While the market trades at all time highs, finding quality companies trading at fair or undervalued price becomes very difficult. What else is there to do with your free time while you pile up some cash for the next dip?
I decided to plunge back into Warren Buffett’s letters to shareholders and continue to learn from the greatest investor of all times!
I always feel like a kid when he publishes a new letter to shareholders. Warren never published a book about investing, but he gave interviews and wrote long letters every years since 1977 in which he explains his mistakes, good deals, decisions, risks and future prospects, but also how to invest like him.
Let’s see what he had to say for the year of 1979!
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. In our view, many businesses would be better understood by their shareholder owners, as well as the general public, if managements and financial analysts modified the primary emphasis they place upon earnings per shares, and upon yearly changes in that figure.
Earnings per shares are a yardstick widely used by investors and Wall Street. But, earnings per share can be manipulated in a number of ways. This is why Warren Buffett suggests that investor should focus on return on equity capital.
A company can buy back its shares, thus increasing the earnings per share while it’s earnings remained stable or even decreased.
A company could also use a lot of leverage in order to get market shares and increase earnings but at what cost?! Profitable companies should be able to grow with their cash-flow and with little or no debts.
Both our operating and investment experience cause us to conclude that “turnarounds” seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at bargain price.
As a Benjamin Graham disciple, Warren Buffett started is investing journey buying “bargains” with a “margin of safety”. But, later in his career, Charlie Munger, his business partner, pointed out that it is far better to invest in quality businesses at fair price than in lousy businesses at a bargain.
Simply because good businesses have better return on equity than their peers. Over the long-term, the extra cash-flow they generate help them increase their market shares and build what Warren called a “wide moat”. These businesses perform better and give a better return to investors. Just think about Coke (KO) or Johnson & Johnson (JNJ) for example. You’ll probably find it difficult to buy shares of these businesses at a bargain. But if you have the opportunity to buy them at fair price or even at a small premium, they might even give you a better return on invested capital over the long-term than a lousy business bought at what appears to be a bargain.
You do not adequately protect yourself by being half awake while others are sleeping. It was a mistake to buy fifteen-year bonds, and yet we did; we made an even more serious mistake in not selling them (at losses, if necessary) when our present views began to crystallize.
Bonds, generally won’t protect you from inflation. Now, inflation sits under 2% per year. But, at the end of the ’70s and at the beginning of the ’80s, inflation was crazy high! Imagine if you would tie all your money in 30 years bonds right now at current rates (±3.4%). You would think “Hey, my cash is protected since inflation is less than 2% and I’m getting 3,5%. I’ll even get richer!”. But, 2 years from now, inflation could jump to 4% or 5% or 6%… Who knows? Now you would lose money and be stuck for the next 28 years with that investment… unless you decide to sell it at a loss…
It as been proven that bonds are poor investments to protect from inflation. While great companies like Wal Mart or McDonalds can easily pass on inflation to their customers by price increases. Would you stop eating Big Mac meals if McDonalds would increase their price by 4%? Probably not if your a fan! Actually, companies like these can perform particularly well when economy is not at its best.
This is why I’m a fan of dividend growth investing. I seek a 3,5% initial yield and a dividend growth of 8%. This should keep me up above inflation! But for sure, my capital is not guaranteed and no one insures me against dumb mistakes I could make investing in the wrong companies or in great companies but at too much of a premium…
In large part, companies obtain the shareholder constituency that they seek and deserve. If they focus their thinking and communications on short-term results or short-term stock market consequences they will, in large part, attract shareholders who focus on the same factors. And if they are cynical in their treatment of investors, eventually that cynicism is highly likely to be returned by the investment community.
Warren Buffett is known for being interested in companies run by”candid” managers that are honest with their shareholders. It is becoming more and more difficult to find these men or women nowadays!
His words of wisdom are so true! Look at Tesla stock… or FCEL… Or Twitter… Do you feel like these stocks are held by long-term investors? I personally know someone who has traded these stocks at least a hundred times… in the last 3 months! He does not feel safe holding them for too long. The ride is too bumpy! And I saw him sell at a loss so many times that I stopped counting. He says he prefers to surf the waves than to hold boring stocks… We’ll see who’s swimming naked when the tide goes out (quote from Warren Buffett)!
Now look at BRK-A, Warren Buffett’s company. The average daily volume on this stock is 294 over the last 3 months. Only 294 shares per day are exchanged!!! Now compare this to Facebook who has 65,000,000 shares exchanged per day! Okay… I know, BRK-A shares are trading at more than 190,000$ per share and Facebook’s shares are trading at 65$ per share. But if we multiply the price per share by the number of trades, this means that in average, Facebook’s stock generates money movements of 4,225,000,000$ per day vs Berkshire Hathaway’s stock which is involved in the movement of 55,860,000$ per day. It’s a huge difference!
Do you own Berkshire Hathaway’s stock in your portfolio?
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