A letter a day!
Letter#70 2016
Key learnings:
1.rom the year 1990, Berkshire started acquiring ownerships in the company rather than making small investments. In this phase, it also committed some errors.
"I earlier described our gradual shift from a company obtaining most of its gains from investment activities to one that grows in value by owning businesses. Launching that transition, we took baby steps making small acquisitions whose impact on Berkshire’s profits was dwarfed by our gains from marketable.
securities. Despite that cautious approach, I made one particularly egregious error, acquiring Dexter Shoe for $434 million in 1993. Dexter’s value promptly went to zero. The story gets worse: I used stock for the purchase, giving the sellers 25,203 shares of Berkshire that at yearend 2016 were worth more than $6 billion."
2.Spend more time looking for systematic risks rather than unsystematic risks. (i.e the risk which are outside of your control)
"Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics –that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: “We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.”
During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively- financed American businesses will almost certainly do well."
- Share repurchases (buybacks)
From the viewpoint of the existing shareholders (i.e. shareholders who purchase shares only to participate in the buybacks), buybacks are mostly good. Though the day-to-day impact of these purchases is usually minuscule, it’s always better for a seller to have an additional buyer in the market.
From the viewpoint of the continuing shareholder (i.e who doesn’t participate in the buyback and continue to hold the shares), buybacks will make sense only if they are made at the price which is less than the intrinsic value.
For example : If there are three equal partners in a business worth Rs 3,000 and one is bought out by the partnership for Rs 900, each of the remaining partners realizes an immediate gain of Rs 50. If the exiting partner is paid Rs 1,100, however, the continuing partners each suffer a loss of Rs 50.
Therefore, whether buy backs will be advantageous for the continuing shareholders is totally price dependent.
"It is important to remember that there are two occasions in which repurchases should not take place, even if the company’s shares are underpriced. One is when a business both needs all its available money to protect or expand its own operations and is also uncomfortable adding further debt. Here, the internal need for funds should take priority. This exception assumes, of course, that the business has a decent future awaiting it after the needed expenditures are made.
The second exception, less common, materializes when a business acquisition (or some other investment opportunity) offers far greater value than do the undervalued shares of the potential repurchaser. Long ago, Berkshire itself often had to choose between these alternatives. At our present size, the issue is far less likely to arise."
4.Always look for the management that highlight more of the “unusual items” whether good or bad, than the usual items.
"Charlie and I want managements, in their commentary, to describe unusual items – good or bad – that affect the GAAP numbers. After all, the reason we look at these numbers of the past is to make estimates of the future. But a management that regularly attempts to wave away very real costs by highlighting “adjusted
per-share earnings” makes us nervous. That’s because bad behavior is contagious: CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be “helpful” as well. Goals like that can lead, for example, to insurers underestimating their loss reserves, a practice that has destroyed many industry participants.
Charlie and I cringe when we hear analysts talk admiringly about managements who always “make the numbers.” In truth, business is too unpredictable for the numbers always to be met. Inevitably, surprises occur. When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers."
- There are three connected realities that cause investing success to breed failure.
1)First, a good record quickly attracts a torrent of money.
2)Second, huge sums invariably act as an anchor on investment performance: What is easy with millions, struggles with billions.
3)Third, most managers will nevertheless seek new money because of their personal equation namely, the more funds they have under management, the more their fees.
"I wrote my limited partners: “I feel substantially greater size is more likely to harm future results than to help them. This might not be true for my own personal results, but it is likely to be true for your results. Therefore, I intend to admit no additional partners to BPL. I have notified Susie that if we have any more children, it is up to her to find some other partnership for them.”
The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds."
