American investor Warren Buffett writes an open letter to Berkshire Hathaway shareholders, an American multinational conglomerate which he chairs every year.
The company owns nearly 10percent stakes in fortune companies such as soft drink giant, Coca-Cola, and Wells Fargo, an American multinational financial services company, just to mention a few.
As at September, Berkshire Hathaway Inc.’s operating profit jumped 14percent to a record as Warren Buffett’s conglomerate saw gains from its railroad and got some long-awaited earnings from Kraft Heinz Co
The company ended September with a record $128.2 billion of cash, despite repurchasing $700 million of stock in the quarter, and its stock price has lagged the broader market by the most since 2009.
Operating earnings surged to $7.86 billion in the third quarter, thanks in part to a rise in investment income and Berkshire’s reinsurance group posting its first underwriting profit of the year despite losses from a Japanese typhoon. Revenue climbed 2.4percent on increases from the company’s insurers and manufacturing businesses.
Buy stocks in businesses that you would like to own yourself
Warren advises investors to buy stocks as the owner and not as a speculator. According to Warren, when many investors buy stock, they become price-conscious, constantly checking the ticker to see if the prices are up or down
From Buffett’s perspective, buying a stock should follow the same kind of rigorous analysis as buying a business. “If you are not willing to own a stock for ten years, do not even think about owning it for ten minutes,” he wrote in his 1996 letter.
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Rather than getting too caught up in the web of price movement, Buffett says investors should think of buying into a company that makes a great product, with a strong competitive advantage, and can provide investors with consistent returns over the long-term.
“Whenever Charlie and I buy common stocks for Berkshire’s insurance companies… we approach the transaction as if we were buying into private business,” he wrote in his 1987 letter, “We look at the economic prospects of the business, the people in charge of running it, and the price we must pay. We do not have in mind any time or price for sale.”
Ignore short-term movements in stock prices
For many stock investors, price is everything and the maxim is buy low, sell high Buffett disagrees completely with this approach. And with Berkshire’s portfolio, he is adamant that the price of a stock is one of the least important factors to consider when deciding whether to buy or sell shares in a particular company.
The company’s operations and underlying value are the only things that matter, to Buffett. That’s because the price of a stock, on any given day, is mostly dictated by the forces of demand and supply.
For Buffett, investors succeed when they can ignore these forces and his up-and-down emotional states. Instead, they look at whether the companies that they are invested in are profitable, returning dividends to investors, maintaining high product quality, and so on. Eventually, Buffett says, the market will catch up and reward those companies.
Be fearful when others are greedy, and greedy when others are fearful
During a market downturn, Buffett believes that savvy investors should continue looking at the fundamental value of companies, seeking companies that can sustain their competitive advantage for a long time, and investing with an owner’s mentality.
If investors can do that, they will naturally tend to go in the opposite direction of the crowd to “be fearful when others are greedy and greedy only when others are fearful,” as he wrote in 2004.
His reasoning is simple when others are fearful, prices go down, but prices are only likely to remain low in the short term. In the long term, Buffett is bullish on any business that creates great products, has great management, and offers great competitive advantages.
For example, piling cash into distressed American companies like General Electric, Goldman Sachs, and Bank of America during 2008 financial crisis, Buffett reportedly made $10bn by 2013.
Don’t invest in businesses that are too complex to fully understand
Relying on his “circle of competence” belief, Buffett advice that investors “never invest in a business you cannot understand.”
In other words, don’t choose businesses requiring knowledge outside your circle of competence, at least not until you have acquired sufficient knowledge to do so.
Buffett lumps factors affecting a business into categories: the knowable, the unknowable, the important and the unimportant.
If you don’t have sufficient knowledge about a company, it becomes harder to hold long-term investments and predict what the company (and its industry) will look like a few years down the line.
Stock option as executive compensation
Buffett has several issues with the practice of CEOs granting themselves stock options as compensation.
There’s the problem of dilution as this increases the number of shares of a company, diluting the existing pool of shareholders and reducing the value of shareholders’ current holdings, Buffett’s beliefs that managers should work to increase the value of his share of the company.
Then there’s the corporate malfeasance possible when executives with a better understanding of their company’s value (or lack thereof) can leverage their options into undeserved wealth.
