The Essays of Warren Buffett: Lessons for Corporate America

by Warren Buffett

proxy statements,

A proxy statement is a document containing the information theSecurities and Exchange Commission (SEC) requires companies to provide to shareholders so shareholders can make informed decisions about matters that will be brought up at an annual or special stockholder meeting. Proxy statements must disclose the company's voting procedure, nominated candidates for its board of directors and compensation of directors and executives.

an index fund.

Definition?

Graham held that price is what you pay and value is what you get. These two things are rarely identical, but most people rarely notice any difference.

margin-of-safety principle. This principle holds that one should not make an investment in a security unless there is a sufficient basis for believing that the price being paid is substantially lower than the value being delivered.

Many professionals make another common mistake, Buffett notes, by distinguishing between “growth investing” and “value investing.” Growth and value, Buffett says, are not distinct. They are integrally linked since growth must be treated as a component of value.

The circle of competence principle is the third leg of the Graham/Buffett stool of intelligent investing, along with Mr. Market and the margin of safety. This commonsense rule instructs investors to consider investments only concerning businesses they are capable of understanding with a modicum of effort.

Buffett lays out the rationale and terms under which Berkshire occasionally embarks on share repurchase programs: when the stock trades at a deep discount to intrinsic value. That makes the investment an easy case, of clear value to continuing holders, though Buffett has mixed feelings about repurchasing as Berkshire's selling shareholders cash in at a discount. The solution: clear disclosure to enable such selling holders to make an informed decision.

intrinsic value, “the discounted value of the cash that can be taken out of a business during its remaining life.” Though simple to state, calculating intrinsic value is neither easy nor objective. It depends on estimation of both future cash flows and interest rate movements.

Buffett emphasizes that useful financial statements must enable a user to answer three basic questions about a business: approximately how much a company is worth, its likely ability to meet its future obligations, and how good a job its managers are doing in operating the business.

3 questions useful financial statements answer about a business

So it is possible to make important investment decisions on the basis of available financial information if one exercises knowledgeable judgment. That judgment may include making adjustments to determine look-through earnings, owner earnings and intrinsic value.

Your Chairman has a firm belief that owners are entitled to hear directly from the CEO as to what is going on and how he evaluates the business, currently and prospectively. You would demand that in a private company; you should expect no less in a public company.

In large part, companies obtain the shareholder constituency that they seek and deserve. If they focus their thinking and communications on short-term results or

short-term stock market consequences they will, in large part, attract shareholders who focus on the same factors. And if they are cynical in their treatment of investors, eventually that cynicism is highly likely to be returned by the investment community.

If we have good long-term expectations, short-term price changes are meaningless for us except to the extent they offer us an opportunity to increase our ownership at an attractive price.

Short term changes in a businesses price should not matter if our long term expetations of the businesses value is high, if anything it presents opportunity to buy more of the business at a discounted rate

directly owning a diversified group of businesses that generate cash and consistently earn above-average returns on capital. Our second choice is to own parts of similar businesses, attained primarily through purchases of marketable common stocks by our insurance subsidiaries. The price and availability of businesses and the need for insurance capital determine any given year's capital allocation.

Two pronged approach

limitations of conventional accounting,

Limitations of GAAP mean that Berkshire focus on other ways of valuating their business

This is precisely the choice that often faces us since entire businesses (whose earnings will be fully reportable) frequently sell for double the pro-rata price of small portions (whose earnings will be largely unreportable).

There is unreportable value to some businesses

Managements that say or imply during a public offering that their stock is undervalued are usually being economical with the truth or uneconomical with their existing shareholders' money: Owners unfairly lose if their managers deliberately sell assets for 80¢ that in fact are worth $1.

Owners lose if a business implies that their stock, during stock offering, is undervalued

gin rummy behavior.

Pumping major capital in to a business that is underperforming is not the way to go according to Buffett and Munger. Rather they would hope that good managers and their valuation of the business is enough that it will hopefully generate more equity over time.

The CEO who misleads others in public may eventually mislead himself in private.

