After a long cooling off period, here is our third part of the much liked series from Mr. Kshitiz Jain. This one should be read by everyone as the takeaways are extremely relevant for Indians.

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Berkshire Hathway Shareholder letter – 1979

Learning 1

Buffet explains that for investors to judge a good company the measure that should be focused on is Return on Capital Employed (ROCE). But, investors need to be careful of the factors like leverage, accounting measures etc. which can distort the ratios.

Learning 2

Buffet in his letter brings out two of the most important factors that impact the returns of individual investors i.e. Inflation and Taxation.

 “For the inflation rate, coupled with individual tax rates, will be the ultimate determinant as to whether our internal operating performance produces successful investment results – i.e., a reasonable gain in purchasing power from funds committed – for you as shareholders

Learning 3

In my view, the below lines is what made Buffet so successful as an investor. It clearly brings out Buffet from the shadow of his teacher Benjamin Graham, who is widely known as the “father of value investing”. Quality of company should be the first criteria for an investor, only if this criterion is met, investor should look at prices.

“ 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 a bargain price.”

Learning 4

Buffet in this letter touches upon another common investment instrument i.e. Bonds. He suggests that investors should avoid investing in long tenor bonds, especially in an inflation-ridden world. According to him, fixed price contracts like bonds are nonexistent in virtually all other areas of commerce. Parties to long-term contracts now either index prices in some manner, or insist on the right to review the situation every year or so. Similarly, fixed rate bonds for long tenors, does not make sense as it is difficult to predict interest rate and inflation scenario for such a long term.

My two cents

Firstly, an important lesson which Buffet talks about is that investors should avoid instruments like fixed deposits (FD) which due to lower returns than inflation end up destroying the purchasing power of the investors. Investors should focus on the real return (Nominal return – inflation) generated by an instrument of company instead of the nominal return generated.

Secondly, taxation is another important factor that impacts an investor’s return. Inflation adjusted post tax return is actually what an investor will earn. For an investor’s money to grow, the post-tax return from an instrument should be more than inflation.

Equity is the only asset class which is known to give real returns over a long period of time. So for investors looking to create wealth over a long term, equity exposure is necessary.


Learning from Warren Buffet Series – Part 2

warren buffet investing

Here is the second in our Warren Buffet Series. (Refer Part 1). This one is quite interesting and relevant.

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Berkshire Hathaway Shareholder letter – 1978

Learning 1

Buffet warns investors against forecasting folly that prevails in the stock market. He clearly communicates to his shareholders his philosophy of investing for the long term. It helps him to align his shareholders expectation with his thinking.

“We make no attempt to predict how security markets will behave; successfully forecasting short term stock price movements are something we think neither we nor anyone else can do.  In the longer run, however, we feel that many of our major equity holdings are going to be worth considerably more money than we paid, and that investment gains will add significantly to the operating returns of the insurance group.”

Learning 2

Buffet highlights some of the characteristics of certain industries that need to be avoided by investors, by using his investment in Textile as an example. Again clearly admitting his mistakes head on.

  1. Slow capital turnover
  2. Low profit margins on sales
  3. Highly competitive landscape
  4. Capital intensive industry with low differentiation in goods

“The textile industry illustrates in textbook style how  producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage.  As long as excess productive capacity exists, prices tend to reflect direct operating costs rather than capital employed.  Such a supply-excess condition appears likely to prevail most of the time in the textile industry, and our expectations are for profits of relatively modest amounts in relation to capital.”

Learning 3

Buffet describes two facets of his highly successful investing style, which he feels is going to reap benefits for him and his shareholders over the years. Buffet and his partner Charlie Munger has been two of the best known proponents of this style of investing. i.e. Concentrated value investing. A concentrated value investor looks for a company where he can see more value than the market price and when he finds such an opportunity, he will invest a significant amount of his portfolio in that company.

My two cents

As investors in equity market or mutual funds, the 3 biggest learning from the letter are:

  1. Ignore the short term noise and focus on the long term. So markets will be volatile but as long term investors, all you need to know is that you are invested in the right funds and have some patience
  2. Avoid stocks or Mutual funds with portfolio of companies having bad quality businesses
  3. Invest only after making sure that there is margin of safety or to put it simply, invest at a price cheaper than its value and when you are convinced about the attractiveness, you need to invest a large percentage of your portfolio. For Mutual funds investors you can look for mutual fund managers playing by this style. Word of caution here, this is just one of the successful investing style and there are various other styles which have been highly successful.

Learning from Warren Buffet Series – Part 1

What is this series about?

We have all heard a lot about the ace investor Warren Buffet. But how many of us have really read through his letters? So here we are, launching a learning series where our expert Mr. Kshitiz Jain summarizes the learning from each of his letters and connects it to what it means for us. So whether you invest in stocks or mutual funds, do takeaway some key learning for investing in general!

Also, participate in sharing the knowledge. So do Comment / Share / Like.

