July 22, 2015
One great thing about wisdom is that once you have it you don’t need to upgrade it again and again. Wisdom is beyond time and so are the words written by Warren Buffett to its shareholders in his 1978 to 1980 letters. He definitely needs no introduction unless and until you had moved in to Himalaya that too quite long time back. He is a legend amongst investor community. His letters are considered as the almanac of value investment. Here are seven timeless snippets from letters written during 1978 and 1980.
First and foremost it is about your attitude towards buying something. Let us look at what WB’s Berkshire Hathaway used to do in those days. It had two pronged strategy: One, buy out of business, and two, investment in marketable security as a part of its insurance investment portfolio. For a value investor second strategy applies. WB makes it clear that it is never about buying a stock. It is always buying a business in its entirety, as if you are going to run the business. In his words: “Selection of marketable equity securities in much the same way as if a business is to be acquired in its entirety.”
WB is very clear about his selection criteria for investment which is laid out below:
Investopedia defines economic moat as “a business’ ability to maintain competitive advantages over its competitors in order to protect its long-term profits andmarket sharefrom competing firms.” Warren helps us identify one in his 1978 letter as: “A textile company which is the largest employer of in town utilizing a labour force of high average age possessing relatively non-transferable skill.” It is like having your cake and eating it too.
WB always advocated investing in dividend paying stock. He preferred companies which has a good dividend pay-out history. However he is not silent about retaining earning in his letters:” Retaining earning is okay where the record indicates even better prospects for profitable employment of capital. However, in industries with low capital requirements, or if management has a record of plowing capital into projects of low profitability; then earnings should be paid out or used to repurchase shares – often by far the most attractive option for capital utilization.”
Further he goes on explaining why Repurchase of share is the best shot:” The competition nature of corporate acquisition activities ensures the payment in full or more than full price when a company buys another completely, but the auction method of stock market allows finely run companies to repurchase its own share at less than 50 % of that needed to acquire the same earning power thru corporate acquisition.”
The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share. To paraphrase WB, reported earning never shows the true picture of the health of the company. As per him, the correct formula of Earning should be this: