Over the weekend the legendary investor and chief executive of Berkshire Hathaway, the fifth largest company in the world, posted his annual letter to shareholders.
Being the company’s 50th anniversary, this year is particularly special. Buffett alongside the company chairman and long time partner, Charlie Munger, both wrote an extended letter describing the past 50 years at the company from their perspective.
It is worth noting that over that time, the market price for Berkshire’s shares have increased by a staggering 1,826,163%.
So what can we learn from arguably the world’s greatest ever investor and the CEO of a company which deploys literally billions of dollars in cash each year? And how does it apply to making everyday investment and savings decisions? Actually, rather a lot…
The Hope Diamond
One of the overriding themes of Buffett’s 14 page letter – and something he has employed (and preached) now for more than forty years – is the need to buy well. In his letter he says: “Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.”
Saving for your future is not about making short term, high risk bets hoping for large short term gains, it is about thinking carefully about why an investment makes sense and understanding the inherent value within it.
Buffett puts it another way: “It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone.”
So, if an adviser offers you an investment which simply doesn’t look good, don’t make it. Better to keep the cash for when you find the “Hope Diamond”.
Two plus two will always equal four
That said, it is also important not to make investments in things which look or sound too good to be true – they usually are.
In his letter, Buffett talks about why conglomerates (apart from Berkshire Hathaway, of course) don’t usually work.
To illustrate his point, Buffett describes the case of Jimmy Ling who took a company called LTV, through what Buffett describes as “corporate razzle-dazzle”, from sales of only $36m in 1965, to number 14 on the Fortune 500 list in just two years.
To do this, Ling employed a strategy he called “project redeployment” – basically buying a large company then “spinning off” its various divisions. His “magic formula” – loved at the time by Wall Street – he called two plus two equals five.
Not surprisingly, by the early 1970s, as Buffett explains, “Ling’s empire was melting” and Ling was fired. The stocks depreciated in value and shareholders lost money.
As well as employing a clearly disastrous management strategy, Ling (and many other CEOs like him at the time) used accounting techniques which would nowadays probably be regarded as fraudulent.
Buffett explained that many companies came unstuck: “Eventually […] the clock struck twelve, and everything turned to pumpkins and mice.
“[…] it became evident that business models based on the serial issuances of overpriced shares – just like chain-letter models – most assuredly redistribute wealth, but in no way create it.
“Both phenomena, nevertheless, periodically blossom in our country – they are every promoter’s dream – though often they appear in a carefully-crafted disguise. The ending is always the same: Money flows from the gullible to the fraudster. And with stocks, unlike chain letters, the sums hijacked can be staggering.”
There are very many examples in the world of international financial advice where unwitting investors have fallen prey to this type of speculation – sometimes investments do simply fall as they are inclined to do – but often unscrupulous salesmen (fund promoters) simply promise the Earth and deliver soil, at best.
Buffett reminds us: “Whatever their line, never forget that two plus two will always equal four. And when someone tells you how old-fashioned that math is – zip up your wallet, take a vacation and come back in a few years to buy stocks at cheap prices.”
Cash is important
“At a healthy business, cash is sometimes thought of as something to be minimized – as an unproductive asset that acts as a drag on such markers as return on equity,” says Buffett.
“Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent.”
OK, so Buffett is clearly talking about the cash on the balance sheet of a business here, but don’t ever forget you need access to cash.
There are many instances where an unscrupulous adviser when giving investment advice will explain the myriad reasons why he or she thinks you should invest substantial amounts of your monthly income into an investment – a regular savings plan for example.
Stop and think. Could this money be used more efficiently for the next 10, 15 or 20 years? Why is the adviser so keen for me to put so much cash into it now? What does he get out of it?
Also, don’t forget that there are times when you need access to cash quickly and easily. By putting all of your spare cash into a contractual savings plan you are inhibiting your ability to have the access, meaning you may have to borrow in an emergency – arguably the worst time a person can borrow.
So, in short, think wisely about why you are making an investment decision, don’t be rushed or “sold to” and make sure you know exactly how much you are paying. Something’s ultimate worth to you, is very much dependent on how much you paid for it.
If you would like to talk to someone about your financial position or are worried you have made an investment you regret, speak to one of our qualified, regulated financial advisers using the link below.