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Warren Buffett MBA Talk | Part 7: Inactivity & dividends

"Wall Street makes its money on activity, you make your money on inactivity."

The opening quote for this clip of Warren Buffett's M.B.A. talk series was derived from his response when a student asked about the benefits of being an outsider of Wall Street. Buffett further states that he avoids environments that encourage too much activity, with Wall Street being the epitome of that. These environments cause over-stimulation. Ultimately, all that one needs is a single great investment a year.

Essentially, brokers make most of the money through activity. Therefore, they encourage investors to trade within their portfolios frequently. This is not needed to be a successful investor, however, being in an atmosphere like Wall Street, allows you to think otherwise.

Another student asked this question:
How can an investor value shares of Berkshire Hathaway if the company does not pay dividends?

Buffett responds:

"The question is if Berkshire can retain $1.00 in earnings and earn more than $1.00 at a decent rate. That's what they try to do."

"It is run for its owners, but not run to give them dividends because so far, every dollar we have earned and could have paid out, we have turned into more than a dollar; it is worth more than a dollar to keep it." 

Many have questioned Warren Buffett on his dividend policy, or lack thereof. I think there is a misconception where many believe that all companies should pay dividends. In studying this in graduate school, dividend payout makes the most sense when a company is unable to earn a high rate of return on retained earnings and should therefore distribute this to shareholders, so that they can do so themselves. However, Berkshire shareholders have the world's greatest investor and capital allocator investing for them, so expecting a dividend at this point in time does not make sense. And as he said, the bigger the company gets, the more difficult it is for him to invest capital, so at some point in the future, dividends may be a possibility. I am happy to have Mr. Buffett working for me, and he continues to add value and measures themselves by performance. Can't get it any better than that. 

A third student asked:
How do you know when a business has reached its full potential?

Buffett, consistent with his investing philosophy of buy and hold forever, says that they do not buy businesses with a price target in mind. The best businesses are the ones that you can hold on to forever.

"The way to look at a business is, is it going to produce more and more and more over time? If the answer to that question is yes, then you do not need to ask any more questions."

 

Investing Philosophy

When you find great businesses with excellent future economics and able and honest management, he previously mentioned that there should not be an exit strategy. These are businesses that are so rare to be found, that it makes no sense to sell them once you find them. He speaks about this on many occasions at meetings with students and frequently says that it took him a long time to understand that concept. In an age where there is so much more access to information and a constant bombardment from all sorts of media, inactivity has really become a challenge to those 'patient' investors. However, these are the investors that are most successful.

I do believe in this strategy of inactivity, but one must have truly understood the business initially, for this to hold up. On the other hand, Buffett did mention that there were times where sales were necessary; for example, in the purchase of a more appealing deal, or something drastic occurs that changes the overall dynamics of the business.

Life Philosophy

This clip reminded me of another one of Warren Buffett's famous quotes.

"We don't get paid for activity, just for being right. As to how long we'll wait, we'll wait indefinitely."

This is really a lesson in understanding what you are doing, not swaying from those principles and being patient. For such an exciting field, investing, having a certain degree of temperament is very crucial to one's success. I suppose it makes a lot of sense to be because it suites my personality. However, I do believe that investing is way more simple that it is made out to be and Warren Buffett's philosophy resonates with me because of that fact. Beyond the betas, deltas, alphas, standard deviations, models, theories, there is an underlying strategy that is simple. I agree with the principle known as Occam's Razor: The simplest answer is often correct. The same with life; life is very simple, we just make it complicated. Live a simple life and it will be reflected in all your experiences.






Related Posts
Warren Buffett MBA Talk | Part 1: Integrity
Warren Buffett MBA Talk | Part 2: Smart Choices
Warren Buffett MBA Talk | Part 3: Choosing Businesses
Warren Buffett MBA Talk | Part 4: Share of Mind
Warren Buffett MBA Talk | Part 5: Circle of Competence
Warren Buffett MBA Talk | Part 6: Macroeconomic Factors
Warren Buffett MBA Talk | Part 7: Inactivity & Dividends
Warren Buffett MBA Talk | Part 8: Diversification
Warren Buffett MBA Talk | Part 9: Market Cap
Warren Buffett MBA Talk | Part 10: Ovarian Lottery

Warren Buffett MBA Talk | Part 6: macroeconomic factors do not make a difference

"Biggest mistakes were mistakes of omission, not of commission"

Warren Buffett talks about a few ideas in this clip; timing of investments, investment mistakes and effects of macroeconomic factors. These are his comments in brief.

