Friday, March 22, 2013

Warren Buffett on "The Key to Investing"

Warren Buffett had this to say in a 1999 Fortune article that was written as the tech bubble was coming to an end:

"The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors."

In the article, Buffett also points out that many of the most "glamorous" businesses -- many that have changed the world dramatically for the better -- did not ultimately reward their investors.

One often has little to do with the other.

At the time, he was saying that stocks, due to excessive valuations and the high expectations of investors, were likely to disappoint (of course, he supposedly didn't get the "new paradigm"). Yet, Buffett was still optimistic that the businesses themselves would keep increasing in value and that, over time, investors would be "considerably wealthier, simply because the American business establishment that they own will have been chugging along, increasing its profits..."

The intrinsic worth of American business has been increasing since that article was written. Businesses just needed a good chunk of the past decade plus for the per-share value to catch up to the then prevailing premium market prices.

At the time that article was written, Buffett made it clear he wasn't predicting what stock prices might do in the near-term or even longer.

Those who have read and listened to him over the years knows Buffett has never really been interested in that sort of thing.

Instead, he was thinking in terms of how price compared to valuation, and likely longer term outcomes, not trying to predict price action. Eventually, value is what counts, but individual marketable securities, and markets more generally, are capable of moving in ways that have little to do with value for very long periods of time.

The intrinsic worth of American business might be increasing over time, but stock prices may not necessarily reflect that until much later.

So while valuations may be less nonsensical these days, it still reveals nothing about what stocks might do over the next several years. Attempting to judge where market prices stand in relation to per-share value is time well spent. Guessing what the price action might be over the next month or even several years is not.

Buffett added this in the most recent Berkshire Hathaway (BRKa) shareholder letter:

"American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor. (The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions. And don't forget that shareholders received substantial dividends throughout the century as well.)

Since the basic game is so favorable, Charlie and I believe it's a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of 'experts,' or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it."

It's understandable, even if not particularly enriching, that investors and other market participants weigh the risk of loss versus the possibility of gains asymmetrically.

Loss aversion is a very powerful thing.*

Having said that, those who think they can "dance in and out" effectively (and many certainly seem to try!) might want to carefully consider the last line in the above excerpt from the letter.


Long position in BRKb established at much lower than recent prices

* Those who underestimate the potential impact of loss aversion on long-term results are likely making an expensive mistake. This potent bias can be, to an extent, overcome, but requires first that it be taken seriously followed by some kind of trained response to counter it. For me, learning to manage the tendency only begins with an awareness of and respect for its significance.
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