The Essays of Warren Buffett
Edited by Lawrence Cunningham
Year in, year out, Warren Buffett comes up as one of the two or three wealthiest people in the world. He is also arguably the most successful investor of all time. Countless books have been written about him, but The Essays of Warren Buffett, expertly put together by Lawrence Cunningham, is the only edited compendium of writings from the ‘Sage of Omaha’ himself.
The book is a carefully chosen selection of Buffett’s famous annual letters to shareholders in Berkshire Hathaway, the fantastically profitable holding company that he has managed since the 1970s with partner Charlie Munger, with an average annual return of 25% over the last 25 years. Though it still owns large stakes in many publicly listed companies, it also buys outstanding private companies, which in 2006 had collective revenues of close to $100 billion.
Apart from a youthful apprenticeship with his mentor, Benjamin Graham (author of The Intelligent Investor), when he lived in New York, Buffett has always lived in Omaha, Nebraska, and his approach to investing is a long way from Wall Street in every sense. His letters to shareholders are eagerly anticipated because they contain many simple nuggets of wisdom, often delivered through amusing anecdotes or pithy sayings. (He once, for instance, ruefully apologized for the expense of maintaining a private jet, which he dubbed ‘The Indefensible’.)
Following are some themes that emerge from his writings.
Look for underlying value
For Buffett, the key to winning in the stock market is not in predicting the market’s direction, but in knowing the value of businesses, irrespective of their current quoted price. He criticizes investment advisers who waste their time making forecasts about the economy, when it is much more important is to find good businesses that will remain good for years to come.
He also dismisses efficient market theory (EMT), which holds that there is no point analyzing and calculating the value of a business because the stock market, working with perfect efficiency, always reveals a company’s value through its share price. In fact, he believes, prices only reflect value most of the time, and having total faith in them prevents people from actually trying to understand businesses. Buffett quotes his mentor, Ben Graham: “In the short run, the market is a voting machine but in the long run it is a weighing machine.”
Stock market prices for companies are driven by emotion, not truth, and the truth about a company lies in its operating results rather than its current stock price or its glossy forecasts. Berkshire often makes its best acquisitions when fear is at its highest, or sentiment about the market at its lowest. For the investor in fundamentals, these are times to buy.
Markets are risky, good businesses are not
Buying stocks is generally seen to be about taking risks, but the Buffett way reduces risk to a bare minimum. Noting that many of his family members and close friends have invested the majority of their net worth in Berkshire, he notes, “I’ve never believed in risking what my family and friends have and need in order to pursue what they don’t have and don’t need.” There is no point in losing a night’s sleep over a stock ‘play’ just to gain a bit more. Better to be so sure about an investment that the ups and downs of its stock price will not worry you. You know the company’s intrinsic worth, and that the market will sooner or later recognize this. This is the essence of value investing.
Buffett famously does not invest in industries he does not fully understand. He was widely criticized for entering the technology stocks boom of the late 1990s, instead buying companies that produced boring things like paint, bricks and carpets. His golden rule is, invest only in your ‘circle of competence’ – areas you know something about, where you can understand how a company makes its money. A quote from Thomas Watson of IBM sums up Buffett’s philosophy: “I’m no genius. I’m smart in spots – but I stay around those spots.” Like everyone else, he appreciates the growth to the economy that new ideas and technologies bring, but as an investor, he notes, “…our reaction to a fermenting industry is much like our attitude toward space exploration: We applaud the endeavor but prefer to skip the ride.”
Lessons for the small investor
Many lessons can be drawn from Buffett’s essays for the small investor, including:
Buffett likes to invest in what he calls The Inevitables, companies whose products will still be bought 10, 20 30 years from now, and whose brand is so famous it gives them the lion’s share of a market. Berkshire has had large holdings in Coca Cola and Gillette for many years because although things like distribution, manufacturing processes and product innovation will evolve, people will still be drinking Coke and needing to shave for our investment lifetimes, and they will turn to the trusted names.
