Why do I admire Warren Buffet?

Lot of people recognize or use Warren Buffet's name, majority knows him as one of the wealthiest man alive. I thought i will add why I personally admire him.

To start, it's not because he is one of the wealthiest man in world, there are plently of other super wealthy whom I don't admire or I don't care. In case of Warren Buffet, it adds credibility and shows that what he does works (really well)!!

I admire Warren Buffet because ...
  - His records are proven over a long period of time (50+ years) and not a one time 'lucky' phonomemon.
  - His principles are simple to understand (didnt say easy to follow :-) ). You don't have to be a genius to understand it.
  - He is open in sharing his investment principles and what worked for him. There is no secret trading platform or investment armies with complex trading algorithms.
  - He admits his mistakes!! Refer to his annual shareholders letter, latest available here
  - His principles are rational and makes sense!! E.g: "Be greedy when others are fearful and be fearful when others are gready", "The more number of decisions you make, the more chances of mistakes", "Price is what you pay. Value is what you get", and many more... 
  - Does not prefer loosing sleep (risk) for few extra $$.
  - Very modest salary of $100,000 for a corporation with its size and profit. And unlike Wall Street CEOs who earns 1$ salary and multi millions in stock option and other benifits, he does not have a stock options.
  - He treats his shareholders are partners, and candidly discuss his objectives and why he does certain things in certain ways. His shareholder's handbook is a great read.
  - His way of managing his companies (80+) is different. He Identifies/acquires talent/companies and give them freedom to do what they are good at and continue to grow business. Does not interfere in day to day activities of his CEOs. Does praise his managers indivudiually, openly often in his meetings and letters.So, most of the owners/CEOs continue to work for him after Bershire buys the business from them.
  - Allocates capital the most efficient ways.
  - Manages Risk better than pretty much anybody!! Read last year's shareholder letter where he states that risk management is CEO's responsibility and not that of a Risk Manager's or that of a committee's job.
  - He does not claim that he knows the future in short term. Unlike many others, who claims that they can predict S&P accurately for next week and month, he says he CAN'T predict future in short term.
  - Lives a modest life inspite and extreme wealth and success.
  - Donated most of his wealth to charity. That too, he didnt set up a new charity in his name, instead found the best available (Bill Gates) and allocated his wealth to their charity.
  - He made his wealth by investing in capital markets, which is an area of interest to me.

Above all, I personally find that his principles makes sense to me and that is something I can follow. And it worked for me in past and continue to works for me!!! Inspite of all these, I am not saying he is perfect and not human!!

My earlier posts about Buffet can be viewed here

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Book Review: You Can Be a Stock Market Genius

I recently purchased 3 books after taking inputs from couple of people and looking through the list of best books listed by the investors I follow.
 1. You Can Be A Stock Market Genius By Joel GreenBlatt
 2. Quality Of Earnings - The Investor's Guide to How Much Money A Company Is Really Making By Thornton L. O'Glove
 3. Analysis of Financial Statements By Leopold A Bernsterin & John J Wild

Title: You Can Be a Stock Market Genius - Uncover the secret hiding places of stock market profits.

Author: Joel GreenBlatt

First Edition: 1999

Publisher: Simon & Schuster New York

Now, don't be misled by the title. It is in fact a good book. It's not a 'hot' book which just came out now, it was published first edition on 1999.

This is not a book for everyone; it is focused on different types of corporate actions and opportunities for profits arising due to it. In the book, author goes over multiple topics were market can be inefficient (at least for short durations). It covers topics including Spin-offs, Mergers, Restructurings, Bankruptcies, Rights Offerings, Risk Arbitrage, Merger Securities, Recapitalizations.

Good think about it is that the author provided one or more case studies (from his own experience) along with discussion of each type of opportunities. Also a pretty comprehensive list of resources where we can look for new opportunities and how to pursue are given in last chapter. As the author says multiple times on the book, this book servers as a guide and makes the readers aware that these types of opportunities exists, so the read have an idea about what to look for. It's a light read, no formulas or complex equations. All the case studies discussed (one case come close to a blowup, but ended well) in the book are success, it would have be interesting read about few cases where it was disaster (because it happens!!).

