Posts Tagged WarrenBuffett
If you already have a million dollars or more, this blogpost is not for you.
For all others, I’ll cut the bullshit and get to the chase. I am just mighty pissed off.
When you have less than a million dollars –
Please don’t listen to any or all the Gurus who are propagating 16% CAGR, 18% CAGR, 20% CAGR. You know the usual spiel. Say, you have 5 Lakh rupees. Gurus recommend that you should be happy be 18% CAGR or 20% CAGR and over a long period of time (40 years), you would be so rich, that even the rich would be ashamed.
For all those studies, where you read that if you had invested in quality at any price, and just held on to them for a long period of time (40 years), you would have made enough money to be proud of yourself.
You really want to know what they DON’T tell you.
By the time you are rich, you will be OLD. You will be very old. Your kids and grand kids, of course, would really appreciate all your journey, effort and all the good things that you have done for them. You will just die as a rich man without all the good things before it. That’s just a tragedy.
Since the readers of this blog are reasonably well versed with numbers, let me illustrate it with numbers.
Let me get the first and the easiest thing out of the way without the numbers. People keep doing these fancy calculations in excel about how much their salary is growing to grow, how health expenses will increase, plug in a sexy inflation number and try to arrive at a figure which they think will be enough for retirement.
Let me solve that for you. You need a million dollars (ex-Mumbai). Unless you want to live the luxurious life of Vijay Mallya ,(well, if you were Mallya, you wouldn’t do all these calculations), a million dollars would let you live and eventually die peacefully.
Ok, now for the numbers bit.
Let’s say you start investing at the age of 27 (well, how better it would be if you could start investing at the age of 15, but try convincing your teenage son or a fresh graduate not to spend on the latest smartphone and you’ll know what I mean). You start with Rs. 5 lakh (You can plug in any arbitary number).
Let’s say you manage to do 18% CAGR over a long period, say 40 years. Do you know how much money you would have by the time you are 67? 37 cr 51 lakh.
Whoa. That’s a lot of amount you say. Definitely it is.
But what would you do with so much amount at 67? You would be old, frail and not really ready to say travel widely or eat whatever you want or whatever shaukh (sic) you have.
Ok. So, how much money would you have by the time you are 57? 7 cr 16 lakh. Did you observe the difference?
Ok. So, how much money would you have by the time you are still fit, healthy and want to do what you want – say at the age of 47? 1 cr 37 lakh.
Did you see the difference? Did you really observe the beauty of compounding? You would not dream to live a reasonably luxurious life, traveling where you want, doing what you want to do with 1 cr 37 lakh.
And that’s my problem with folks preaching ‘my target is 18% cagr because the Gurus said it’, ‘I am ok with 16-20% cagr, but I don’t yet have a million dollars’.
Nobody, or rather, from whatever I have read spells out clearly on this intricate relationship between CAGR and Age. You can be rich, but you are already old.
I would rather die with 10 cr, in the process doing what I want than die with 37 cr to make my children and grand children happy.
And that brings me to my real point.
You should really not be aiming anything less than 35-40% CAGR if you are not already a millionaire. It just sucks not to aim for it.
Why did I say 35-40% at a minimum? That’s because, you can make 100x your money in 15 years with a 36% CAGR. Your 5 lakh will become 5 cr in 15 years (if you start at 27, by the time you are 42 – you are reasonably rich and an almost millionaire). This is not something that I picked up from the now famous 100-to-1 book. That never spoke of age. In fact, he talks very long time frames.
Is this the bull market in me speaking? Definitely. But why not? Look, unless you are outrageously lucky with a stock or timing the depth of a bear market, your BIG returns are going to come only in a bull market. Again, numbers. If a Rs. 20 has to become Rs. 100, you need a 400% return. That same Rs. 100 to come back to Rs. 20 requires just a 80% drop. So, you absolutely need to make killer returns in the bull market to survive the bear market.
