Warren Buffett's Ground Rules: Words of Wisdom from the Partnership Letters of the World's Greatest Investor

by Jeremy C. Miller

If I was running $1 million, or $10 million for that matter, I’d be fully invested. The highest rates of return I’ve ever achieved were in the 1950’s. I killed the Dow. You ought to see the numbers. But I was investing peanuts back then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.2

Yes, I would still say the same thing today. In fact, we are still earning those types of returns on some of our smaller investments. The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts. It would perhaps even be easier to make that much money in today’s environment because information is easier to access. You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map—way off the map. You may find local companies that have nothing wrong with them at all. A company that I found, Western Insurance Securities, was trading for $3/share when it was earning $20/share!! I tried to buy up as much of it as possible. No one will tell you about these businesses. You have to find them.

As the 1950s were drawing to a close, an investing public that had previously been interested in buying stocks directly shifted its preference to mutual funds; the tailwind for the industry was enormous.

Certainly he could have made even more if he had also decided to sell the Partnership but he opted to close instead. Apparently he had offers but he turned them down.18 In doing so, Buffett characteristically maintained the alignment with partners that he saw as all-important. He made his money with them, not from them. Closing and not selling was simply the right thing to do. If he didn’t think he should be invested, why should he tell them to be?

The remarkable alignment he cherished with his partners drove him to operate and communicate honestly and transparently, as all good advisors and fiduciaries should. By talking frankly about the prospects for the Partnership and acting in the partners’ best interest even when it ran counter to his financial incentives as the managing partner, Buffett once again demonstrated character that should serve as a model to the financial services industry.

Many find the concepts of Graham—thinking of stocks as businesses and Mr. Market—as logical in theory. However, talking about value investing is very different than actually practicing it. If it were easy, everyone would do it.

It’s hard not to cave your principles in at the top of the cycle when your value approach has apparently stopped working and everyone around you seems to be making money easily (that’s why so many people do it).

If the general market were to return to an undervalued status our capital might be employed exclusively in general issues and perhaps some borrowed money would be used in this operation at that time. Conversely, if the market should go considerably higher our policy will be to reduce our general issues as profits present themselves and increase the work-out portfolio.

All of the above is not intended to imply that market analysis is foremost in my mind. Primary attention is given at all times to the detection of substantially undervalued securities.

The market decline has created greater opportunity among undervalued situations so that, generally, our portfolio is heavier in undervalued situations relative to work-outs than it was last year…. At the end of 1956, we had a ratio of about 70–30 between general issues and work-outs. Now it is about 85–15.

investment performance must be judged over a period of time with such a period including both advancing and declining markets.

This performance is mainly the result of having a large portion of our money in controlled assets and workout situations rather than general market situations at a time when the Dow declined substantially.

We also experienced a flow of “workout” opportunities where the percentages were very much to our liking. The problem was always which, not what. Accordingly, we were able to own fifteen to twenty-five issues and be enthusiastic about the probabilities inherent in all holdings.

We will not go into businesses where technology which is way over my head is crucial to the investment decision. I know about as much about semi-conductors or integrated circuits as I do of the mating habits of the chrzaszcz.

Furthermore, we will not follow the frequently prevalent approach of investing in securities where an attempt to anticipate market action overrides business valuations.

Interestingly enough, although I consider myself to be primarily in the quantitative school (and as I write this no one has come back from recess—I may be the only one left in the class), the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a “high-probability insight.” This is what causes the cash register to really sing. However, it is an infrequent occurrence, as insights usually are, and, of course, no insight is required on the quantitative side—the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions.

I know I don’t want to be totally occupied with out-pacing an investment rabbit all my life. The only way to slow down is to stop.

Buffett made sure that all players were on a level playing field when it came to deciding what they should do with their Controls. He insisted upon not talking to partners individually about the three companies; he wanted everyone to be on equal footing, for everyone to have access to the exact same information. He took questions in writing and then included the answers so all partners would benefit.

To this day, while it’s extremely common for large institutional investors to gain an edge over smaller investors through regular private meetings with public company management teams, Buffett refuses to do it. All investors receive the same opportunity once a year at the shareholder meeting in Omaha to ask their questions and have them answered in front of everyone.

As long as I am “on stage,” publishing a regular record and assuming responsibility for management of what amounts to virtually 100% of the net worth of many partners, I will never be able to put sustained effort into any non-BPL activity. If I am going to participate publicly, I can’t help being competitive. I know I don’t want to be totally occupied with out-pacing an investment rabbit all my life. The only way to slow down is to stop.

Our experience in workouts this year has been atrocious—during this period I have felt like the bird that inadvertently flew into the middle of a badminton game. We are not alone in such experience, but it came at a time when we were toward the upper limit of what has been our historical range of percentage commitment in this category.

If we are not getting a good return on the textile business of Berkshire Hathaway Inc., why do we continue to operate it? Pretty much for the reasons outlined in my letter. I don’t want to liquidate a business employing 1,100 people when the Management has worked hard to improve their relative industry position, with reasonable results, and as long as the business does not require substantial additional capital investment. I have no desire to trade severe human dislocations for a few percentage points additional return per annum. Obviously, if we faced material compulsory additional investment or sustained operating losses, the decision might have to be different, but I don’t anticipate such alternatives.

My activity has not been burdened by second-guessing, discussing non sequiturs, or hand holding. You have let me play the game without telling me what club to use, how to grip it, or how much better the other players were doing. I’ve appreciated this, and the results you have achieved have significantly reflected your attitudes and behavior. If you don’t feel this is the case, you underestimate the importance of personal encouragement and empathy in maximizing human effort and achievement.

Bill Ruane reportedly once said that when it comes to investing, Graham wrote the Bible and Buffett wrote the New Testament.

“It’s better to buy a wonderful business at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements.”4

If I can’t understand something, I tend to forget it. Passing an opportunity which I don’t understand—even if someone else is perceptive enough to analyze it and get paid well for doing it—doesn’t bother me. All I want to be sure of is that I get paid well for the things I do feel capable of handling—and that I am right when I make affirmative decisions.

Many people, in buying bonds, select maturities based on how long they think they are going to want to hold bonds, how long they are going to live, etc. While this is not a silly approach, it is not necessarily the most logical. The primary determinants in selection of maturity should probably be (1) the shape of the yield curve; (2) your expectations regarding future levels of interest rates; and (3) the degree of quotational fluctuation you are willing to endure or hope to possibly profit from. Of course, (2) is the most important but by far the most difficult upon which to comment intelligently.