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Kindle Notes & Highlights
by
David Clark
The short-term price direction of any security or derivative contract is subject to all kinds of wild price swings due to events that have nothing to do with the actual long-term value of the underlying business or asset.
“Knowing what you don’t know is more useful than being brilliant.”
Charlie’s investment philosophy is predicated on the theory that a shortsighted stock market will sometimes underprice a company’s shares relative to the long-term economic value of the company. When that happens, he buys into the company, holds it for the long term, and lets the underlying economics of the business eventually lift the stock price. The only thing he has to be careful about is not doing something stupid, which in his case are mostly errors of omission, such as not acting when he sees a good investment or buying too little of it when the opportunity presents itself. Which is
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“Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand—you must learn to handle mistakes and new facts that change the odds.”
Sometimes the shortsighted stock market serves up an investment opportunity that is so obvious it is hard to resist. This usually happens when there is a stock market panic and investors are fleeing any and all investments, even the ones with great long-term economics working in their favor. This fleeing of investors is the draining of the barrel—stock prices drop, which makes it easier for Charlie to see the fish: underpriced great businesses.
“Sit on your ass investing. You’re paying less to brokers, you’re listening to less nonsense, and if it works, the tax system gives you an extra one, two, or three percentage points per annum.” – This important investment philosophy assumes that one is better off buying a business with exceptional business economics working in its favor and holding it for many years than engaging in a lot of buying and selling, trying to anticipate market trends. Constantly buying and selling means constantly being taxed. If one holds an investment for twenty years there is only one tax to pay, which,
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Charlie knows that time is a good friend to a business that has exceptional economics working in its favor, but for a mediocre business time can be a curse.
Fool me once, shame on you; fool me twice, shame on me.
An adviser who counsels diversification never looks very good or very bad, just average.
“You should remember that good ideas are rare—when the odds are greatly in your favor, bet heavily.”
Remember, in Charlie’s world, as stock prices fall, the odds become more in our favor, provided we invest in companies with good long-term economics working in their favor.
Charlie is telling us that if we invest in an index fund, we will do no better than the average investor. We will never excel beyond the average, and average can also mean losing.
“I’ve never been able to predict accurately. I don’t make money predicting accurately. We just tend to get into good businesses and stay there.”
Charlie advocates keeping $10 million in cash, and Berkshire keeps $72 billion sitting around in cash, waiting for the right deal to show up. The lousy return their cash balances are getting is a trade-off—poor initial rate of return in exchange for years of high returns from finding excellent businesses selling at a fair price.
EBITDA – “I think that, every time you see the word EBITDA, you should substitute the word ‘bullshit earnings.’ ” – EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.” Charlie considers interest, depreciation, and taxes to be very real expenses that have to be paid. Interest and taxes have to be paid in the current year. Depreciation is a cost that has to be paid at a later date—for example, when a plant and equipment eventually need replacing. That eventual replacement is a capital cost. And capital costs can destroy what otherwise appears to be a really great
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Charlie’s rule for financial firms is really simple: what looks good on the outside may be seriously rotten on the inside.
Charlie’s lesson here is that a combination of supersmart people and large amounts of leverage often ends in disaster. I might add that the combination of really dumb people and large amounts of leverage usually ends in disaster as well.
There are two hedge fund rules for raising and keeping money. The first rule: Promise investors the sky, because if the hedge fund doesn’t promise to make you a lot of money, you won’t invest your money. The second rule: Any hedge fund that invests your money conservatively won’t keep it for very long because the guys down the street who leveraged up, threw the dice, and won will show much higher returns.
“In terms of business mistakes that I’ve seen over a long lifetime, I would say that trying to minimize taxes too much is one of the great standard causes of really dumb mistakes. . . . Anytime somebody offers you a tax shelter from here on in life, my advice would be don’t buy it.” –
ENDURING PROBLEMS – “An isolated example that’s very rare is much easier to endure than a perfect sea of misery that never ceases.” – Charlie is talking about the difference between an excellent company, which might confront a major problem a few times in a span of twenty years, compared with a mediocre company, which might go from problem to problem, year after year. A perfect example of an “excellent company” is the Coca-Cola Company. Over the last fifty years Coca-Cola has screwed up twice—once when it got into the movie business and again when it reformulated its flagship product and came
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Prepare for the worst, and hope for the best. It is always wise to be prepared for the worst. Benjamin Graham’s “margin of safety” was devised to protect us from the worst. When it comes to stocks, Charlie thinks of the margin of safety in terms of price and quality—the lower the price, the higher the margin of safety; the higher the quality of the business, the higher the margin of safety. Raise the price, and the margin of safety starts to evaporate. Lower the quality of the business, and the margin of safety drops. If we buy a high-quality business at the right price, the margin of safety
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What did Charlie learn from all that? He learned that as stock prices rise, the odds start going against investors. And when prices fall, the odds start turning in investors’ favor.
He also learned that if he stays fully invested in the market as it rises, he won’t have any cash to invest with when the market crashes. It doesn’t matter how good the odds are; if you don’t have any cash to bet with, you are never going to make a dime.
“If you buy something because it’s undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That’s hard. But, if you can buy a few great companies, then you can sit on your ass. That’s a good thing.” –
“View a stock as an ownership of the business and judge the staying quality of the business in terms of its competitive advantage.”
