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    Value investing the Buffett way: 1992 – 1997

    “We think the very term "value investing" is redundant. What is "investing" if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value - in the hope that it can soon be sold for a still-higher price - should be labelled speculation (which is neither illegal, immoral nor - in our view - financially fattening).”

    Warren Buffett mentioned in his 1992 letter that when investing, practice does not make perfect but rather that practice makes permanent. It pays to be active, interested and open-minded when investing, but patience is essential. Instead of looking for fair businesses at good prices, rather take your time to buy good businesses at fair prices.

    One should always be open to new ideas. Berkshire, for example, included holdings from the shoe industry in its portfolio, at that time Mr Buffett mentioned he probably would’ve never thought of it five years prior. It is again stressed to look at intrinsic value rather than book value. These two often diverge during the short run. Intrinsic value equals the present value of all future cash flows that can be taken out of a business during its remaining life, whereas book value includes retained earnings.

    He sees “risk” as the possibility of loss or injury and not volatility, as it’s widely defined (particularly in academic circles). “It is better to be approximately right than precisely wrong.”

    In his opinion, the real risk that an investor must assess is whether his after tax returns from an investment will match inflation over the prospective holding periods plus a modest real return on the initial stake. In order to achieve this, the principles to be evaluated include the certainty of:
    • economic characteristics of the business;
    • company management (to operate the business to its potential and to wisely employ its cash flows;
    • management that can be trusted to run the business to reward the shareholders rather than themselves;
    • the purchase price of the business;
    • the levels of taxation and inflation that will be experienced and that will determine the degree by which an investor's purchasing-power return is reduced from his gross return.

    “You know it when you see it – you don’t need complex equations or price histories.”

    Berkshire ignores political and economic forecasts, which are wrong most of the time, and has proven to be an expensive distraction for many investors and businessmen. Buffett mentions that Berkshire usually makes its best purchases when apprehensions about some macro event are at a peak, “Fear is the foe of the faddist, but the friend of the fundamentalist.”

    He looks for managers that earn extraordinary returns from what appear to be ordinary businesses. His goal is then to acquire either part or all of the business that is understandable, has sustainable underlying economics, and is run by managers whom he likes, admires, and trusts. Before looking at a new investment one should consider adding to old ones. If a business is attractive enough to buy once, it may well pay to repeat the process.

    Qualitative analysis is of immense importance, as seen in factors such as good corporate governance. “Directors should speak their mind and persuade other members for the greater good. The requisites for board membership should be business savvy, interest in the job, and owner-orientation. Not because they’re prominent or add diversity”.

    Interestingly, in the late 1990’s Mr Buffet makes his infamous concerns regarding tech companies. He exclaims the importance of a “margin of safety” that Ben Graham identified as the cornerstone of intelligent investing. He called himself a life-long sufferer from technophobia (admittedly Berkshire did start uploading their annual reports to the internet in the 1990’s – but as a means of saving printing and distribution costs). He does not invest in tech stocks because he does not understand the business model – plain and simple.

    It is evident from this report that Warren Buffett seeks to focus his time and effort on what he knows. This is his “circle of competence”. Investors would do well to only invest where they have expertise and resist investing purely on the back of a ‘good story’. At Seed we don’t claim to ‘know it all’, but rather focus on our areas of expertise to provide solid inflation beating returns for our clients.

    Kind regards,

    Lourens Rabé

    www.seedinvestments.co.za
    info@seedinvestments.co.za
    021 914 4966

    Permalink2014-01-28, 08:45:46, by Mike Email , Leave a comment

    Seed Weekly - Charlie Munger: Poor Charlie’s Almanac

    Over the Christmas break, I had the opportunity to read Poor Charlie’s Almanack – a compendium of insightful articles, essays about and talks from Charlie Munger.

    Who is Charlie Munger? He is the partner of the better known Warren Buffett, chairman and CEO of listed Berkshire Hathaway. He has partnered Buffett for some 45 years. Munger, now 90 years old, is vice chairman of the Berkshire Hathaway and Chairman of Wesco Financial Corporation.

    Munger is noted as an excellent thinker and this book gave some insight into how his mind works. Buffett said of him, “Charlie can analyse and evaluate any kind of deal faster and more accurately than any man alive. He sees valid weakness in sixty seconds.”

    Munger has a systematic way of analysing problems and approaches to business analysis and assessment. Instead of making a standalone assessment of a company and its finances, he will rather conduct a more comprehensive analysis, calling the tools that he uses his “Multiple Mental Model”.

    “You must know the big ideas in the big disciplines and use them routinely – all of them. Not just a few. Most people are trained in one model – economics for example – and try to solve all problems in one way. You know the old saying, “to the man with a hammer, the world looks like a nail.” This is a dumb way of handling problems.”

    When properly collected and organised, his Multiple Mental Models (around 100 of them he estimates) provides a context or latticework that leads to remarkable insights as to the purpose and nature of life. His models supply the analytical structure that enables him to reduce the inherent chaos and confusion of a complex investment problem into a clarified set of fundamentals. Some of the more important models that he knows well and uses often include:

    • Redundancy / backup, breakpoints and critical mass system model from engineering
    • Compound interest, permutations, probability and decision tree model from maths
    • Breakpoint / tipping moment / autocatalysis model from physics and chemistry
    • Cognitive misjudgement model from psychology
    • Accounting – double entry bookkeeping
    • Microeconomics – scale and competitive destruction
    • Chemistry

    His most basic guiding principles and fundamental philosophy of life includes preparation, patience, discipline, and decisiveness.

    As part of his decision making process, Charlie Munger firmly believes in using checklists for investing decisions. Such a checklist, not necessarily used by Munger, was outlined in the book and covered the following headings:

    • Risk – all investment valuations should begin by measuring risk;
    • Independence – only in fairy tales are emperors told they are naked;
    • Preparation – the only way to win is to work, work, work and hope to have a few insights;
    • Intellectual humility – acknowledge what you don’t know is the dawning of wisdom;
    • Analytics rigor – use of the scientific method and effective checklists minimises errors and omissions;
    • Allocation – proper allocation of capital is an investors number one job;
    • Patience – resist the natural human bias to act;
    • Decisiveness - when proper circumstances present themselves act with decisiveness and conviction;
    • Change – live with change and accept irremovable complexity; and
    • Focus – keep things simple and remember what you set out to do.

    All in all, a very good outline for decision making from a very successful investor.

    Kind regards,

    Ian de Lange

    www.seedinvestments.co.za
    info@seedinvestments.co.za
    021 914 4966

    Permalink2014-01-21, 12:00:35, by Mike Email , Leave a comment