So many stocks, so little capital to invest… While I’ll still have to wait at least for a week or two before I have enough capital to start hunting for my next buy, I have a lot of time to read, analyze stocks and continue my education as a self-taught dividend growth investor.
One of my favorite source of investment advice comes from the letters to shareholders written by Warren Buffet. I thought I should share the best quotes here with you.
Here’s the best from the 1980 letter to shareholders of Berkshire-Hathaway :
While it doesn’t have anything to do with the 1980 letter to shareholder, I just wanted to say that I’m also currently reading The Snowball: Warren Buffett and the Business of Life. It’s a great biography about Warren Buffett, what kind of man he his, what kind of child he was and how he became a self-made multi-billionnaire. Though he was an obsessive guy, he sure knew and still know how to make money. I’m at page 300 so far out of a more than 800 pages book and I can’t say that I learned a lot more about how to be a better investor. I already read many books about dividend growth investing, value investing and even better, I read all the letters to shareholders that Warren Buffett wrote several times. But it’s definitely fun to learn more about him, his life, his investments. One thing I realized though, was that Warren was facing the same problem I face when he first started : limited capital!
When I realized that investing could eventually make me financially independent, I started to become obsessed like him. I actually started to see things differently. With compounding interest, 1000$ today could be worth 100,000$ later. Fifty bucks here and there saved today could be worth a couple thousands bucks several years from now. Now, when I spend a 100$ in a restaurant (like I did last week), I know that it takes 3,000$ invested for a year to get that 100$ back… That’s expensive for a bad meal in a cheap restaurant…
To overcome that problem, I started to find ways to save more money on every paycheck. I cut unnecessary expenses and even made sure I could get a new promotion so that my job income could increase by 11,500$ within 2 years, that way I could save more and put more capital at work.
Within a year, I’ve been able to build myself a more than 100$ per month stream of passive income that will grow each and every year without me doing anything more than what I did : find a good company fairly valued to invest in and buy some shares! But… I still feel I didn’t do enough. I should have been able to save a lot more…
To solve that problem, Warren started to invest other people’s money and kept part of the profit. I might start doing that pretty soon with my girlfriend’s money (but will not take any profit for myself), but she’s far from rich so it won’t occupy a lot of my time! ahah I could eventually invest some of my parent’s or friend’s money but it could get complicated. Usually, people don’t understand that they should welcome bouncing principle if they want to beat inflation… As soon as they see some “red” in their investments, they want to sell even though they haven’t lost anything at all. It’s all just paper losses… or paper gains. Before a market crash or dip, if they had a 100 shares of XYZ great company paying a growing dividend, they still own 100 shares of that company even if the price dipped. Price is what you pay, but value is what you get. If I decide to invest their money eventually, I’ll probably wait for the next market crash bottom and make them buy the greatest dividend growth stocks at the lowest price possible. Warren suffered from anxiety because he was investing a lot of other people’s money and he felt responsible for their losses or gains. That’s probably what helped him surpass the market return almost every year since he started investing though!
While The Snowball: Warren Buffett and the Business of Life is a great book that I would recommend to every investor, I love Warren Buffett’s letters to shareholders and I also think that every investor should read them.
Let’s see what were the best quotes the 1980 letter contains.
Earnings per share
Earnings per share will rise constantly on a dormant savings account or on a U.S Savings Bond bearing a fixed rate of return simply because “earnings” (the stated interest rate) are continuously plowed back and added to the capital base. Thus, even a “stopped clock” can look like a growth stock if the dividend payout ratio is low. (Warren Buffett)
This statement is an important one for a dividend growth investor like me. Investors like to look at earnings per share or price/earnings ratios to assess a stock. Wall Street also emphasizes a lot on earnings seasons and short term earnings results. Every quarter, companies publish their earnings and stocks fall or soar a couple percentage points based on the results and based on if they met or not Wall Street expectations.
What Warren Buffett wanted us to understand here is that :
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. (Warren Buffett)
There are in fact many ways and tricks management can use to “boost” earnings figures and make them appear as they did great. One of them which is widely used is to buy back their shares. Less shares outstanding means that the earnings are divided by a lower number of shares thus boosting earnings per share. But sales and revenue really are flat… Like a stopped clock.
In fact, for a dividend to be considered as safe, an investor should make sure that the sales and revenues are also growing at a rate that can sustain the dividend growth. To increase a dividend, a company can either increase its payout ratio, buy back shares or really grow its sales and revenues. If they increase the dividend because of the third reason, you might have a better dividend growth candidate because, eventually, there will be a limit to how much more the dividend can be increased by share buybacks or dividend payout ratio increase. One day, these companies will either stall or cut their dividends if their sales don’t grow.
Good businesses at a fair price vs poor businesses bought at a bargain
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. (Warren Buffet)
Early in his career, Warren Buffett used to invest like Benjamin Graham taught him to invest. He refered to that technique as the cigar-butt investing technique. It was simple and sound. Find a business selling at a discount of its book value to give yourself a margin of safety and smoke its last puff!! Using that technique, Warren had invested in textile, a declining industry and bought Berkshire-Hathaway and even Waumbec Mills eventually. Even though he was able to buy a lot of machinery and real estate for a bargain, investing against the tide is rarely a good idea. Even with the best managers, the best staff, the best machinery, it was impossible to compete against third-world in this declining industry. As soon as a problem was solved, twelve new problems would arise…
That’s one of the question an investor should ask himself before investing. Is it a growing industry? Are you able to project yourself in the future and see that company still in operation and see it even bigger than it is right now? If not, than you should pass…
These are difficult questions but even though Warren has been able to make a lot of money with that technique, eventually he realized that it is far better to buy a great company at a fair price than to buy a lousy one at a bargain. There are no free lunch in life… And, with internet and communications going so fast these days, such bargains are often not what they seem to be and might be very risky trades.