His attitude is: If you find a small number of companies with a strong competitive advantage and at reasonable prices, why diversify? Paradoxically, putting more of your money into a smaller number of carefully chosen stocks means you can relax. In any given year, Berkshire Hathaway may make only a handful of investments in the stock market, sometimes none at all. Often, Buffett notes, the smartest investment move is inactivity:
“Charlie and I decided long ago that in an investment lifetime it’s too hard to make hundreds of smart decisions…Therefore, we adopted a strategy that required our being smart – and not too smart at that – only a very few times. Indeed, we’ll now settle for one good idea a year. (Charlie says it’s my turn).”
Annual Report (1993)
Buying for keeps
Along with its investments in the stocks of large corporations, Berkshire buys many smaller companies outright, such as Borsheims jewellers, See’s Candies and Nebraska Furniture Mart. These are often family enterprises lovingly built up over many years. The owners wish to realize some gains for all their hard work, yet do not just want to sell to anyone. When Berkshire steps in, everyone wins: it gets a fantastic business that will keep growing indefinitely, while the owners usually stay in place to keep running it, doing what they love. By selling to Berkshire, they receive guarantees that the business will not be merged with another, sold off, broken up or moved from its home town base.
When Buffett finds owners who have a strong emotional attachment to their company, it generally suggests the company will have honest accounting, respect for customers, pride in the product and loyal and effective management in place – in short, integrity. He remarks that, “After some mistakes, I learned to go into business only with people whom I like, trust and admire”. This strategy can be a remarkably good filter for making investment decisions.
Once Buffett buys a company he intends to keep it, even if it goes through rough patches and does not contribute much to Berkshire’s bottom line. In the meantime, it tries to get the problems fixed. He tells the CEOs of each company he buys to run the business as if:
This is an outlook that runs counter to the approach of just about every other investment company, but as Buffett wrote in his 1985 Annual Report, “No matter how great the talent or effort, some things just take time: you can’t produce a baby in one month by getting nine women pregnant”. Berkshire, he notes, has “the longest investment horizon to be found in the public-company universe”.
Investors in his fund are expected to hold onto their stock for many years, even passing it on to relatives after their death. In Berkshire’s Owner’s Manual, Buffett writes: “We hope you instead visualize yourself as a part owner of a business that you expect to stay with indefinitely, much as you might if you owned a farm or apartment house in partnership with members of your family.” The company’s Annual Meeting in Omaha is designed for the faithful, part information and part entertainment, and attracts thousands of stockholders from around the world.
Though most of the essays in the book are a few years old, their basic lessons have not dated. Buffett established his investing style decades ago, and though it has undergone refinements, the philosophy remains: work with people you like and trust, and as long the financial fundamentals are also good, prosperity will take care of itself. We have a tendency to think that anything related to business or money requires us to be hard nosed, but basic to Berkshire’s fortunes has been developing a system for finding people who care. Interestingly, Buffett is well known for not going along with most other tycoons in calling for lower corporate taxes. He is quite happy to pay a US rate 35% because he feels that, in a capitalist society that rewards financial success above all others, it is fair that he has to give a fair amount of it back in the form of redistributed wealth to people whose success is not related to money, such as nurses and teachers.
What will happen when Buffett dies? His vast fortune is already being divested into the Bill and Melinda Gates Foundation, but this does not mean Berkshire will be wound up. On the contrary, he and Munger have created a set of ‘business genes’, a way of doing things that will outlive them no matter who is actually running the company. Ultimately, their greatest legacy may not simply be the enrichment of Berkshire’s shareholders or the actual money that is given away, but demonstrating an investing philosophy that anyone can follow to their profit.
Though not really an easy read for beginner investors, with a little effort to understand the financial terms a purchase of The Essays of Warren Buffett will be amply rewarded. Readers can supplement it with more recent Buffett letters found on the Berkshire Hathaway website, and for an excellent portrait of the man himself, Roger Lowenstein’s biography, Buffett: The Making of an American Capitalist is recommended.
Source: 50 Prosperity Classics: Attract It, Create It, Manage It, Share It by Tom Butler-Bowdon (London & Boston: Nicholas Brealey).