Return on Incremental Capital

Mr.Buffett has taught us –

Never count on making a good sale. Have a purchase price be so attractive that even a mediocre sale gives good results. The better sales will be the frosting on the cake.

Our business is making excellent purchases – not making extraordinary sales.

Mr. Buffett believes that big money can be made by making investment decisions based on qualitative factors whereas sure money can be made by making investment decisions based on quantitative factors. And hence, on the basis of this; he considers himself as a quantitatively focused investor.

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.

Business must have two characteristics: (1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.

Many a time, management only focuses on the increasing future Earning Per Share (EPS) by sacrificing the strength of the balance sheet. But they forget that if the balance sheet does not remain strong for a longer period of time then business is going to have a tough time into the future.

Accounting numbers, of course, are the language of business and as such are of enormous help to anyone evaluating the worth of a business and tracking its progress. Charlie and I would be lost without these numbers: they invariably are the starting point for us in evaluating our own businesses and those of others. Managers and owners need to remember, however, that accounting is but an aid to business thinking, never a substitute for it.

“What we learn from history is that we do not learn from history.”

Any company’s level of profitability is determined by three items: (1) what its assets earn; (2) what its liabilities cost; and (3) its utilization of “leverage” – that is, the degree to which its assets are funded by liabilities rather than by equity. Great companies = Float + Investment + Cash with higher return ratio

If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter. What really gets our attention, however, is a comfortable business at a comfortable price.

Buy commodity, sell brand has long been a formula for business success.

Capital-intensive business, look for PBT / interest cost rather EBITDA / interest cost.

When we are fearful with our investment decisions then we focus on the each and every aspects which can result in the erosion of the capital.

Mr.Buffett has taught us many concepts and wisdom which is essential to us while making an investment decision. I am hereby compiling all my learning from the letters of Mr.Warren Buffett. Also an evolution of Mr.Buffett from bargain to quality businesses.

For all in one learning from Mr.Warren Buffett’s Letters, Click here –> BIBLIOPHILE WARREN BUFFETT’S LETTER 1957-2017

Warren Buffett’s Letter 1997

We need to wait for the opportunity which falls under our Circle of Competence and we are comfortable with it, rather catch each opportunity.

WB 1997 01

We do not have to try to capture each and every single opportunity available rather we should focus on the opportunity which falls under our Circle of Competence and our philosophy. Till the time, we need to wait for the appropriate opportunity. Those who try to capture every opportunity, they do not get a better investment result.

As we have discussed investment into the cyclical industries in one of the articles of the same series (WARREN BUFFETT’S LETTER – 1987), we further get insights from Mr. Buffett –

WB 1997 02

When higher the supply of a particular commodity then prices of that particular commodity starts falling and vice-versa with the lower supply of the commodity. We should build a position into commodity companies during an excess supply of a particular commodity and we get insights for dry out excess supply.

Repurchase of Shares

WB 1997 03

WB 1997 04

We have seen in the current market fall that many people lose their investment, many have made an investment by bringing borrowing. But those who are careful and defensive investors, those get an opportunity to acquire position into the businesses at an attractive valuation. Many of the investors, I know who was holding a good liquidity position in their portfolio. They got saved from market fall. I also have experienced similar because of having good liquidity positions into my portfolio.

Acquisitions

Berkshire has made an acquisition into Star Furniture and International Dairy Queen (Company has a 5792 dairy stores in 23 countries)

Warren Buffett’s Letter 1998

When the company spends any money than Mr. Buffett always analyze that whether company able to create more than one dollar for anyone dollar spend or not. If the company can able to create more than one dollar for every dollar spend then they are happy to spend money. If the company is incurring a capital expenditure and consistently company is not able to earn higher returns than the company is facing capital allocation problem. We do not have to check it for 1, 2 or 3 years but we need to check it for a longer horizon.

Indian Company examples –

One of the textile machinery manufacturing company –

One of the tyres manufacturing company –

One of the largest IT Company –

TCS

Berkshire help to the CEOs of companies in which they have made an investment –

WB 1998 01

They also focus on the long-term benefits from the business rather focus on the shorter term perspective. Additionally, Mr. Buffett and Mr. Charlie provide an environment to the CEOs where CEOs can show their talent.

WB 1998 02

When CEOs does not have such kind of pressure and time freedom then they can able to perform well with the value creation among the business. Unnecessary and excess of meetings also reduces the performance. Also, those who do not have a pressure, get the freedom to work then they will produce a better result.

General Re

Berkshire has made a 100% ownership acquisition of General Re which is operated into the reinsurance business. The company is the largest U.S. property-casualty reinsurer, the company also owns 82% of the oldest reinsurance company in the world, Cologne Re. The two companies together reinsure all lines of insurance and operate in 124 countries.

Warren Buffett’s Letters 1957 – 2012