"You can always find a few reasons why a particular time is not ideal to buy a stock. If you are right about a business, you will make a lot of money; and the timing part of it is a very tricky thing, so I don't worry about any given event if I've got a wonderful business, what it does next year or something of the sort."

"The wonderful business you can figure out what will happen, you can't figure out when it will happen. You don't want to focus too much on when, you want to focus on what. If you're right about what, you don't have to focus on when too much."

A student then asked about his investment mistakes. He replied by stating his biggest mistakes were of omission, not of commission. He refers to mistakes of omissions as huge mistakes that G.A.A.P. does not detect. Also, buying into something where you like the terms and not the business. These usually turn out to be huge mistakes as well. Buffett tells the students that it is better to learn from other people's mistakes and also to stay within the circle of competence; stick to businesses they understand, where they will be knowledgeable about why they made the decision to purchase the stock in the first place.

The next question was on the effects of macroeconomic factors on his investment decisions. This was his response.

"When it comes to investments, you have to figure out what is important and knowable. The macroeconomic factors are important, but they are not knowable."

He says that passing up great investment opportunities based on interest rates or other macroeconomic factors is unwise. It does not make any difference if you have found a great business.

Investment Philosophy

Warren Buffett has always maintained consistency in his investment principles. The same themes of circle of competence, underlying business economics and great businesses are always mentioned. What I would focus on here is the timing. I look to his philosophy for motivation through this tough economic period. I know that there is so much fear in the market right now, and stocks are being oversold. Great businesses are being sold for prices that were not seen in decades. Based on all that he teaches and his recent article in The New York Times, this is the time to be in equity and over time, a lot of money will be made. Consider two of his quotes:

"Be greedy when the market is fearful, and fearful when the market is greedy"

"In the short-term, the market is a voting machine, but in the long-term it is a weighing machine."

This is a clear indication of today being a buying opportunity of a lifetime. Dive in.

Life Philosophy

What life lesson can we learn from this part of the lecture? I think what is important is to stick to what you want to do and what you know given the conditions of the world. The most important thing you can do for the world is to improve yourself, therefore, if you focus on what is out there (macroeconomic trends), and not focus on what's inside of you, then you will get lost in the irrelevant. For example, I know many people today are concerned about the state of the economy and are scared of a recession. Does this really matter in the grand scheme of things? Pay attention to yourself and what you know and believe that you are an asset. The end of the world is not hear, things will revert to normal soon enough, therefore do not allow this tough period to control your life. There will always be ups and downs in the business cycle. What is most important is how one deals with these situations. James Allen said,

"Circumstances don't make a man, they reveal him."

Be strong and trust in yourself. Nothing else can have an impact on your underlying fundamentals.






Related Posts
Warren Buffett MBA Talk | Part 1: Integrity
Warren Buffett MBA Talk | Part 2: Smart Choices
Warren Buffett MBA Talk | Part 3: Choosing Businesses
Warren Buffett MBA Talk | Part 4: Share of Mind
Warren Buffett MBA Talk | Part 5: Circle of Competence
Warren Buffett MBA Talk | Part 6: Macroeconomic Factors
Warren Buffett MBA Talk | Part 7: Inactivity & Dividends
Warren Buffett MBA Talk | Part 8: Diversification
Warren Buffett MBA Talk | Part 9: Market Cap
Warren Buffett MBA Talk | Part 10: Ovarian Lottery

Warren Buffett MBA Talk | Part 5: circle of competence

"That is the key, defining your circle of competence. The important thing is not how big your circle is, but its staying inside the circle."

The first question that was asked in this segment was about Warren Buffett's qualitative and quantitative analysis of companies, and whether or not he has bought a company when the numbers tell him not to. This was his response.

"The best buys have been when the numbers almost tell you not to. Then you feel so strongly about the product and not just the fact you are getting a huge cigar butt for cheap."

If you have read Philip Fisher, you probably understand the analogy "cigar butt". A cigar butt is basically a company that has one last puff of profitability left in it that is highly undervalued, so you are able to make a one-time profit out of it.

Buffett then went on to explain why cigar butt investing is not a good strategy. These companies do not have repetitive profitability. Ultimately you want to own companies that has great future economics for a long time to come.

Buffett continues by saying that he understands qualitative as soon as he gets the phone call.