Berkshire Hathaway Shareholder letter – 1977

Characteristics of Good Management : Buffet letters gives us a lot of insight on this matter
  1. Buffet prefers to give his shareholders bad news first, followed by good news. There are various evidences throughout the letters. This is a hallmark of good management, while reading annual reports look for these characteristics.
  2. Good Management will readily accepts its mistake and instead of finding excuses looks to either cut losses or keep their shareholders well informed about their mistake and learning from it. Buffet accepts that Textile business has not been working well and explains in detail the reason why they are continuing with the business.
  3. Good management will give clear guidance and instead of being just overly optimistic, good management will manage shareholder expectations honestly.
  4. Managerial Discipline even in the wake of industry wide malpractices.
Investing gyaan: Buffet gives us a unique insight in his style of investing
  1. While investing in stocks evaluate as if you are buying ownership of the company and not just looking to earn short term gains.
  2. Buffet defines the type of business, one should invest in:
    1. One that we can understand,
    2. With favorable long-term prospects,
    3. Operated by honest and competent people
    4. Available at a very attractive price.
  3. Long term investment horizon and ignoring short term volatility  – “Most of our large stock positions are going to be held for many years and the scorecard on our investment decisions will be provided by business results over that period and not by prices on any given day.”
  4. Invest in companies or industries where the industry scenario is favorable, this gives the company scope to make mistakes, learn and move on – “One of the lessons your management has learned – and, unfortunately, sometimes re-learned – is the importance of being in businesses where tailwinds prevail rather than headwinds.”
  5. Stock market gives you opportunities to buy outstanding businesses at discounts which will not be available, if you are looking to acquire entire companies – “Our experience has been that pro-rata portions of truly outstanding businesses sometimes sell in the securities markets at very large discounts from the prices they would command in negotiated transactions involving entire companies. Consequently, bargains in business ownership, which simply are not available directly through corporate acquisition, can be obtained indirectly through stock ownership.  When prices are appropriate, we are willing to take very large positions in selected companies, not with any intention of taking control and not foreseeing sell-out or merger, but with the expectation that excellent business results by corporations will translate over the long term into correspondingly excellent market value and dividend results for owners, minority as well as majority.”
My two cents

Buffet helps us to answer two of the most important question that an investor needs to answer. I have tried to extend these learning further for mutual fund investors.

Where to invest?

Invest in good quality well managed businesses that you understand and are available at attractive prices. This is one of the most important learning that investors should always try to invest in quality business, even if they may not be the flavor of the month. A good quality well managed business that is currently out of favor is the best thing that can happen for an investor. Similarly, good quality mutual funds managed by fund managers with long term track records may under perform for short periods in between but will give higher returns in the long term.

How to identify good management?

Management that is honest, manages shareholders expectations with clear guidance, readily accepts mistakes and disciplined. Similarly, a mutual fund manager who has a disciplined approach to investing and does not waver from his investing style and fund mandate even in tough market situations would be someone to entrust your investments with.

Do you get attracted by market forecasts?

“Bullish on market, see Sensex at 32000 by December 2016″ – Citi Jan 13, 2016

“Citi’s December 2017 Sensex target at 31500, implies 5% upside”- May 05, 2017

We often come across news headlines such as above. The “expert” forecaster’s ever changing goal posts.

Forecasts are everywhere. The financial markets are inundated with forecasts by the so called “experts” either on TV or in print media. This is not an article against any single forecaster. I am just trying to show how wrong the so called experts can go while predicting the financial market’s movement.

We as human beings by nature look for certainty, in an uncertain future. This is the reason, unfortunately as investors we tend to give far greater weight to these “predictions” in print or on TV. As Howard Marks of Oaktree Capital wrote in his memo to clients on the same topic “The opinions of experts concerning the future are accorded great weight . . . but they’re still just opinions.

Many of my friends and relatives come up to me and ask questions like “Is the Sensex going to touch 35000 by Dec 2017?”, Or “Is RIL stock going to cross 2000 this month?” My answer to all such questions is unequivocally “I don’t know”.

I would always advise everyone to not invest on basis of forecasts. Always do your own due diligence before making an investment decision. As per a legend, one of the top bankers in the world, JP Morgan when asked about what stock market will do, replied, “It will fluctuate”. If one of the top bankers in the world doesn’t know, we better avoid falling into that trap.

Having said that, there is a difference in forecasting and making a probability based judgment. Judgment based on proper due diligence is far better than opinion of experts. We as investors should avoid the noise surrounding us. We should try to focus on our own analysis of important and relevant information to do our investments.

I would close this article with an excerpt from the Howard Marks’ Memo titled “Expert Opinion” which is a huge inspiration for this article, and, also because I could not have put it any better.

One of the most powerful things we can do as a human being in our hyper connected, 24/7 media world is say: “I don’t know.” Or more provocatively, “I don’t care.”

Not about everything, of course –just most things. Because most things don’t matter, and most news stories aren’t worth tracking