Investment Shastra

Take-away from Warren_Buffett’s Letter to Shareholders 2017

Warren Buffet

In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price. That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers. Even if there are multiple businesses with durable competitive strengths, Buffett skipped them, because they didn’t offer a sensible purchase price. Sensible price is often ignored by investors because either they lack patience or are afraid of missing out the rally. Currently, Berkshire Hathaway holds $116 Bn out of $308 Bn or 37% of its networth.

Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need In India, we can assume this risk analogues to investing in Small and Micro cap stocks. Everyone knows how risky small-sized companies are, and still many retail investors hold large portion of portfolio in such stocks. This happens, because we often get lured by making a quick buck in stocks, without realizing we could lose our entire capital. If one invests a good portion of ones networth in equities, one doesn’t need to take lot of risk. Stick to Large and Mid-sized Blue Chip stocks, and one would sleep well. This would give us what we need without risking what we already have.

Despite our recent drought of acquisitions, Charlie and I believe that from time to time Berkshire will have opportunities to make very large purchases. In the meantime, we will stick with our simple guideline: The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own. When we get good prices for some stocks, we should invest heavily as opposed to people who tend invest minuscule amounts in 100s of stocks. Now that markets are overvalued, we should be more cautious and not push a lot of funds in stocks. Howard Marks always mentions that, ‘When everyone gets excited about the equities, we should get more cautious. Similarly, when others get really scared, we must get more aggressive in buying equities.’

Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well. Sometimes the payoffs to us will be modest; occasionally the cash register will ring loudly. And sometimes I will make expensive mistakes. Overall – and over time – we should get decent results. In America, equity investors have the wind at their back. At MoneyWorks4me, we always own/recommend stocks as owners of business and remain unaffected by daily stock-price movements. We instead get aggressive and buy more when prices go down from our buy price. Stocks over time reflect value of an underlying business rather than investor sentiment. We have always had stocks falling below our purchase price but recovering over time and often going beyond our expected fair value. The belief that we are owners of business keeps us calm. We don’t fall for short term-noise, which is created by media and brokers. If you had heard the brokers, you would have sold banks when they were trading at 5X earnings in Feb’16 and fast growing Consumer stocks trading at 25-28X earnings during demonetization period. Also, you wouldn’t have scooped high ROE IT stocks when they were trading at valuations in low teens last year. Unless we differ from how others think, we can’t make returns different than the market.

This table offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions. In the next 53 years our shares (and others) will experience declines resembling those in the table. No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow. We have always insisted not to trade in F&O which have high leverage and can potentially wipe out capital altogether. #Warren_Buffett highlights that drawdown in equity/stock are imminent, and can’t be avoided, even if the company is as renowned as Berkshire Hathaway. Steep fall in stock prices always come, and they will happen in future too. If we want to remain calm, we should avoid borrowing like a plague. We must also reduce exposure to equities, if the markets are euphoric. Being fully invested in equities also rattles the mind and makes us sell out portfolio due to fear of losing lot of capital. Missing a part of rally may lower our returns in short term, but the comfort of having cushion in form of cash makes us add more to equity, when markets turn volatile rather than selling it at a loss.

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