"If you don't know enough about the business instantly, you would not know enough in a month or two. You have to have a background of understanding and know what you do understand and what you don't understand. That is the key; defining your circle of competence. The important thing is not how big your circle is, but it is staying inside the circle."

 

Investment Philosophy

This idea of circle of competence is very important in developing one's investment philosophy because it allows you to truly be comfortable with your investments. You will be fully knowledgeable about certain companies or industries. This will make the investment process much easier because you will fully understand your purchase, hence reducing the amount of work needed to evaluate companies. Right now, I am in the process of understanding certain companies and industries to improve my circle of competence. My goal is to sleep comfortably at night knowing my purchases were knowledgeable, informed and will ultimately earn me an above average return.

 

Life Philosophy

I have decided to incorporate how Warren Buffett's investment philosophy applies to life as well. It is very obvious that Warren Buffett's way of thinking is both consistent with his life and investing principles. I always thought it to be important to know what you enjoy doing and just do that; in a sense, stay within your circle of competence. There are many times where we are persuaded to do things that we know we are not comfortable doing, only to experience an unpleasant outcome. Don't misunderstand what I am saying. I am not saying avoid new experience or challenges; what I am saying is it is important to make wise, informed decisions based on your knowledge of a particular situation. Look at the upside versus the downside, or analyze the various outcomes if different choices are made and then decide. This way, at least you were aware of the different risks involved and you would be more prepared and comfortable with the outcome.






Related Posts
Warren Buffett MBA Talk | Part 1: Integrity
Warren Buffett MBA Talk | Part 2: Smart Choices
Warren Buffett MBA Talk | Part 3: Choosing Businesses
Warren Buffett MBA Talk | Part 4: Share of Mind
Warren Buffett MBA Talk | Part 5: Circle of Competence
Warren Buffett MBA Talk | Part 6: Macroeconomic Factors
Warren Buffett MBA Talk | Part 7: Inactivity & Dividends
Warren Buffett MBA Talk | Part 8: Diversification
Warren Buffett MBA Talk | Part 9: Market Cap
Warren Buffett MBA Talk | Part 10: Ovarian Lottery

Warren Buffett mba talk | part 4: share of mind

"You want to do everything in the world to ensure that the experience of giving that gift leads to a favorable reaction"

In Part 4, Warren Buffett responds to this question: How to determine a fair price to pay for a business? He responds by talking about great companies that create 'share of mind'. These are companies that create a positive perception in the minds of consumers. He then eludes to great businesses such as See's Candy, which he bought in 1972 for $25 million and Disney, which he knows has done a great job creating this moat.

These are some of his brief comments.

We will not buy into any business that we are not terribly sure of.

We do not expect extremely high returns.

We look for untapped pricing power. (See's Candy example)

The Walt Disney Company - He says it is difficult to compete with the brand that Disney has created around the world. These are the types of companies you want to own. Simple enough strategies. I think right now, it is at a bargain price. (Last Price: $20.16 @ November 12th, 2008.








Related Posts
Warren Buffett MBA Talk | Part 1: Integrity
Warren Buffett MBA Talk | Part 2: Smart Choices
Warren Buffett MBA Talk | Part 3: Choosing Businesses
Warren Buffett MBA Talk | Part 4: Share of Mind
Warren Buffett MBA Talk | Part 5: Circle of Competence
Warren Buffett MBA Talk | Part 6: Macroeconomic Factors
Warren Buffett MBA Talk | Part 7: Inactivity & Dividends
Warren Buffett MBA Talk | Part 8: Diversification
Warren Buffett MBA Talk | Part 9: Market Cap
Warren Buffett MBA Talk | Part 10: Ovarian Lottery

Warren Buffett MBA talk | Part 3: Choosing Businesses

"Investing is putting out money to be sure of getting more money back at an appropriate rate. And to do that, you have to understand the business."

In part three of this lecture, Warren talks about what constitutes a great company. He begins by briefly stating that one should take a job one loves, then describes what he looks for in businesses he buys. This is the basic approach to investment analysis by Warren Buffett and is the foundation upon which he begins choosing businesses for the long term.

These are some of the main points of part 3 of this lecture:

1. Only do work you would enjoy.

Take a job, that if you were independently wealthy, you would take. You will get a lot more out of it and will enjoy it more.

If you think you will be happier making 2X instead of X, you are making a mistake. You ought to find something you like and you will get in trouble if you think that making 10X or 20X is the answer to everything in life because then you will do things like borrow money when you shouldn't or cut corners on things your employers want you to cut corners on. It does not make any sense; you would not like it when you look back on it.