Being candid is a quality of a good manager

Ben Graham,

Search for his work which Warren learnt from.

long-term investors who seek to profit from the progress of the company rather than from the investment mistakes of their partners.

management is reluctant to open up on matters of business substance.

Instead, we expect a company's CEO to explain in his or her own words what's happening.

Full disclosure between the company and its shareholders is important. Buffet understands this importance and tackles his responsibility to personally address his shareholders as CEO confidently. Additionally, it seems that one should be skeptical of companies that utilise abstract or vague accounting methods, maybe management is hiding something.

(More money, it has been noted, has been stolen with the point of a pen than at the point of a gun.)

Selective disclosure as Buffet sees it is a corrupt practice that limits the opportunities of the individual investor and only advantages agencies and their business ties that are looking for an edge. Another problem associated with this is the pressure then for CEOs to meet their “numbers”. Bad accounting practices can lead to companies having to play catch up quarter by quarter until their numbers are really in trouble.

beware of companies displaying weak accounting. If a company still does not expense options, or if its pension assumptions are fanciful, watch out.

Finally, be suspicious of companies that trumpet earnings projections and growth expectations.

Charlie and I not only don't know today what our businesses will earn next year—we don't even know what they will earn next quarter.

Managers that always promise to “make the numbers” will at some point be tempted to make up the numbers.

a CEO who doesn't perform is frequently carried indefinitely.

the CEO has no immediate superior whose performance is itself getting measured.

mistakes in selecting directors are particularly serious because appointments are so hard to undo:

the controlling owner is also the manager.

“boardroom atmosphere.” It's almost impossible, for example, in a boardroom populated by well-mannered people, to raise the question of whether the CEO should be replaced.

It's interesting how this is viewed as rude

Assuming I'm even marginally rational, elementary arithmetic should make it clear that my heart and mind belong to the owners of Coke, not to its management.

Based-Buffett

Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.

Buffet highlights his error in judgement when he decided to not liquidise his textile busiiess earlier. A tough decision in the short run would have prevented serious losses in the long run.

Not all of our businesses are destined to increase profits. When an industry's underlying economics are crumbling, talented management may slow the rate of decline.

The type of industry you enter is an important factor to consider. Business savvy annd good management alone do not guarantee profitability.

“If you want to get a reputation as a good businessman, be sure to get into a good business.”)

A savings account in which interest was reinvested would achieve the same year-by-year increase in earnings—and, at only 8% interest, would quadruple its annual earnings in 18 years.

Buffet highlights that companies will often not look at the main cause of growth, and may overlook the simple fact that a companie's growth may simply be attributed to retained earnkngs and compound interest. Reinvesting interest year after year.

Many corporate compensation plans reward managers handsomely for earnings increases produced solely, or in large part, by retained earnings—i.e., earnings withheld from owners.

managerial Rip Van Winkle, ready to doze for ten years, could not wish for a better “incentive” system.

Interestingly, a future stock promise to employees may have alterior motives behind it. If dividends are only a small portion of a companies net expenses then it would be benefitial for a company to incentivize employees to stay in the company and continuously add value that can be capitalized on. This value added grows due to compound interest and would only benefit the companies yearly retained earnings

An owner must weigh upside potential against downside risk; an option holder has no downside.

conclusion: options should be priced at true business value.

Options should go to deserving managers and they should be priced at business value rather than market value. It doesn't serve managers well to sell part of their business at a bargain price.

that every dime paid out in dividends reduces the value of all outstanding options.

“We can afford to lose money—even a lot of money. But we can't afford to lose reputation—even a shred of reputation.”

When auditors are put on the spot, they will do their duty.

Its the job of the audit committee to find out excatly what the auditors know. Put them on the spot and ask common sensical questions of which Buffett advises 4

Having managers who love their businesses is no small advantage.

Cultures self-propagate.

The type of culture you have in your business is incredibly important, cultures self propogate so make sure you have one in place that you want to grow.

Our advantage, rather, was attitude: we had learned from Ben Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values.

You don't need to be an expert in order to achieve satisfactory investment returns.