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Warren Buffet's Lehman Analysis

My second post related to Buffet, this one looked interesting. During height if panic, Lehman team approached Buffet requesting investment in their company. Buffet asked Lehman's management team to invest in Lehman along side with him (or should I say, asked to eat their own cooking?).

Lehman CEO Richard Fuld called Buffett on March 28, 2008 to discuss the possibility of Buffett "investing at least $2 billion in Lehman."

"Two items immediately concerned Buffett during his (March 28) conversation with Fuld."

First, "Buffett took it as a negative that Fuld suggested that Lehman executives were not willing to participate in a significant way" by investing in the firm under the same term.

Second, Buffett thought Fuld's complaints about short sellers indicated a "failure to admit one's own problems."

Complete news and actual report from court-appointed Lehman bankruptcy examiner Mr. Anton Valukas is available here.

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Warren Buffet's Annual Report & Shareholders Letter - 2009

Berkshire Hathaway Annual Report & Warren Buffet's Annual Shareholders Letter - 2009 : PDF Report
Individual year's performance is available in the annual report.

Following chart shows Berkshire Hathaway performance along with S&P 500 from Year 1965 to 2009.

Following chart shows Berkshire's relative performance compared to S&P 500. E.g, in 1965, Berkshire gained 23.8% while S&P gained 10%, which gives the relative performance of +13.8% for Berkshire.

Few highlights from the report:

What We Don’t Do
Few examples of how we apply Charlie's thinking at Berkshire:

• Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be.
• We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback position at Berkshire.
• We tend to let our many subsidiaries operate on their own, without our supervising and monitoring them to any degree.
• We make no attempt to woo Wall Street. Investors who buy and sell based upon media or analyst commentary are not for us. Instead we want partners who join us at Berkshire because they wish to make a long-term investment in a business they themselves understand and because it’s one that follows policies with which they concur.

Berkshire has around 80 fully owned companies and its broadly classified into four.
Major operating sectors: major companies

Insurance: GEICO, National Indemnity, General RE

Regulated Utility Business: MidAmerican Energy Holdings, Burlington Northern Santa Fe Railway (BNSF),

Manufacturing, Service & Retailing Operations: Benjamin Moore, Borsheims, Dairy Queen, Nebraska Furniture Mart, See's Candy, Net Jets
Finance & Financial Products: Clayton Homes, CORT & XTRA leasing, Berkadia Commercial Mortgage

Investments:
Portfolio contains 13 companies with more than 1$ market value. All well known companies including Amex, P&G, Coca-Cola, Wal-Mart, Wells Fargo etc. Total investment portfolio market value is currently $59 Billion. And a $26.0 B position on non-traded securities including Dow Chemical, GE, Goldman Sachs, Swiss Re & Wrigley added for a total cost of $21.1 B.

On Stock-for-stock offer: In evaluating a stock-for-stock offer, shareholders of the target company quite understandably focus on the market price of the acquirer’s shares that are to be given them. But they also expect the transaction to deliver them the intrinsic value of their own shares – the ones they are giving up. If shares of a prospective acquirer are selling below their intrinsic value, it’s impossible for that buyer to make a sensible deal in an all-stock deal. You simply can’t exchange an undervalued stock for a fully-valued one without hurting your shareholders.

Quotes:
   "If Charlie, I and Ajith are ever in a sinking boat - and you can only save one of us - swing to Ajith" ( referring to Ajith Jain of National Indemnity)
   "Don't ask a barber whether you need a haircut" - referring to use of investment bankers to evaluate an acquisition.
   "I subtly indicated that I was older and wiser, I was just older" referring to manager's reservation on GEICO's failed credit card offering idea.