People will try to dissaude you by quoting process will get corrupted, people will indulge in speculative stocks etc. My question is – what’s a corrupt process? Just because there is a wave of high quality, high management integrity bull market this time, everybody is on this bandwagon of the right process etc. It’s almost as if investing was just born in 2009.
And speculation. I don’t think speculation is going to net you 35-40% CAGR for 15 years. I have not met anybody yet doing this.
Is this easy? It’s obviously not meant to be easy. Just because you have some internet forums and whatsapp groups these days doesn’t mean investing is easy. There is a lot of hard work, there is a lot of luck and there is a lot of position sizing science involved before you make that million dollars. As Munger says, ‘It’s not meant to be easy. If you think it is easy, you are stupid’.
And speaking of Munger (which, in these days of the current bull market, seem to encapsulate all other Gurus), here’s what he had to say in Snowball – remember, when he was young –
So, for all those people who keep saying 18-20% CAGR, you are either already a millionaire or you are just bullshitting. Aim higher. Work harder. Enjoy the process of investing. And actually enjoy life at the right age. There is no fun in dying rich. And there is a tragedy in dying really rich without having enjoyed or doing what you really wanted to do.
Go for 35-40% CAGR (atleast). Become a millionaire. Live comfortably.
P.S – Cynical folks may obviously point out that 5 lakh is only a starting capital and people will add as and when they grow in life. You know, if people were so disciplined in investing, we’d have a lot more people active in 10 year and 15 year SIPs.
P.P.S – Other folks might point out CAGR is not important but how much, as a % of your networth, is more important to overall gains. Absolutely agree. Convince your friend in a bear market to put 90% of his networth in equities. % of networth is very important, but even with smaller sums of money (and I do think Rs. 5 lakh is a smaller amount of money these days, with freshers from IIMs earning Rs.20 lakh), CAGR at the right levels covers a lot of ground.
Every Tom, Dick and Harry seems to be posting about Berkshire’s Annual Letter 2011. Most of the blogposts I’ve read seem to be interpreting what Buffett said. However, my endeavor in this blogpost is to cull out the bits that I liked (and thought were important) in the Annual Letter and present them here. No interpretations, no extension of logic etc. Just pure excerpts from the annual letter found here. I am sure each one of us on different points on the investing learning curve will interpret his statements differently and there is no one single interpretation that would do justice.
On Berkshire’s intrinsic value,
Our share of their earnings, however, are far from fully reflected in our earnings; only the dividends we receive from these businesses show up in our financial reports. Over time, though, the undistributed earnings of these companies that are attributable to our ownership are of huge importance to us. That’s because they will be used in a variety of ways to increase future earnings and dividends of the investee. They may also be devoted to stock repurchases, which will increase our share of the company’s future earnings.
On Buffett’s Natural Gas bet,
A few years back, I spent about $2 billion buying several bond issues of Energy Future Holdings, an electric utility operation serving portions of Texas. That was a mistake – a big mistake. In large measure, the company’s prospects were tied to the price of natural gas, which tanked shortly after our purchase and remains depressed. Though we have annually received interest payments of about $102 million since our purchase, the company’s ability to pay will soon be exhausted unless gas prices rise substantially. We wrote down our investment by $1 billion in 2010 and by an additional $390 million last year.
On Berkshire’s performance in bull and bear markets,
We’ve regularly emphasized that our book-value performance is almost certain to outpace the S&P 500 in a bad year for the stock market and just as certainly will fall short in a strong up-year. The test is how we do over time. Last year’s annual report included a table laying out results for the 42 five-year periods since we took over at Berkshire in 1965 (i.e., 1965-69, 1966-70, etc.). All showed our book value beating the S&P, and our string held for 2007-11. It will almost certainly snap, though, if the S&P 500 should put together a five-year winning streak (which it may well be on its way to doing as I write this)
On Stock buyback/repurchases,
Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.
