BUFFETT'S ANNUAL LETTER - REFRESHING INVESTING FUNDAMENTALS

By Ruma Dubey

Warren Buffett. The name evokes a sense of respect seldom felt for any investor. And it’s a name which transcends creed, race, country. More than his investments, it is the values which Buffett represents, as a human being, which set him apart. For those like us, who are into the stock market, Buffett is like a guide book – he teaches us about investment and how to lead a simple and fulfilling life.

Every year, the letter which Buffett writes to his shareholders is waited with a lot of eagerness. Apart from getting a peek into where his vision for the future lay, it is a pleasure to read his thought process and understand better about investments. This year’s letter, which he wrote to Berkshire shareholders yesterday was like a refresher course for us investors. As usual it had nuggets of wisdom, more valuable than gold. This time he reminisces about his purchase of a farm in 1986 and a building near rhe New York University in 1993, which was used to drive in the point of keeping investments simple, diversified and low-cost.  

He opened his letter with a quote from Benjamin Graham, saying, “Investment is the most intelligent when it is most businesslike” as Buffett says, he owes a lot of his knowledge about investing to Graham.  He said that the 400-acre farm which he purchased for $280,000 was bought when the farm land bubble burst and land prices were going abegging. 28 years later, this farm tripled his earnings and it is valued five times his purchase price. And he still knows nothing about farming and has visited the farm only twice.

The building which he bought in 1993 was also bought when the commercial realty bubble had burst. Today, his earnings from leases in the building have tripled, his annual distributions exceed 35% of the initial investment made. The original mortgage was refinanced in 1996 and again in 1999, moves that allowed several special distributions totaling more than 150% of what he had had invested. Till date, he has never viewed the property.

He uses these two examples from his life to drive home the fundamentals of investing. And this is where we see his brilliance in the simplicity of his advice.

• Keep things simple and don't swing for the fences.

• When promised quick profits, respond with a quick "no."

• Focus on the future productivity of the asset you are considering. If you don't feel comfortable making a rough estimate of the asset's future earnings, just forget it and move on.

• With regards to speculation he says -  I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game.

• A real winner of an advice - the fact that a given asset has appreciated in the recent past is never a reason to buy it. (This is for all those who run after a stock after it has appreciated and get onto an already fast moving bus which is about to press on its brakes furiously – you are sure to fall).

• For those who value stocks on a day-to-day basis – when he invested in the properties he thought of the long term value, not daily valuations. He puts it so beautifully, “Games are won by players who focus on the playing field -- not by those whose eyes are glued to the scoreboard.” He says that when he bought those two properties, he was not bothered about interest rates, economy or the stock market – he only concentrated on his long term valuations. That conviction in the future and not be bothered about short term events is what we all should learn – especially when we now bas our trades on RBI, Fed Reserve meets.

• For those investing based on macro/market predictions of others – it’s a waste of time and dangerous as it blurs your own vision of important facts. He says that his evaluation for investment is very simple – if he can estimate a earning range for the next five years and if the returns are reasonably good, then he buys; he says he never considers political factors or macro environments while making decisions and never does he listen to views of other people.

• On both the property investments, the common link was the burst of the bubble. He reiterates his advice of buying when all sell and sell when all buy. He says, “Tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.”

• He says that one should invest based on one’s “circle of competence” and make study of business they want to invest in a priority. And for those who do not have this competence, he says,” the goal should not be to pick up winners but rather be to own a cross section of businesses that in aggregate are bound to do well.” – This he explains is the ‘what’ of investing.

• With regards to ‘when’ of investing, he advices to accumulate shares over a long period and never sell when the news is bad and stocks are well off their highs. If one has a diversified portfolio and keeps acquisition costs low, no one will ever lose money. 

• Regarding the distribution of investment, he says - Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.

Great words of wisdowm. When you read this, you feel, that he has not said anything new which you did not know. And that’s the crux of investing – the simpler it is, the more money you will make. In fact if your investment is not simple, clearly, you are not investing right!

You can read the entire letter here - http://finance.fortune.cnn.com/2014/02/24/warren-buffett-berkshire-letter/