Should we buy long-term bonds?
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. (Warren Buffett)
Between 1979 and 1980, the inflation rate was near 12%. At such a rate, on december 31st, you needed 1120$ to buy the same goods you could have bought with 1000$ 12 months before. While we are currently accustomed to low inflation rates (±2%), we never know when inflation rates can start to increase and my first personal benchmark to which I measure my success is my ability to beat inflation. I actually seek a dividend growth of 6-8% to make sure I will not only beat inflation, but also make my income grow.
The problems with long-term bonds is that their rates are fixed while inflation is not and you have no control over inflation. A lot can happen within 15 years. People tend to think that bonds are safer than stocks while in fact they aren’t. If inflation stands at 7%, then your 6% 15 years bond won’t be worth the paper on which it’s printed!!! Who will want to buy it? You’ll have to wait until the end of the term to get your capital back or sell right now at a loss. Either way, you’ll lose money. Buying a 15 years bond is betting that inflation will always be lower or equal to the rate guaranteed by your bond. It’s a bet I would not do…
I would not do it because even though they publish an inflation rate near 2%, most of the things I personally consume have an even higher rate of inflation. Just this year, my energy bill had been increased by 4,6%, my property taxes by 11%, food… well it’s hard to say but I know that meat price has increased by more than 10%… I wouldn’t like to have my money stuck in a bond yielding me 3 or 4% per year for 15 years.
Huge companies like Johnson & Johnson, McDonald’s, Exxon, Wal Mart have the ability to pass inflation to their customers and as such, they give a better protection against inflation than a bond could.
During these high inflation years, many insurance companies even decided that a one year long auto policy was too long and they decided to sell 6 months term auto policy to have a better control over their premiums because of the rising price of auto parts and repair costs. Bonds returns couldn’t protect their funds from inflation.
This led Warren opt for this statement:
Neither a short term borrower nor a long-term lender be.
A company has the shareholders it deserves
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 to like candid and honest managers. He considers shareholders as partners and discuss candidly about his good shots and mistakes in his letters to shareholders.
As a dividend growth investor, I seek company that pay and rise their dividend each and every year. I know that most investors seeking the same will usually invest in the same companies I do. There is a limited pool of companies in which we can invest. These companies won’t decide to cut their dividend out of the blue because they know that investors will kick them out of the board!
But, if I should decide to invest in a company that just recently instated a dividend, I know that investors holding its stock aren’t there for the dividend. Most are there for the capital gain most probably. So, if they cut the dividend, only a little part of their shareholders will complain, most might even think it’s a good idea because it will let management with more cash to boost the earnings and the share price.
It is very important to understand this concept. Phil Fisher, an investor and author once compared shareholders and businesses to a restaurants and its customers. If you sell fast food, don’t expect to see the same kind of customers you’d see at the Four Seasons! And if you try to sell oriental food on monday, italian food on Tuesday, steak on Wednesday, mexican food on thursday and french food during the week-end, you’ll get your customer confused or dissatisfied… The same will happen with shareholders.
The reasoning of managements that seek large trading activity in their shares puzzles us. In effect, such managements are saying that they want a good many of the existing clientele continually to desert them in favor of new ones – because you can’t add lots of new owners (with new expectations) without losing lots of former owners. (Warren Buffett)
Warren won’t split Berkshire-Hathaway stock. In fact, its stock is currently selling at over 206,000$ per share!!! The average volume on this stock is around 300 trades per day. Not a lot… I personally think it’s exaggerated. It doesn’t make it very liquid. But, Warren was seeking for long-term shareholders and that’s what he has.
Warren also refused to pay a dividend because he thinks he can bring more value to shareholders by retaining earnings and reinvesting them than paying a dividend. After all, would you be able to achieve his rate of return?
Not all investors agree with him though. And, in fact, I don’t on that subject.
If I would own 5 shares of Berkshire-Hathaway (worth more than a million dollars) and I’d like to retire from my job, I wouldn’t have many possibilities with such a strategy. Dividends could provide me income that I could spend to afford life and I could keep all my shares and let them grow in value… But, since he doesn’t want to pay a dividend, I would either have to borrow money against them or I would have to sell a share and then I would have 200k to spend… That’s too much money to keep in a bank account… I would have to reinvest it to make sure that all my eggs aren’t in the same basket and that my money doesn’t lose it power of purchase due to inflation. A 1 to 10 split could provide his shareholders with more options. They could sell one share or two per year and still be able to keep most of their assets invested with him.
Accumulating assets and money must have a purpose in the end. I don’t accumulate money and assets just for collecting it. My goal is to retire early and live from the cash-flow generated by my investments.
But, I agree that Warren Buffett is a far better investor than I will ever be.
The best investor of all times offers free lessons
Warren Buffett is the best investor of all times. With a growing fortune of more than 60 billions as of today his track record is impressive. He has been able to let his money compound at a rate above 19% per year since he first started. These astonishing results are almost impossible to replicate. But, one does not need to be Warren Buffett to do just great and reach financial freedom. By saving at least 30% to 40% of my salary for the next 12 years, I should almost be millionnaire by my 50th birthday and since dividend growth investing offers both a growing income and a growing capital value, I could die multi-millionnaire even without adding any new capital and even if my money compounds only at 6-8% per year! But, I don’t see any reasons to die with so much money… I’ll most probably find a way to either spend it or give it to my kids.
Warren Buffett’s letters to shareholders are free on Berkshire-Hathaway’s website. They are a great source of information for a self-taught investor and I definitely suggest you go read them all!
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