For example, a $6-per-share stock multiplied by 1 million shares outstanding equates to a market value for the whole company of $6 million. Then he asks himself what the company is worth as an economic entity from a long-term perspective. If the company is worth a lot more than its market valuation, it is a potential buy. If it is worth less, he gives it a pass, but if it has a “durable competitive advantage,” he will keep an eye on it in the hope that at some future date it will be selling at a bargain price or even a fair price. Finding a business with a durable competitive advantage means
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“I think that one should recognize reality even when one doesn’t like it; indeed, especially when one doesn’t like it.” – The reality that Charlie is talking about here is when a much-loved investment enters a new realm of economic reality—which means that over time the underlying economics of the company have changed so much that the once great business is no longer such a wonderful enterprise.
“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folk saying: ‘It’s the strong swimmers who drown.’ ”
opportunity to buy a business that has a huge potential, it is a big mistake. The key here is to buy aggressively
Investors are often wrong about business valuations; most of the time they think a company is worth far more than it will ever earn. But that doesn’t help us; what helps us is when they do just the opposite, when they think that a business is worth far less than its long-term economics indicate and therefore misprice it on the downside. It’s the mispricing on the downside that gives Charlie his buying opportunities.
“You have to be very patient, you have to wait until something comes along, which, at the price you’re paying, is easy. That’s contrary to human nature, just to sit there all day long doing nothing, waiting. It’s easy for us, we have a lot of other things to do. But for an ordinary person, can you imagine just sitting for five years doing nothing? You don’t feel active, you don’t feel useful, so you do something stupid.”
“Successful investing requires this crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don’t last very long.”
“Everywhere there is a large commission, there is a high probability of a rip-off.” – Commission equals incentives.
If people believe that their house and investments are going up in value, they will be more willing to spend more, which is good for the economy. However, if they believe that their house and investments are going down in value, they will stop buying things, which is bad for the economy. This is the wealth effect. Ex–Federal Reserve Chairman Ben Bernanke, in his quest to revive the economy and lower the unemployment rate, became enamored with this theory. He used the wealth effect to justify pumping trillions of dollars into the economy via lower interest rates and the printing of money to
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“I think democracies are prone to inflation because politicians will naturally spend—they have the power to print money and will use money to get votes.”
As a hamburger rises in price, so does the price of the shares of the company that sells the hamburger. Inflation raises the prices of both commodities and assets, and shares in a company represent ownership in the company’s assets.
Inflation is the friend of people who own assets. Inflation is also the enemy of the people who own cash or bonds.
Now you know why Charlie and Warren are so big on insurance companies and banks: not only are they the perfect hedge against inflation, they actually benefit from it. For banks and insurance companies, inflation truly is the gift that keeps on giving.
“If you intelligently trade derivatives it’s like a license to steal, so you can understand why they all want to do it . . . but what is the big plus in having everyone gamble with everyone else? I lived in a world with low gambling for decades when I was younger and I liked it better. I think it was better for the country. It’s like having thousands of professional poker players. What damn good are they doing for anybody?” –
There’s a saying in Indonesia: ‘What you’re calling corrupt is Asian family values.’ ”
The shifting of American factory jobs to China pretty much ended the period in US economic history in which an uneducated man or woman could go to work on a factory floor and get ahead. Why? The first reason is that good manufacturing jobs for the uneducated are simply no longer here; they are in places such as China and Mexico. The second is that good jobs in the United States require education and training.
The top 1% controls 39% of the world’s wealth, but what that really means is that 39% of the world’s wealth is tucked away in the world’s banks and investment funds, which are very busy investing this surplus wealth in the world’s economy. Which is a very good thing for the other 99% of the world.
Want to know how Singapore and Hong Kong became the two financial centers of Asia? Low corporate taxes attracted rich corporations to them and with the rich corporations came their surplus capital, which was tucked away in local banks such as the OCBC Bank in Singapore and the Bank of China in Hong Kong, where it has been used to help finance the economic miracles of Singapore and Hong Kong. Charlie is in favor of using lower tax rates as a means to attract and keep more corporations in the United States.
“When you mix raisins with turds, you still have turds.” – Here Charlie is talking about companies buying other companies. If a great company buys a turd of a company, it ends up with a mixture and the turd of a company drags down the results of the great company. A perfect example of this “mixing raisins with turds” phenomenon was when Coca-Cola bought its way into the moviemaking business.
“In business we often find that the winning system goes almost ridiculously far in maximizing and or minimizing one or a few variables—like the discount warehouses of Costco.” –
In the old days, before Warren met Charlie, he would have bought Company B. But after Warren met Charlie he became a Company A man with all his heart and soul. Just remember: “A great business at a fair price is superior to a fair business at a great price.” It worked well for Charlie and Warren, and it will work for you as well.
“There are two kinds of businesses: The first earns 12%, and you can take it out at the end of the year. The second earns 12%, but all the excess cash must be reinvested—there’s never any cash. It reminds me of the guy who looks at all of his equipment and says, ‘There’s all of my profit.’ We hate that kind of business.”
“Over the very long term, history shows that the chances of any business surviving in a manner agreeable to a company’s owners are slim at best.”
“When we bought See’s Candy, we didn’t know the power of a good brand. Over time, we just discovered that we could raise prices 10% a year and no one cared. Learning that changed Berkshire. It was really important.”
With See’s Charlie and Warren had finally found the Holy Grail of investments: a company that has an ever-increasing underlying value. And to unlock that value all they had to do was hold the investment for as long as possible.
