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Warren Buffet Letters to shareholders (1978-1980)

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.

1. Never select a stock. Always select a business

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.”

2. Qualifying criteria for selecting a business

WB is very clear about his selection criteria for investment which is laid out below:

  • One that you can understand
  • With favourable long-term prospects
  • Operated by honest and competent people, and
  • Available at a very attractive price

3. Always try to find an investable company with an impregnable moat

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.

4. Buying Strategy: How to think long term

Long term thinking

  • ‘Bargain price’ is the word: WB always buys the company at bargain price, however he is not concerned with whether the market quickly revalue upward securities that he believe are selling at bargain prices.In fact, he prefers just the opposite since:” In most years, we expect to have funds available to be a net buyer of securities. And consistent attractive purchasing is likely to prove to be of more eventual benefit to us than any selling opportunities provided by a short‐term run up in stock prices to levels at which we are unwilling to continue buying.” That’s a classic long term view.
  • Concentration pays off i.e. go up to the hilt: For finding a pearl you have to dive deeper. WB says “Our policy is to concentrate holdings. We try to avoid buying a little of this or that when we are only lukewarm about the business or its price.When we are convinced as to attractiveness, we believe in buying worthwhile amounts.” But he also advie never to put all your eggs in same basket.

5. Retained Earnings Vs dividend pay-out

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.”

6. Profit growth rate vs Return on equity growth rate

Return on equity

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:

formula for earning

7.Other wisdoms

  • You shall make no attempt to buy equities for anticipated favourable stock price behaviour in the short term.  In fact, if their business experience continues to satisfy , you should welcome lower market prices of stocks you own as an opportunity to acquire  even more of a good thing at a better price.
  • Turnaround seldom turns; same energy and talent are much better utilized in good business purchased at fair price than a poor business purchased at a bargain price.