Our new series will discuss the investing philosophy of Warren Buffett with direct excerpts from his Chairman’s letters to shareholders. As an investment student, this is a must read for all who intend to pursue such a feat. These letters are known to be one of the greatest sources of investment advice and is probably the most anticipated investment document each year.
We will start out series by studying and analyzing his letters all the way back to 1977 until present day. It may take us some time to do so, but I know at the end, we will have learned a great deal from this entire experience. Our investment I.Q. will surely raise several points, which is incentive enough to perform this task.
Warren Buffett on Earnings Per Share:
“Most companies define “record” earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest rates earnings each year because of compounding."
What we, as investors, should be looking at:
“…we believe a more appropriate measure of managerial economic performance to be return on equity capital”.
Warren Buffett on long-term investing:
“…Most of our large stock positions are going to be held for many years and the scorecard on our investment decisions will be provided by business results over that period, and not by prices on any given day. Just as it would be foolish to focus unduly on short-term prospects when acquiring an entire company, we think it equally unsound to become mesmerized by prospective near term earnings or recent trends in earnings when purchasing small pieces of a company; i.e., marketable common stocks”.
Warren Buffett’s underlying investment philosophy has been the same since 1977. There is no significant difference in buying an entire company and buying shares of a company. Similar considerations must be made.
“We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price. We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price.”
“Our experience has been that pro-rata portions of truly outstanding businesses sometimes sell in the securities markets at very large discounts from the prices they would command in negotiated transactions involving entire companies. Consequently, bargains in business ownership, which simply are not available directly through corporate acquisition, can be obtained indirectly through stock ownership. When prices are appropriate, we are willing to take very large positions in selected companies, not with any intention of taking control and not foreseeing sell-out or merger, but with the expectation that excellent business results by corporations will translate over the long term into correspondingly excellent market value and dividend results for owners, minority as well as majority.”
The importance and role of management when selecting companies for stock or full ownership.
”Capital Cities possesses both extraordinary properties and extraordinary management. And these management skills extend equally to operations and employment of corporate capital. To purchase, directly, properties such as Capital Cities owns would cost in the area of twice our cost of purchase via the stock market, and direct ownership would offer no important advantages to us. While control would give us the opportunity – and the responsibility – to manage operations and corporate resources, we would not be able to provide management in either of those respects equal to that now in place. In effect, we can obtain a better management result through non-control than control. This is an unorthodox view, but one we believe to be sound.”
I thought this to be an important part to include from this letter as it discusses Banking as investments. The point he was making was that a bank does not have to be a large bank to make it a good investment. The Illinois National Bank was an excellently run small bank that was extremely profitable.
“Earnings in 1977 amounted to $3.6 million, more than achieved by many banks two or three times its size.”
What I have learned from this report.
- Warren Buffett’s investment philosophy has remained fundamentally the same today as it was decades ago.
- Invest in stocks where you would feel comfortable owning the entire company.
- Buy companies with great management; rather than thinking you can change the management yourself.
- Buy companies that you understand with great management, favorable long-term economics, and most importantly at great prices.
- Big does not always mean most profitable.
What knowledge have you gained from this report?
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