Starting from this post onwards, the ‘Lessons from Buffett’s Letters’ series will have a different title for each post, instead of just the year. This will give the readers a pointer for what’s in the post, so they’ll know if it’ll interest them or not. The 1992 letter emphasizes business acquisitions, so let’s get into it:
“Of all our activities at Berkshire, the most exhilarating for Charlie and me is the acquisition of a business with excellent economic characteristics and a management that we like, trust and admire. Such acquisitions are not easy to make but we look for them constantly. In the search, we adopt the same attitude one might find appropriate in looking for a spouse: It pays to be active, interested and open-minded, but it does not pay to be in a hurry.”
This attitude is probably one of the best ones to have (if not the best) in other areas too. Whether it’s buying a home, a financial investment, or making any other major life decision, it pays to do your homework. But don’t rush it. In my own observations, I notice two groups of people who rush their investing and take on too much risk:
- Young people who dream of being a millionaire by 30, who think they need to take huge risks to get there
- Much older people who have never saved and invested anything, who are now panicking because they can’t retire
Their reasons are different, but their aim is the same. Both groups are looking for a quick win. They speculate on half-brained ideas without knowing the risks. A few might get lucky (temporarily), but most will lose money. I say ‘temporarily’ because the few who get lucky, usually don’t realize it was luck. They think it was their knowledge or ability. They then get greedy and take more risks, for as long as they are lucky. This inevitably ends badly, and they learn that they weren’t as smart as they thought.
“In the past, I’ve observed that many acquisition-hungry managers were apparently mesmerized by their childhood reading of the story about the frog-kissing princess. Remembering her success, they pay dearly for the right to kiss corporate toads, expecting wondrous transfigurations. Initially, disappointing results only deepen their desire to round up new toads. (“Fanaticism,” said Santyana, “consists of redoubling your effort when you’ve forgotten your aim.”) Ultimately, even the most optimistic manager must face reality. Standing knee-deep in unresponsive toads, he then announces an enormous “restructuring” charge. In this corporate equivalent of a Head Start program, the CEO receives the education but the stockholders pay the tuition.”
A more recent example of this is Yahoo. For years they have been making business acquisitions that have gone badly for them. But they kept doing it anyway. In total Yahoo has acquired 114 companies, with billions of dollars lost along the way. Their track record is abysmal, and in 2016 and 2017 it is playing out exactly as Buffett wrote in 1992.
“In my early days as a manager I, too, dated a few toads. They were cheap dates – I’ve never been much of a sport – but my results matched those of acquirers who courted higher-priced toads. I kissed and they croaked. After several failures of this type, I finally remembered some useful advice I once got from a golf pro (who, like all pros who have had anything to do with my game, wishes to remain anonymous). Said the pro: “Practice doesn’t make perfect; practice makes permanent.” And thereafter I revised my strategy and tried to buy good businesses at fair prices rather than fair businesses at good prices.”
This is the difference between Buffett’s Berkshire Hathaway and Yahoo. He learned from his mistakes and changed course, and Yahoo didn’t.
“We do not, however, see this long-term focus as eliminating the need for us to achieve decent short-term results as well. After all, we were thinking long-range thoughts five or ten years ago, and the moves we made then should now be paying off. If plantings made confidently are repeatedly followed by disappointing harvests, something is wrong with the farmer. (Or perhaps with the farm: Investors should understand that for certain companies, and even for some industries, there simply is no good long-term strategy.) Just as you should be suspicious of managers who pump up short-term earnings by accounting maneuvers, asset sales and the like, so also should you be suspicious of those managers who fail to deliver for extended periods and blame it on their long-term focus. (Even Alice, after listening to the Queen lecture her about “jam tomorrow,” finally insisted, “It must come sometimes to jam today.”)”
This provides a good basis for evaluating something (that isn’t new) at any given time. Whenever a struggling business justifies it’s position because it’s working on the medium- to long-term, ask:
- What about the medium- and long-term plans from 5 or 7 years ago?
- What about last year’s plan for a turnaround?
- Why is each coming year predicted to be “The best year ever,” without that really happening?
“Most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual crossdressing. We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive. In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).”
I agree completely that the two approaches are not separate at all. In my recent interview with GuruFocus I described myself as 80% value and 20% growth investor. Speaking of which…
“Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor.”
This is a good part of the explanation on why I am mostly a value investor. Growth can actually work against the investor in some cases. If the growth is relatively small, the investor would be better off having done something else with the money.
“We try to stick to businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we’re not smart enough to predict future cash flows. Incidentally, that shortcoming doesn’t bother us. What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know. An investor needs to do very few things right as long as he or she avoids big mistakes.”