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Archive for October, 2006

I just finished watching a talk given by Warren Buffett at the University of Florida. Watch the free video above for yourself to learn some of his thinking! I have written fragmented snippets of some of the things that he talked about below.

If you were graduating and were asked to pick someone from your class who will most likely succeed, what most of us will choose.

His thoughts on investing in Japan.

“Time is the friend of a wonderful business; but the enemy of a lousy business.”

His adversion of using leverage no matter how good the odds are.

“To risk something that is important to you for something this is not important to you is foolish. You only have to get rich once.”

His involvement in Long Term Capital Management.

“Work in a job that you love, and not something that will look good in your resume.”

He buys business that he can understand, with a moat around it and with honest and able management. If he’s unable to see them 10 years from now, he won’t buy it.

This point is worth pondering:
Everyone has a circle of competence when it comes to understanding businesses. It might be 20 stocks or 50 stocks out of the thousands of listed stocks. It is not how big your circle is, but how you stay inside the circle!

Activity versus inactivity.

What he will do if given a chance to live all over again.

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Since this was written by Warren Buffett in 1990, it refers to the mistakes that he made from 1965-1990. Here’s a summary of what he did wrongly.

Buying Berkshire

His first mistake was buying a textile business. Even though he knew the industry was not promising, he was enticed to buy because it was cheap. While buying cheap shares was rewarding to him in his early years, this strategy was not ideal at all.

If you can buy a business at a sufficiently low price, there should be a point in the future where you can unload it at a decent profit. However, this approach is foolish as the “bargain” price might turn out to be not a bargain at all.

In a difficult business, there are usually many problems that it has to face one after another.

Also, any advantage obtained from a low price is usually quickly eroded by the returns of the business.

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”


“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

Easy Does It

Charlie Munger and Warren Buffett did not learn how to solve difficult business problems. Instead, what they have learnt is to avoid them.

In both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult.

Of course, there are occassions when tough problems must be tackled. In other instances, a great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, problem.

His Most Surprising Discovery

He refers to an overwhelming important unseen force in business called “the institutional imperative.” Examples given by Buffett include:

1) An institution will resist any change in its current direction.

2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds.

3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops.

4) The behavior of peer companies, whether they are expanding, acquiring, setting
executive compensation or whatever, will be mindlessly imitated.

All these are not caused by stupidity, but by institutional dynamics.

Business Partners

Buffett learnt to go into business only with people that he liked, trust and admire. While this policy will not ensure success, wonders can be accomplished if this relationship is made with people in business with good economics characteristics.

On the other hand, he will never go into partnerships with people who lack admirable qualities, no matter how good the propects of the business could be.

Publicly Unseen Mistakes

Some of Buffett’s mistakes were not publicly visible. There were a couple of stock and business purchases whose virtues he understood and yet didn’t make. This inaction has cost Berkshire’s shareholders dearly.

Conservative Financial Policies

In Buffett’s view, Berkshire’s consistently conservative financial policies was not a mistake.

Howeever, it was clear that significantly higher leverage ratios would have produced considerably better returns on equity than the 23.8% they averaged.

Even in 1965, if he could have judged there to be a 99% probability that higher leverage would be good (and a 1% chance of anguish), he wouldn’t have liked the 99:1 odds.

Leverage to him is an acceleration of your process. If your action is sensible, you should still get good results.

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First a Dream, a book by Jim Clayton, influenced Warren Buffett to buy over Jim’s company after he had read the book.

Here’s a one hour video of an interview of Kevin Clayton, the son of Jim Clayton and CEO of Clayton Homes. The interviewer Robert Miles asks a series of questions covering all aspects of the business from getting started, to taking over from his father, and to selling to Warren Buffett.

The video may also help the viewer understand the qualitative aspects that Warren Buffett may consider when making an investment.

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Marketable Securities

Buffett had his first Coca-Cola in either 1935 or 1936. In 1936, he started buying Cokes at the rate of six for 25 cents from Buffett & Son, the family grocery store, to sell around the neighborhood for 5 cents each.

While selling the product, he observed the extraordinary consumer attractiveness and commercial possibilities of Coca-Cola.

For the next 52 years, he did not buy a single share of the company, doing so only in the summer of 1988. In the past year, Berkshire’s holdings of Coca-Cola increased from 14,172,500 shares at the end of 1988 to 23,350,000.

Yet another example of the incredible speed with which Buffett responds to investment opportunities. :)

Zero-Coupon Securities

Most bonds require regular payments of interest, usually semi-annually. A zero-coupon bond, conversely, requires no current interest payments. Instead, the investor receives his yield by purchasing the security at a significant discount from the final maturity value.

The effective interest rate is then determined by the original issue price, the maturity value, and the amount of time between issuance and maturity.

For example, Berkshire issued some zero-coupon bonds at 44.314% of maturity value (due in 15 years). For investors purchasing the bonds, that is the mathematical equivalent of a 5.5% current payment compounded semi-annually.

The point about zero-coupon bonds is that the issuers do not need to pay any interest on their loans. This offers one advantage: It is impossible to default on a promise to pay nothing – until maturity date.

That also means that the time elapsing between folly and failure can be stretched out.

The warning sign for mischief-making should go to the zero-coupon issuer unable to make its interest payments on a current basis.

Whenever someone creates a capital structure that does not allow all interest, both payable and accrued, to be comfortably met out of current cash flow net of ample capital expenditure, be extra careful!

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