The first law of capital allocation – whether the money is slated for acquisitions or share repurchases – is that what is smart at one price is dumb at another. (One CEO who always stresses the price/value factor in repurchase decisions is Jamie Dimon at J.P. Morgan; I recommend that you read his annual letter.)
When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well.
Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.
The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.
On Insurance businesses,
At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained. Many insurers pass the first three tests and flunk the fourth.
On his two new personnel,
Todd Combs built a $1.75 billion portfolio (at cost) last year, and Ted Weschler will soon create one of similar size. Each of them receives 80% of his performance compensation from his own results and 20% from his partner’s. When our quarterly filings report relatively small holdings, these are not likely to be buys I made (though the media often overlook that point) but rather holdings denoting purchases by Todd or Ted.
On Berkshire’s derivative positions,
Though our existing contracts have very minor collateral requirements, the rules have changed for new positions. Consequently, we will not be initiating any major derivatives positions. We shun contracts of any type that could require the instant posting of collateral. The possibility of some sudden and huge posting requirement – arising from an out-of-the-blue event such as a worldwide financial panic or massive terrorist attack – is inconsistent with our primary objectives of redundant liquidity and unquestioned financial strength.
On basic choices for investors (which I highly recommend to be read in full rather than this brief summary),
Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.
From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.
Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.
The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century. This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future. The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful).
Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard “cash is king” in late 2008, just when cash should have been deployed rather than held. Similarly, we heard “cash is trash” in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort.
My own preference – and you knew this was coming – is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.
One book recommendation,
I think you’ll also like a short book that Peter Bevelin has put together explaining Berkshire’s investment and operating principles. It sums up what Charlie and I have been saying over the years in annual reports and at annual meetings.
(all emphasis mine)
I have started reading ‘Common Stocks and Uncommon Profits’, written by Phil Fisher, published way back in 1957. Almost all vintage investors say that this is the Bible for Growth Investing. Even Warren Buffett has this to say on Phil Fisher – ‘I am an eager reader of whatever Phil has to say, and I recommend him to you.’ Buffett has also indicated in the past that Fisher has influenced him in changing his mindset from a pure value to a somewhat growth investing perspective.
I probably should have read this much earlier. Especially in the collapse that we had 3 years back. The series of paragraphs below will tell you how prescient Phil Fisher was.
I was not too far into the book (page 38-40, in fact) when I stumbled on this gem (nothing to do with growth investing, everything to do with the big picture). I only wished I had come across this earlier. Simply outstanding. And remember, this book was written in 1957. What he says in the following paragraphs is probably an exact reflection of what has happened in all crisis since, across the world (1984 S&L, 1987 Black Monday, 1997 Asian crisis, 2000 crisis, 2008 crisis), including the great crisis we’ve had recently. Must read (emphasis all mine).
There is a greater advantage in owning certain types of common stocks, as a result of a basic policy change that has occurred within the framework of our federal government largely since 1932.
Both prior to and since that date, regardless of how little they had to do with bringing it about, both major parties took and usually received credit for any prosperity that might occur when they were in power. Similarly, they were usually blamed by both the opposition and the general public if a bad slump occurred. However, prior to 1932, there would have been serious question from the responsible leadership of either party as to whether there was any moral justification or even political wisdom in deliberately running a huge deficit in order to buttress ailing segments of business. Fighting unemployment by methods far more costly than the opening of bread lines and soup kitchens would not have been given serious consideration, regardless of which party might have been in office.
Since 1932, all that is reversed. The Democrats may or may not be less concerned with a balanced federal budget than the Republicans. However, from President Eisenhower on down, with the possible exception of former Secretary of the Treasury Humphrey, the responsible Republican leadership has said again and again that if business should really turn down, they would not hesitate to lower taxes or make whatever other deficit-producing moves were necessary to restore prosperity and eliminate unemployment. This is a far cry from the doctrines that prevailed prior to the big depression.
