WARREN BUFFETT’S LETTER – 1992

WB Letter 1992

Mr. Buffett has written that they own a collection of business which is exceptional and also a run by an exceptional manager which has resulted in the higher returns.

Nowadays I have experience that everyone is becoming a market expert and providing their view on the short-term direction of the market. For such people, Mr. Buffett has given a good quote –

WB 1992 01

The Salomon Interlude

In 1991, Salomon Brothers caught for bond trading scandal and Mr. Buffett has performed as a chairman of Salomon for the ten months to resolve a problem at Saloman. At Salomon, they have been submitting false bids in an attempt to purchase more Treasury bonds than permitted by one buyer during the period between December 1990 and May 1991.

Five authorities – the SEC, the Federal Reserve Bank of New York, the U.S. Treasury, the U.S. Attorney for the Southern District of New York, and the Antitrust Division of the Department of Justice – had important concerns about Salomon.

Acquisitions

Many acquisition-hungry managers made an acquisition with the hope that they will transform business which will provide them with a good opportunity to earn. When a manager gets failed, they learn a lesson but shareholders pay fees for selecting them as an investment candidate. Mr. Buffett has accepted that during his earlier career, he also has made an acquisition but he able to achieve success due to cheapness into acquisitions and some of the acquisition got failed also. And due to such mistakes to get a failure, he revised his strategy to make an investment.

TATA Steel 01

TATA Steel 02

WB 1992 02

Berkshire has made an investment into the Central States Indemnity which is an insurance company provides an insurance to the credit-card holders who are unable themselves to pay because they have become disabled or unemployed.

H.H.Brown, a Subsidiary of a Berkshire has made an acquisition of Lowell Shoe Company which is into the manufacturing of the shoes for nurses, and other kinds of shoes as well.

Mr. Buffett has initial thought of purchase General Dynamics for the tendering stocks to the buyback and earns a small profit in short term. But Mr. Buffett began to study the company and he found that Bill Anders, CEO of the company has performed a decent job to run a business. Mr. Buffett has dropped the idea of buyback opportunity and decided to become a long-term investor of the company.

Investing strategy of Berkshire has been little change and also Mr. Buffett has made some compromise on the price to purchase a business’s due to market condition and their increased size.

WB 1992 03

Now, how to know an attractive price? Mr. Buffett has explained that we look attractive price with the framework of value or a growth investor – what we consider to ourselves. He explained that growth is always a component of the calculation of the value of any company. He mentioned that people using value investing term everywhere with the paying higher price then calculated the value in the hope that someone pays higher to purchase an asset from them. But such activities do not consider as an investment, it is a speculation.

People consider value investing where attribute such as low Price – to – Earnings ratio, low Price to Book Value ratio or high dividend yield or combination from mentioned and not consider value investing where reverse attributes are available. Many a time, business growth also tell us little about the value but it is also true that often growth has a positive impact on the value. We have to analyze that whether a business can able to generate a good return on the incremental invested capital or business generating a low return on incremental capital. Former one provides the benefit of growth to the investors and latter one hurts to the investment.

Ex – Value Trap

Taken from Thoughts on Thoughts blog

MTNL

The company looks very cheap on the basis of the financial metrics, but if someone who does not have paid attention to the business of the company then—

MTNL Chart

An investor has lost his capital also. So, that in value investing also, we cannot escape from the future. (For detail article, Kindly visit – http://neerajmarathe.blogspot.in/2010/04/mtnl-value-trap.html)

Value Trap – One of the educational providing company which fall under the criteria of value investing

Jetking

The company is not able to generate good growth in sales and in the profitability but investment and cash have grown well. Also currently the company is available below cash + investment which fall under the criteria of the value investing. But what about the growth into the business or on the survival of the business. Will be cash & investment remain with the company in the future? Lower sales, higher expenses, lower profitability and for last 3 years the company has stopped paying a dividend. Should we consider such investment as value investing or value trap?

Ex – Growth at the low return on capital companies

The company which is generating a good sales growth but they is not able to generate a higher return on capital they employed then those companies require to take debt or dilute an equity (in-short they need external funding). Investors in such companies will face difficult to create wealth or sustain wealth.

High growth with low return

We can see that companies having a higher sales growth but cannot able to generate a higher return on capital then they require to bring external finance to fund the growth. The growth of such companies will extend for the long period but investors face difficult to create wealth.

High growth with low return chart

Ex – Growth at the higher return on capital companies

Reverse to above if company having a good growth with having a higher return on employed capital then company does not require to bring external financing (if they having a borrowing or a dilution of capital then the size of it is very small in proportion) to fund the growth of a company and also investors of such a company can create a good wealth.

High growth with high return

High growth with high return c 1

Ex – Higher growth but no value

If we just focus on the growth of the company and not on the quality of the growth then we need to lose our capital also.

High growth but no value

A company having good growth but does it have a quality of growth?

High growth but no value C 2

More dangerous balance-sheet quality after FY2010 –

High growth but no value 1

Every time does not value investing or growth investing provides a better investment opportunity but a rational combination of the both can be good investment opportunities.

Mr. Buffett has explained valuation matrix given by Mr. John Burr Williams which is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset. He has given matrix which similarly uses for bond and stocks. But bond involves fixed future cash inflow in-terms of coupon received by us and in equities such coupon is not fixed, we cannot say with surety about future cash inflow and outflow for business. Cash inflow and outflow into equities are highly dependence on the nature of a business, quality of management. For overcoming such problem Mr. Buffett uses two rules at Berkshire –

WB 1992 04

WB 1992 05

According to Mr. Buffett, new issue market is controlling by the stockholders and institution; also new issues come during favorable market conditions and we need to pay a higher multiple. Here, we are not going to get any bargain whereas in the secondary market, many a time, we get x value business at the 1/2x.

