The central theme uniting Buffett’s lucid essays: fundamental business analysis, formulated by Ben Graham and David Dodd, management principles, corporate managers as the stewards of invested capital and shareholders as the suppliers and owners of capital. Buffett took over Berkshire in 1964 and the book value per share was at $19.46 and it’s intrinsic value per share far lower. Today, it’s book value per share is around $100,000 and it’s intrinsic value far higher. The growth rate during this period is 20% compounded annually. Berkshire is now a holding company engaged in 80 distinct business lines. It’s other interests are so vast that, as Buffett writes: “when you look at Berkshire, you are looking across corporate America. Buffett and Charlie Munger have built this by investing in businesses with excellent economic characteristics and run by outstanding managers. They prefer negotiated acquisitions of 100% of such a business at a fair price. They also take a double barreled approach of buying on the open market less than 100% when they can do so at a pro-rata price well below what it would take to buy 100%. Genius! These results follow not from any master plan but from focused investing – allocating capital by concentrating on businesses with outstanding economic characteristics and run by first-rate managers. His economic goal is long term. Buffett foregoes expansion and sells equity only when it receives as much in value as it gives.
Corporate Governance
The best managers think like owners and they have shareholder interests at heart. The essays address some important governance problems. First, importance of forthrightness and candor in communication. They avoid making predictions. Next is to select people who are able, honest and hardworking. CEO is important. CEO’s performance is harder to measure. No one is senior to CEO and board of directors can’t serve that role. Outstanding CEOs do not need a lot of coaching from owners. Buffett believes that board should be small in size and composed mostly outside directors. The CEOs at Berkshire are given simple set of commands. 1. run the business as if they are sole owner. 2. it is the only asset they hold. 3. they can never sell it or merge it for 100 years.
Finance and Investing
Modern finance theory can be misleading. To manage the risk of volatility, many professionals believe the risk is minimized when invested in a diversified group of stocks. Buffett believes that equating volatility with risk is a gross distortion. Modern finance devotees are claiming that Buffett is just lucky. Buffett does not prescribe diversification. Keynes believed that an investor should concentrate in 2 or 3 businesses he knows something about and whose management Is trustworthy. When you invest, you are an owner, so react like one. Graham mentioned that price is what you pay and value is what you get. They are not the same. He also mentioned about Mr. Market who sometimes can get moody and offer prices lower than value. Another legacy from Graham is margin-of-safety. The price being paid must be lower than the value being delivered. Buffett invests in businesses run by people he trusts. Circle of competence, Mr Market and margin of safety. These are the three legs of Graham or Buffett stool of intelligent investing.
Investment Alternatives
After explaining his preference for investing in productive assets, a series of essays addresses a wide range of alternatives.
Common Stock
There is a high cost in trading with fees to brokers and many others during the exchange process. Despite increasing intrinsic value, Berkshire has never effected a stock split or paid cash dividends for over 3 decades. Share repurchases is not the right model for the company. Munger and Buffett is clear on their message: do not buy these securities unless you are prepared to hold them for the long term.
Mergers & Acquisitions
Buy portions or all of businesses with excellent economic characteristics and run by trustworthy managers. Share as currency in an acquisition is a rare case due to size of the company. Finding value-enhancing transactions requires concentration on opportunity costs. Buffett prefers to retain rather than sell to be the buyer of choice for attractive business sellers.
Valuation & Accounting
Buffett’s toolkit is intrinsic value. Financial statements must be able to answer the company worth, ability to meet future obligation and how good the managers are doing in operating the business. Accounting goodwill is the amount of purchase price of a business exceeds the fair value of assets acquired after deducting liabilities. Economic goodwill is combination of intangible assets like brand that can produce earnings in excess of average rates.
Accounting Shenanigans
Accounting can be manipulated. The quest for integrity in financial reporting is endless.
Accounting Policy
Accounting has inherent limits despite being essential. Financial information can be great use to investors. Decision can be made based on earnings, owner earnings and intrinsic value.
Tax Matters
There are tax advantages when it comes to long term investment. Buffett’s death would have no effects for the holders but will be for him.
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