's most valuable words of wisdom : Following are excerpts from Warren Buffett's shareholder letters that in essence are the most important investment tips a common investor can get from a person who has successfully practiced it for nearly 7 decades.
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How Buffett values an asset and Difference between investment and speculation REFERENCE - 2000 shareholder letter - Buffet’s core investing principle is just 2600 years old. Yes you are right its two thousand six hundred. He dates it back to Aesop who in 600BC had the principle “Bird in the hand is worth two in the bush”. This denotes a conservative way of looking at things and not being overly optimistic. An investor needs to ask himself:
(i) How certain am I that there are birds in bush?
Over here Birds is just an example to prove the philosophy. We will need to replace it with dollars and in turn analyze the underlying business as to how much cash it’s going to generate in future and discount it with the risk free rate. It’s un-realistic to have a precise number but one can certainly get a range. So the underlying question is how to estimate the future cash flow? For this an investor needs to know different parameters influencing a business and estimate their future growth. In-contrast to investment, speculation does not pay any attention to the underlying asset. Its main goal is to guess what others are going to perceive the assets value. The line separating investment and speculation become blurred when more and more people join the speculation bandwagon. This is what happened in the internet bubble of late nineties where people used to boast of their portfolios being tripled in a year and anyone labeling it as speculative was called “an ignorant person who did not understand the power of internet” The years of 1999 and 2000 can be termed as a two year long party which was akin to behavior of Cinderella at the ball. Everyone knew that overstaying the festivity. That is continuing to value companies at around 200 times their earnings will eventually bring pumpkins and mice. But no one wanted to miss the grand party of the century. Each and every one at the party thought that he would just sneak out minutes before the midnight. But the problem was the clocks in the ball room didn’t have hands. What an investor should know and his basic goal towards investing REFERENCE - 1996 shareholder letter - Its often quoted by Buffett that intelligent investing needs an IQ of an average person but patience of an above average person. Following are couple of very simple rules. (i) KNOW YOUR CIRCLE OF COMPETENCE: If you think that you can invest in any stock that pops up on your screen then you are not investing but instead speculating. Let us look at this way. If an Engineer is looking for a job then he / she will mostly look for positions related to his field. He will not jump on a position of a Chef or a Tax consultant simply if they offered more pay. But when it comes to investing we just ignore this common sense and feel comfortable in investing in banks , oil companies , bio tech , consumer products , internet startups all at once. In fact there are people who rather prefer to invest in at least twenty different sectors so that they are diversified. But in reality they have very little knowledge about any of the underlying sectors. (ii) NO NEED OF UNDERSTANDING COMPLICATED JARGONS: One does not need to know any of the complicated jargons like beta , co-efficient , resistance level etc etc. The only thing one needs to know is how to effective evaluate future earning potential of a business. Only invest in that business when its selling at a discount. The underlying business needs to have long term prospects. If one is not comfortable owning the business for next 10 years then one need not invest for 10 minutes also. How stock markets work and how we can benefit from it?– when should we buy the stock and when should we sell it? REFERENCE - 1987 shareholder letter - This is the first question that pops up to any person who is new to investment world. The chances are more or less he will get it wrong the first time. Even Buffett was no exception in this rule. When at the age of 11 he bought his first stock of Cities services preferred for $38, he monitored the stock price every day. The stock price initially went down but eventually started rising. Buffett sold it at $40 later to realize that the stock soared to $200. This is when he realized that timing the market was not an efficient long term investing system. He later went on to study under Ben Graham and learnt that the stock quotes are delivered by a highly emotional person called “Mr. Market”. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his. Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him. Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you. But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game. As they say in poker, "If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy." In the short run, the market is a voting machine but in the long run it is a weighing machine. By this Ben Graham meant that the day to day swings in a stock price is mere reflection of people’s perception in the long term prospects of a business. But the long term price movements of a stock is indeed reflective of the underlying fundamentals of the business. |