Even if this change in policy had not become generally accepted, certain other changes have occurred that would produce much the same results, though possibly not so quickly. The income tax only became legal during the Wilson administration. It was not a major influence on the economy until the 1930s. In earlier years, much of the federal revenue came from customs duties and similar excise sources. These fluctuated moderately with the level of prosperity but as a whole were fairly stable. Today, in contrast, about 80 per cent of the federal revenue comes from corporate and personal income taxes. This means that any sharp decline in the general level of business causes a corresponding decline in federal revenue.
Meanwhile, various devices such as farm price supports and unemployment compensation have become embedded in our laws. At just the time that a business decline would be greatly reducing the federal government’s income, expenditures in these fields made mandatory by legislation would cause governmental expenses to mount sharply. Add to this the definite intention of reversing any unfavorable business trend by cutting taxes, building more public works, and lending money to various hard-pressed business groups, and it becomes increasingly plain that if a real depression were to occur the federal deficit could easily run at a rate of $25 to $30 billion per annum. Deficits of this type would produce further inflation in much the same way that the deficits resulting from wartime expenditures produced the major price spirals of the postwar period.
This means that when a depression does occur, it is apt to be shorter than some of the great depressions of the past. It is almost bound to be followed by enough further inflation to produce the type of general price rise that in the past has helped certain industries and hurt others. With this general economic background, the menace of the business cycle may well be as great as it ever was for the stockholder in the financially weak or marginal company. But to the stockholder in the growth company with sufficient financial strength or borrowing ability to withstand a year or two of hard times, a business decline under today’s economic conditions represents a far more a temporary shrinking of market value of his holdings than the basic threat to the very existence of the investment itself that had to be reckoned with prior to 1932.
Another basic financial trend has resulted from this built-in inflationary bias having become embedded so deeply in both our laws and our accepted concepts of the economic duties of government. Bonds have become undesirable investments for the strictly long-term holdings of the average individual investor. The rise in interest rates that had been going on for several years gained major momentum in the fall of 1956. With high-grade bonds subsequently selling at the lowest prices in twenty five years, many voices in the financial community were raised to advocate switching from stocks which were selling at historically high levels into such fixed-income securities. The abnormally high-yield of bonds over dividend return on stocks – in relation to the ratio that normally prevails – would appear to have given strong support to the soundness of this policy. For the short term, such a policy sooner or later may prove profitable. As such, it might have great appeal for those making short or medium term investments – that is, for ‘traders’ with the acuteness and sense of timing to judge when to make the necessary buying and selling moves. This is because the coming of any significant business recession is almost certain to cause an easing of money rates and a corresponding rise in bond prices at a time when equity quotations are hardly likely to be buoyant. This leads us to the conclusion that high-grade bonds may be good for the speculator and bad for the long term investor. This seems to run directly counter to all normally accepted thinking on this subject. However, any understanding of the influences of inflation will show why this is likely to be the case.
Lessons learnt from just these couple of pages –
a) Depressions are likely to be shorter and shorter. As Buffett would say, volatility is your best friend. You can pick up great businesses at bargain prices during these periods.
b) Avoid companies with less than average financial strength who can’t tide through these short depressions. This especially means high debt firms, who have a low interest cover. Real estate firms usually come under this category (not infra though, I am beginning to like infra now– roads, irrigation and the like (not power sector)).
c) If you have a longer time frame (I do), avoid long term bonds. They are not wealth creators.
Outstanding stuff. As I said earlier, I only wish I could’ve read this in the middle of the depression. I would have picked up a lot more stocks than I did 🙂
P.S – An outstanding Credit Suisse study on Behavioral Finance (easily a must read) (It’s free, surprising for the quality of content in there) – https://infocus.credit-suisse.com/data/_product_documents/_shop/306486/global_investor_111_en.pdf
In this blogspot, I’d first like to talk about the ever-confusing fight between the types of portfolios – concentrated vs diversified – and the type of portfolio you should maintain. I will then move on to explain three types of investor archetypes (analyst, trader and actuary). The objective, at the end of this blogpost is to evaluate where our portfolios stand and where we stand vis-à-vis these investor archetypes. How does that help, you ask? Well, knowing the type of investor you are will more or less drive you towards one or the other type of portfolio which has the highest probability to maximise your wealth.
