In last week’s article, I discussed Warren Buffett’s recent and long-term track record and how Berkshire shareholders have remained committed to him even though he has trailed the market in the last ten years. In this article, I’ve tried to capture some of the reasons why this might be. I’m calling these “contributions” because I think these are investing ideas and principles that Buffett has continuously espoused over the years that have contributed to developing a trust and commitment from investors that is probably unrivaled in the world of investing today. I also think these views fan out further than just Berkshire and are important for all long-term stock investors to consider.
[1] Educating
If you were to pick just one piece of investment related reading a year, I would argue it should be Buffett’s annual letter to shareholders (you can read all the letters back to 1977 here). While the letters have sometimes had a specific focus, there is a consistent drumbeat to most of his messages – it basically comes down to long-term buying of good businesses at what are hopefully reasonable prices, controlling your temperament and believing in the U.S. stock market and corporate America over time
In a podcast with David Perrel, Wall Street Journal Columnist Jason Zweig highlights and praises Buffett and Charlie Munger’s long-term consistency in espousing their investment beliefs.
What’s remarkable about both Charlie Munger and Warren Buffett is that every year for decades at the Berkshire Hathaway meaning they’ve taken on this task of answering questions on any topic from anybody. And, remarkably, they always give the same answers and people keep coming back. And I think it’s because that sort of constant is rare in the business community and in public life as well. And people appreciate always hearing the same message delivered the same way.
Source: David Perell, JASON ZWEIG: SAVING INVESTORS FROM THEMSELVES
Consistent messaging and driving home their investing philosophy year after year are big reasons why stockholders stick with Buffett over time.
[2] Promoting the importance of controlling emotions and combating biases
One of my favorite quotes from Buffett is below:
“To invest successfully does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding the framework.”
In The Intelligent Investor, Ben Graham, Buffett’s mentor, wrote about the concepts of margin of safety, investing over speculating, and not letting Mr. Market, which can be irrational in the short run, get the best of you. Graham’s teaching and writings were instrumental in shaping Buffett’s views on investing. As he said in his 1987 letter to shareholders, “Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success.”
Graham, and then Buffett, were writing about behavioral finance decades before behavioral finance was even a finance subject. They understood the important to emotional discipline and long-term thinking.
As Ben Graham once said, “In the short run, the market is a voting machine but in the long run it is a weighing machine.” What this means is that in the short-term the popularity in the stock market means a lot but over time it’s the underlying fundamentals that matter the most.
[3] Being a long-term optimist
The paragraphs below were taken from Berkshire’s 2008 annual shareholder letter. Buffett has always remained a steadfast, long-term optimist on America and capitalism. He may not always think stocks are cheap, but the idea that as a country and economy we are advancing and the cash flows generated by corporate America will be higher in the future are continuous reminders from Buffett.
Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 211⁄2% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of challenges.
Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – the real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.
Source: BERKSHIRE HATHAWAY INC., SHAREHOLDER LETTERS: 2008
The same message continued in May of this year at Berkshire’s shareholder meeting when Buffett gave a historical perspective on the markets and investors’ attitude toward stocks after the Great Depression. While Buffett may not have been putting large amounts of cash to work in what was the quickest 35% decline and quickest recovery in history, he still delivered a reliable conclusion: “never bet against America”.
[4] Buying stocks when they go on sale
This point and the last two are somewhat joined at the hip since some of the best times to buy stocks are during bear markets or when things seem the darkest. This is also when things are usually the cheapest.
In October 2008, Buffett wrote this Op-Ed piece for the New York Times, Buy American. I Am. In it, he wrote: “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.”
Every 5-6 years, on average, stocks fall by roughly 35%. Sometimes they fall more, sometimes less. But each time they fall, history would tell you this presents an opportunity to buy more stocks at lower valuations and future expected returns go up, not down, but often times investors let fear govern their decisions and they sell stocks after most of the damage is done.