Mistakes:
   For many years I had struggled to think of side products that we could offer our millions of loyal GEICO customers. Unfortunately, I finally succeeded, coming up with a brilliant insight that we should market our own credit card. I reasoned that GEICO policyholders were likely to be good credit risks and, assuming we offered an attractive card, would likely favor us with their business. We got business all right – but of the wrong type.
  Our pre-tax losses from credit-card operations came to about $6.3 million before I finally woke up. We then sold our $98 million portfolio of troubled receivables for 55¢ on the dollar, losing an additional $44 million. GEICO’s managers, it should be emphasized, were never enthusiastic about my idea. They warned me that instead of getting the cream of GEICO’s customers we would get the – – – – – well, let’s call it the non-cream. I subtly indicated that I was older and wiser. I was just older.

On investing in capital intensive business:
   In earlier days, Charlie and I shunned capital-intensive businesses such as public utilities. Indeed, the best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow. We are fortunate to own a number of such businesses, and we would love to buy more. Anticipating, however, that Berkshire will generate ever-increasing amounts of cash, we are today quite willing to enter businesses that regularly require large capital expenditures. We expect only that these businesses have reasonable expectations of earning decent returns on the incremental sums they invest. If our expectations are met – and we believe that they will be – Berkshire’s ever-growing collection of good to great businesses should produce above-average, though certainly not spectacular, returns in the decades ahead.

Derivatives and Risk Management:
   We have long invested in derivatives contracts that Charlie and I think are mispriced, just as we try to invest in mispriced stocks and bonds. Indeed, we first reported to you that we held such contracts in early 1998. The dangers that derivatives pose for both participants and society – dangers of which we’ve long warned, and that can be dynamite – arise when these contracts lead to leverage and/or counterparty risk that is extreme. At Berkshire nothing like that has occurred – nor will it.
    It’s my job to keep Berkshire far away from such problems. Charlie and I believe that a CEO must not delegate risk control. It’s simply too important. At Berkshire, I both initiate and monitor every derivatives contract on our books, with the exception of operations-related contracts at a few of our subsidiaries, such as MidAmerican, and the minor runoff contracts at General Re. If Berkshire ever gets in trouble, it will be my fault. It will not be because of misjudgments made by a Risk Committee or Chief Risk Officer.
 
Berkshire's ACQUISITION CRITERIA:
We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
(1) Large purchases (at least $75M of pre-tax earnings unless the business fit into one of our existing units)

(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations)

(3) Businesses earning good returns on equity while employing little or no debt

(4) Management in place (we can’t supply it)

(5) Simple businesses (if there’s lots of technology, we won’t understand it)

(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).

2010 Annual Meeting
   Details of next annual meeting are also provided. It was interesting to read this section, since I already attended earlier shareholder's meeting. Program structure is pretty much same, with few minor changes.

The OWNER-RELATED BUSINESS PRINCIPLES section on pages 89 - 94 is a must read!!

Some additional comparisons on performance: (Courtesy: WSJ)
Berkshire Class A stock returned over 22% average in last 45 years, while the book value seen an annualized gain of 20%. Closest in mutual fund were Fidelity Magellan Fund which returned 16.3% and Templeton Growth Fund which returned 13.4%. All compared to S&P' annualized around 9.3% during same period. What does that mean in terms of $$? (I think this is the most used about way of comparing!!)
$10,000 invested in each of these will be worth now:
Berkshire: $80 Million
Fidelity: $9.1 Million
Templeton: $2.9 Million
S&P: $560,000

A few percentage points can make that kind of difference?? :-) One noticeable similarity between these two funds and Berkshire is that they all have very low turn over ratio. I have to also add that comparing Berkshire to mutual funds is not exactly fair, since mutual funds managers have restrictions on what they can invest in and have mostly a short team focus to please investors. While as a majority owner in his Berkshire, Buffet does not face those pressures, also he is a proponent of shareholders acting as long term owners.

I just completed my Spreadsheet based Modeling (Linear Programming) course by Prof. Amit Basu, and it was interesting enough for me to try using Berkshire's performance data. Here I am not using any models, but using some of the tools available to interpret the data. I have uploaded it here.

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