TYPES OF PORTFOLIOS
Concentrated vs Diversified
A concentrated portfolio is a portfolio which has only a few stocks in it (not more than 10-15 stocks. Ideally, it is less than 10). The idea behind this kind of portfolio is that very few investing decisions need to taken, but the returns would be pheomenal. The biggest proponent of this type of portfolio is Warren Buffett. People seem to advise that concentrated portfolio is the portfolio to maximize wealth. My opinion would be, if you are not the type of investor who can dedicate a lot of time to study ‘Investing’, it is also the kind of portfolio which might lead to a lot of losses.
A diversified portfolio is a portfolio which has a lot of stocks in it (>15, more like 30. Walter Schloss, a famous value investor has over 100 stocks). The idea behind a diversified portfolio is that it protects your portfolio even if 4-5 stock investments go south, as they form a small percentage of your total portfolio. An index fund is one of the widely used diversified portfolio investments that you can have.
TYPES OF INVESTORS
Analyst vs Trader vs Actuary
Each of these types of investors take an entirely different approach to the market, depending on his/her investment personality.
The Analyst: An investor who carefully thinks through all implications of an investment before putting even a single rupee behind a stock. This type of investor would pore through business valuations, business reports, cash flow statements, balance sheets etc. before taking a call whether to invest in a stock or not. Warren Buffett personifies this type of investor.
The Trader: An investor who invests/doesn’t invest depending on ‘feel of the market’. He trusts his gut feel and goes with the flow of the market, often spotting discrepancies which can make him profits. George Soros epitomizes this type of investor. Many investors also try to be ‘the trader’ getting in and out of markets, often with disastrous results. They don’t realize that there is a huge amount of education, discipline and competence to make money as a trader. The percentage of successful traders worldwide would ascertain to this fact.
The Actuary: Early in my investing career (which is not too long!), I thought there were only two types of investors – the analyst and the trader. However, Nassim Taleb’s book ‘Fooled by Randomness’ introduced me to this third type of investor – the actuary. This type of investor deals with probabilities, much like an insurance company. The Actuary investor is focused on the overall outcome rather than any single event. For example, the Actuary investor is willing to suffer hundreds of tiny losses while waiting for his next profitable trade which will repay his losses many times over. (Usually, this type of investor buys/sell a lot of severly-out-of-money calls/puts (which cost little) and in a significant event (like Lehman’s bankruptcy), this type of call/put (options) will have a lot of value, thereby covering all his prior loss-investments).
So, which type of investor are you? Are you none of these three? Well, Graham has an explanation.
Graham, in his investment classic ‘The Intelligent Investor’ clearly specified the differentiation between an ‘Enterprising Investor’ and a ‘Defensive Investor’ and hence the type of portfolio you need to maintain (concentrated vs diversified). An Enterprising investor is one who can spend a lot of time studying ‘Investing’ (and not the one who is young and ‘100-your age into equities’ philosophy). On the other hand, if you can’t spend a lot of time studying investing, most investors would be better off investing into index funds (the summary of Graham’s definition of a Defensive Investor’).
Therefore, if you are an Enterprising investor, try to create a concentrated portfolio (you fall under ‘the Analyst’ category). Else, stick to a diversified portfolio (index funds or diversified equity funds). Very few us have the competence and knowledge to be successful at trading/actuary. If you do decide to go on the trader/actuary path, please realize that there is a lot more education, discipline and time required to be successful in either of these two disciplines than being an ‘Analyst’.