Just remember this Buffett quote next time stocks fall 30% or more.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
[5] Evolving investment process
Since Buffett was heavily influenced by Ben Graham, he started as a deep value investor, looking for stocks that traded near or below what a private investor might pay for them. If you could find stocks at these levels, there was likely a margin of safety embedded in the valuation.
But at some point in the late 80s or early 90s, and under the influence and advice from Charlie Munger, Buffett transitioned to a quality investor – i.e. looking to buy great businesses at attractive and fair prices. This opened up a much larger universe for Buffett, and as Berkshire grew in size, he was able to invest (or buy outright) in much larger, high quality businesses that he believed had earnings power and had a protective moat around their business and future profits.
As humans, our early experiences, successes and failures influence us greatly. For Buffett, he had success as a deep value investor and possibly some of his best performing years ever. The fact he was able to pivot and embrace high quality investing is impressive and a good lesson for all us because sometimes our success, and even survival, requires a change in how we view things.
[6] Focus on Fees
Buffett is outspokenly critical of investment firms and products, including hedge funds, that charge exorbitant fees. In this interview, he makes the case calling the 2% and 20% (i.e. 2% asset management fee and 20% of profit) model obscene (see video below).
Here is the other thing: you can invest in Berkshire Hathaway for a 0% fee. So you can effectively buy a company that has a track record of effectively allocating capital, buys quality private and public stocks, flexes its cash balance and looks for buying opportunities and entry points on quality assets — you effectively get all that for no fee. Buffett’s is not going to charge you to invest in Berkshire.
[7] Respecting Simplicity
Ben Carlson of Ritholtz Wealth Management summed this up perfectly in this piece, “My Too Hard Pile”. Buffett stays within his circle of competence. There are many businesses he understands and many he doesn’t. He avoided technology companies for years, but as their business models became more understandable and products more pervasive, he adjusted and invested in them and now Apple is Berkshire’s largest position.
Take a look at Berkshire’s acquisition criteria and you’ll get a sense on the value Buffett places on keeping deals simple, fair and straightforward. The criteria can be boiled down to: a large purchase, a firm with long-term earnings power, good returns on equity and little debt, and a management team in place that runs a simple business. Lastly, the seller needs to name a price so that Buffett can determine the expected return. Lots of M&A deals start without with a price that needs to be negotiated, but Berkshire requires that companies that come to their doorstep already have a buyout price in mind. This keeps deal making relatively simple and efficient.
[8] Give Back with Humility
Buffett has committed to donating 99% of his wealth to philanthropy through The Giving Pledge and despite being one of the world’s wealthiest individual, he maintains a relatively humble lifestyle and keeps an even humbler attitude toward his success. The excerpt below was taken from the letter he wrote when committing to The Giving Pledge.
My wealth has come from a combination of living in America, some lucky genes, and compound interest. Both my children and I won what I call the ovarian lottery. (For starters, the odds against my 1930 birth taking place in the U.S. were at least 30 to 1. My being male and white also removed huge obstacles that a majority of Americans then faced.)
My luck was accentuated by my living in a market system that sometimes produces distorted results, though overall it serves our country well. I’ve worked in an economy that rewards someone who saves the lives of others on a battlefield with a medal, rewards a great teacher with thank-you notes from parents, but rewards those who can detect the mispricing of securities with sums reaching into the billions. In short, fate’s distribution of long straws is wildly capricious.
Source: Warren Buffett’s Letter to The Giving Pledge
Buffett’s long-term performance record is inimitable, and as I mentioned in my first article, even though the last 10-15 years haven’t been Berkshire’s best relative to the market, that doesn’t matter because investors have “stayed with the program”, remained committed and received the return the shares have generated, which is better than many other investors. But past performance is exactly what is says it is: in the past. These eight contributions, largely influenced and persistently advocated by Mr. Buffett, will provide much benefit to investors in the future. These contributions might be worth more to the investing world than any past or future return in Berkshire’s stock price.
Photo: Copyright: 123rf.com / lightwise
Justin J. Carbonneau is VP at Validea & Partner at Validea Capital Management.
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