Warren Buffett’s Letters 1957 – 2012

WARREN BUFFETT’S LETTER – 1976 – 1979

I am really grateful to Riddhi for helping me with editing work.

WB Letter 1976

Performance of the company has shown significant improvement in the year 1976 and company has been able to achieve 17.30% returns on shareholders’ equity.

Textile operation

Return on sales and Return on capital employed of textile operations was inadequate due to sluggish industry condition. Performance of any company can be measured by looking at the return on sales and return on capital employed and whether the business has a temporary problem or not.

Insurance operation

In the year 1976, insurance underwriting business has shown good performance due to the increase in the premium rates.

WB Letter 1977

People measure higher earnings per share on the basis of the past record-breaking earnings but according to Mr.Buffett, if the company issued 10% additional equity capital and if due to that there is an increase in earnings per share by 5%; then it is not considered a good performance. He mentioned that rather focusing on the higher reported earnings per share, we should focus on the return on equity capital (I.e. RoE).

Textile operation

Textile operations once again were reported as poor earning in the year 1977. Mr.Buffett gave a reason to the shareholders for remaining into the textile business.

WB 1977 01

Insurance operation

Mr.Buffett quoted the shifting of a pendulum from good period to the worst period –

WB 1977 02

He mentioned his investment criteria as –

WB 1977 03

WB Letter 1978

Diversified Retailing Company got merged into the Berkshire Hathway and due to this merger; holding of Berkshire into the Blue Chip Stamps increased to ~58%.

Textile operation

When a product is indifferentiated and business is capital intensive in nature, we earn inadequate return whereas we can earn above-average returns during a tight supply or shortage of product.

WB Letter 1979

Investment into equities shares carried out till 1979 at the lower of aggregate cost or market value. But from the year 1979, the accounting profession has decided to carry out investment at the market value.

Mr.Buffett has mentioned “Return on Capital Employed” as the criteria for measuring managerial performance.

WB 1979 01

A few years ago, Mr.Buffett had decided to purchase a Waumbec Mills in Manchester, the stock was available statistically cheap, well below the working capital of the business and, in effect, got very substantial amounts of machinery and real estate for less than nothing. But this decision resulted into the poor performance and faced too many difficulties to manage the business. Due to this experience, Mr.Buffett communicates an effective point to understand –

WB 1979 02

According to Mr.Buffett, we should focus on the management who utilize retained earnings effectively and will translate a dollar retained by them into a dollar or more of subsequent market value for us.

Mr.Buffett recognized his mistake in buying a bond and he had accepted this in front of his shareholders.

WB 1979 03

If we recognize our mistake and accept it, only then we can learn from it.

Warren Buffett’s Letters 1957 – 2012

 

Pat Dorsey Moats

On 17th January 2016, I got an opportunity to address one group of investors. I am so thankful to all my friends who provided me such an opportunity.

Investor Philosophy – Pat Dorsey

This presentation (Click here Pat Dorsey) based on what I learned from Pat Dorsey and about his philosophy.

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Company A earns High profit / High Return on Capital that attracts many players to the same industry; which resulted in a higher level of competitions. Higher competitions affect to the margins of the company A and continuously increasing competition affects to the earnings of the company A. and if company A doesn’t have any Competitive Advantage then the business of company A can be in problem.

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So the question is what is the competitive advantage?

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Now, let me explain with a simple example that how USP helps.

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Above all are benefits of having a strong USP of Rajinikanth. Now, compare these benefits to the business class.

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So before understanding, what is the competitive advantage? I explain what can not be a competitive advantage?

If a company cannot able to raise the price of the products/services then we should understand that there is an absence of competitive advantage. (Eg.: – ITC Ltd. – Budget imposes the duty on cigarette but company easily able to pass those costs to the customers and that’s the reason for the survival of the company in adverse situations.)

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We can easily able to recall brands. Meggie is becoming synonyms for noodles, Fevicol becomes synonyms for adhesive, and Colgate is becoming synonyms for toothpaste.

Also, the company which has the ability to change consumer behavior that Amazon has done (From traditional bookstore to online bookstore).

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Patents & Licenses can be useful for protecting the interest of business (not considering strong moats because after the expiry of patents other companies also can able to register it and licenses can fall in the compliance risk).

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Any psychological barrier or any cost associated with a switch from using current product/service to other product/service.

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As the addition of new users make the network more and more strong and replicating such model becomes very difficult.

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Low-cost producer compares to other players in the same industry.

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Wide and strong moat resulted in the long-term Return on Capital generation and if absent of moat not able to provide long-term Return on Capital to the business.

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Bad managers destroy business for own enjoyment and ambitions.

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Now, what to select and what to avoid is up to us. If we able to select good business with the good manager then wealth creation become more effective. That is like the good horse with the good jockey that can able to win a race.

For more details, Kindly check — Part 1 , Part 2

Inspired by — Pat Dorsey Moats

Disclaimer: This is not a recommendation to Buy-Sell-Hold. And I am not a SEBI registered analyst.

I am really grateful to – Mr. Neeraj Marathe Sir, Prof. Sanjay Bakshi Sir, and Mr. Vishal Khandelwal Sir.