2. Warren Buffett's business criteria

What makes companies you like?

i. Go for businesses you understand.
ii. Simple businesses, but not easy businesses.
iii. Business must have a moat.
iv. Honest, hard-working and able management.
v. Good current and future economics.

3. Moats

Buffett goes on to discuss the idea of a moat being the competitive advantage of the company. He uses the example of car insurance. Insurers compete on service and price; since most of the insurers offer similar products, the price is what he must compete on. Therefore he must be the low-cost provider. Therefore, GEICO is the low-cost provider in this industry and therefore, he owns it.

A lot of emphasis is put on the moat. He mentions to the MBA students that the one request he has for his managers is to widen the moats of their respective businesses, that is, strengthen their competitive advantages; throw in alligators and crocodiles and snakes.

Moats can come across through patents, quality of product, service, cost or real estate location.

4. Buy a business you understand

If he is not able to tell what a business will be like 10+ years from now, he is not going to buy it.

I would not buy any stock, if they closed the stock exchange tomorrow for 5 years, I won't be happy owning it.

You're buying a piece of business.

You're not buying a stock; you're buying into a business and once the business does well, you will do well.

If I were teaching a class in business school and on the final exam, I would pass out information on an Internet company and tell the students to value it. Anyone that gave me an answer would flunk. You can't do it.








Related Posts
Warren Buffett MBA Talk | Part 1: Integrity
Warren Buffett MBA Talk | Part 2: Smart Choices
Warren Buffett MBA Talk | Part 3: Choosing Businesses
Warren Buffett MBA Talk | Part 4: Share of Mind
Warren Buffett MBA Talk | Part 5: Circle of Competence
Warren Buffett MBA Talk | Part 6: Macroeconomic Factors
Warren Buffett MBA Talk | Part 7: Inactivity & Dividends
Warren Buffett MBA Talk | Part 8: Diversification
Warren Buffett MBA Talk | Part 9: Market Cap
Warren Buffett MBA Talk | Part 10: Ovarian Lottery

Warren Buffett MBA Talk | Part 2: Smart Choices

"To risk something that is important to you for something that is not important to you is foolish."


Part two of this MBA talk focuses on making the right decisions. He talks about his involvement in the Long Term Capital Management incident and how the very intelligent, high IQ guys running this hedge fund, made bad, risky decisions that ultimately led to a huge failure. He used this as an example of how high IQ is not needed to be successful and also one needs to truly understand the risks one takes and if it is worth it. These are some of his comments from this clip.

 To risk something that is important to you for something that is not important to you is foolish. To make money they [partners in LTCM] did not have and didn't need, they risked what they did have and did need.

If you handed me a gun with one thousand chambers, or one million chambers in it and there was a bullet in one chamber. Then you said put it up to your temple and asked how much do you want to be paid to pull it once. I am not going to pull it. You can name any sum you want, but it does not do anything for me on the upside, and I think the downside is fairly clear.

History does not tell you the probabilities of future financial things happening.

The beta does not tell you a damn thing about the risk of the stock.

Sigmas do not tell you about the risk of a company going bankrupt either.

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In this part of the lecture, he really emphasizes making the right decisions. It is totally unnecessary to take risks, especially when you risk things that are important to you for things you do not need. I see how this can be included in my investment philosophy. If you assumed that the money you are investing is not yours, but belong to shareholders, think if you would purchase a particular company. More importantly, think if the money was yours and you did not want to risk losing anything, consider how careful you should look at the investments. Buffett's rules should apply always:
1. Don't lose money,
2. Don't forget rule number 1.

Choose investments with minimal downside and a lot of upside. Very simple strategy. The same philosophy applies to your choices in life. Do you agree?








Related Posts
Warren Buffett MBA Talk | Part 1: Integrity
Warren Buffett MBA Talk | Part 2: Smart Choices
Warren Buffett MBA Talk | Part 3: Choosing Businesses
Warren Buffett MBA Talk | Part 4: Share of Mind
Warren Buffett MBA Talk | Part 5: Circle of Competence
Warren Buffett MBA Talk | Part 6: Macroeconomic Factors
Warren Buffett MBA Talk | Part 7: Inactivity & Dividends
Warren Buffett MBA Talk | Part 8: Diversification
Warren Buffett MBA Talk | Part 9: Market Cap
Warren Buffett MBA Talk | Part 10: Ovarian Lottery

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