This year is my year to work on myself. I quit my job as an analyst and moved to Thailand. I’m trying to become more focused on working towards my goals. A book my Uncle referred me to years ago was a beacon of light for me then and is now, as I re-read it.
It is Warren Buffett’s letters to shareholders, compiled into a book. Every year he personally writes a letter to his Berkshire Hathaway shareholders. He believes that a “once-a-year report of stewardship should not be turned over to a staff specialist or public relations consultant who is unlikely to be in a position to talk frankly on a manager-to-owner basis.” The result is personal, direct letters filled with business lessons from one of the greatest business minds of our time.
Buffett’s letters are filled with wisdom and overlooked common sense. I find the lessons are applicable to both business and life.
1. Achievement is largely a product of intense focus.
There’s a problem with the idea of diversification: it is meant to be a risk averse strategy but it isn’t. Diversification dilutes volatility until if largely mimics industry and economic performance. Diversification infers the idea that investors are not confident in their own judgement of which companies are best. Most believe that a smart investor should make lots of investments and hope to be right more often than not. It is of the mindset that
“one should never put all their eggs in one basket”
Warren Buffett would rephrase such a comment to
“Put all your eggs in one basket – and watch that basket very closely”
The more companies you invest in, the more you spread your attention thinly. This is where the life lesson comes in:
Success is a product of intense focus, not thinly spread attention.
Buffett owns lots of companies but he has made those acquisitions over decades and has spent a great deal of time first understanding the market and, most importantly, the management of each. He genuinely trusts his managers.
He only buys stock in companies when he thinks the managers are dedicated, principled people who he trusts to watch their baskets. He demands his CEOs run the company as though they were not the CEO, but instead were the sole owner of the company. Buffett asks them to manage the company as if their money, and all their family’s money, were in the stock and they could not sell it for decades to come. This is how Buffett feels comfortable owning eggs in fewer baskets.
This opposition to diversifying for the sake of diversifying is actually a theory based on the famous economist John Maynard Keynes, who advocated that diversification does not actually reduce risk. Keynes’ perspective was that:
Risk is created by a large portfolio where the manager’s attention is spread too thinly.
Risk increases when a manager is monitoring too many companies and cannot truly understand the management, products, competitors, and debt levels. Buffett and Keynes argue that intense focus is where true risk reduction occurs. I think that is true inside and outside business.
2. Trust Yourself, Not Others
Ben Graham was Warren Buffett’s teacher at the Columbia School of Business. Buffett admired him and took many of his lessons to heart. One key lesson was that
“price is what you pay and value is what you get”
Graham used a character called Mr. Market to represent the idea price and value differ in real world stock markets. In his analogy, Mr. Market is the single character who can you buy shares from or sell shares to. Graham describes him as follows:
Mr. Market is moody, prone to manic swings from joy to despair. Sometimes he offers prices way higher than value; sometimes he offers prices way lower than value. The more manic-depressive he is, the greater the spread between price and value.
In other words, the market is not a rational place because people get crazed over rising stocks or panicked over failing ones.
- In a bull market, investors take up a stock’s flag as though it was an infallible, sure way to riches.
- Then news comes of a sell-off, a market turn, or an unexpected change in interest rates and Mr. Market goes from excited, with dollar signs in his eyes, to scared and vulnerable and selling his investments before the floor drops out.
My perspective is that this isn’t an attribute of investors, it’s an attribute of humanity. We are not only emotional but we consistently and drastically underestimate how emotionally minded we are.
The lack of stability we see in our markets can be attributed to the fact that Mr. Market never bought the stock for the real value of the company and its products. Instead, Mr. Market buys for the market value. But market value is based on an expectation of a gain on investments. It’s a gamble more than an investment. Market “value” it is a house of cards, not a real house. In the market, and in life, houses built from cards are always dangerous things.
Buffett’s investments have gained twice the market average over the years. Why? Because he buys stock in good companies and holds on to them. Because he trusts his own judgement, when the market sells off, he buys more. Why? Because if he trusts he is buying actual value in a valuable company than a sell-off is the best time to buy at a good price!!
3. When Building Yourself, Seek to Build Real Value
Just like you want to invest your money in real value, when it comes to personal growth you want to invest your time and energy into building real character.
Apple stock trades for $118 per share (at the time I am writing this). Berkshire Hathaway trades for $223,065 per share. Yet, Apple is worth twice as much as company, $697 billion versus $336 billion. Why is Berkshire’s stock so pricey? Warren Buffett refuses to split the stock to reduce the price per share. But why?
Buffett refuses to split it in order to maintain a market price that is reflective of his company’s actual value. He is literally trying to protect his company from increasing to high prices that do not reflect actual value. He is building a real house, not a house of cards.
By having each share worth a quarter of a million dollars, he repels speculators with short term interest in his company. He wants to repel anyone who isn’t buying for long term value. Many, if not most, stocks are traded by people who buy and sell stock based on speculative guesses on short-term future performance. Many are day traders. Many others will hold a stock for a year or two. Buffett only wants to attract serious investors who plan to hold the stock for ten or twenty years.
Warren Buffett does not own every share of Berkshire Hathaway and so other shareholders are literally his co-owners. He only wants his co-owners to be of a long term mindset. Oddly, this is a rare mindset. All three of the below methods are often used by companies to inflate their stock price and are avoided by Berkshire Hathaway:
- Berkshire has never split the stock to reduce price
- Berkshire has never paid a dividend; all money goes back into investing
- Berkshire rarely buys back its own stock
Buffett believes that many companies often buy back their stock for a price of $2 when it has a value of $1. Why? To inflate a price that is faltering. They are simulating demand.
Deterring short sighted managers is crucial to CEOs making good, clear headed decisions. A manager is at the whim of the owners because owners have voting rights. Buffett does not want owners voting for short term strategies. He jokes that
“calling someone who trades actively in the market an investor is like calling someone who repeatedly engages in one-night stands a romantic.”
At deterring the short-sighted, he has succeeded. Less than 5% of the stock changes hands over the course of a year. Furthermore, 90% of Berkshire shareholders have more money in Berkshire than any other stock. In Berkshire they trust.
Short sighted strategies build little value and can be destructive of actual value. Certainly a life lesson as well.
4. Avoid Debt
When I was 18 my father co-signed my first credit card, on the condition that I pay it off every month. I did. I’ve avoided debt since then and never bought anything I couldn’t afford to pay for in cash. I have never felt as though there was something I needed so badly that I needed to borrow someone else’s money to pay for it.
This allowed me to quit my job and backpack Asia four years ago. It also allowed me to quit my job again this August and move to Thailand so I could figure out how to obtain the goals I’ve been falling short of. Buffett embraces the of avoiding debt even when it sings a siren’s song of further profits.
We use debt sparingly… we will reject interesting opportunities rather than over-leverage our balance sheet. This conservatism has penalized our results but it is the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders… I’ve never believed in risking what my family and friends have and need in order to pursue what they don’t have and don’t need.
Debt is a crushing burden on companies and individuals. It can makes slaves of us, even when using it to buy assets like a house or car. It can lead to poor decision making and debt generally amplifies any negative financial crisis.
This lesson is one we should teach every child. A house is hardly different from a stock; it is equity in a market that rises and falls. It is only liquid (easily turned back to cash) in a strong housing market. Cars are terrible assets to own. They are an asset that is sure to depreciate and, on the way down, instead of giving dividend payments it requires further investment (new tires, new brakes, etc). I wish every American was forced to read Buffett’s thoughts on debt.
5. Dishonesty is Self-Destructive
This relates back to lesson 3, on value. It is a short and simple idea that I do not hear others talk about but have always strongly believed is true for all people, not just CEOs:
We will be candid in our reporting to you, emphasizing pluses and minuses important in appraising business value. Our guideline is to tell you the business facts that we would want to know if our positions were reversed… We also believe candor benefits us as managers: The CEO who misleads other in public may eventually mislead himself in private.
This is a lesson on liars every child deserves.