In 2014, Warren Buffet released his letter to shareholders of Berkshire Hathaway and for the first time, he included the historical stock price data for Berkshire, which has increased by – over – 1,826,163% in the last 50 years.
The annualized return Berkshire’s stock has earned for its shareholders to achieve such magnificent result over 50 years is 21.6% – this is something that plenty of investors and other investment funds would like to achieve.
Aside from the lessons of Warren Buffett, the newsletter also included Charlie Munger’s words of wisdom and vision over the next 50 years. In this article, we will share 18 big lessons of Buffett and Munger.
- How would you know the right value of a stock despite all the fluctuations in price that reflected the new businesses that are involved. Ben Graham, mentor of Warren Buffett suggested, you must be able to estimate a business’s true worth, or “intrinsic value,” which may be entirely separate from its stock market price. For Graham, a business’s intrinsic value could be estimated from its financial statements, namely the balance sheet and income statement.
He believed that the intrinsic, or central, value of any asset would be revealed by quantitative elements and that prices tend to fluctuate around this true value.
However, he emphasized the point that security analysis usually cannot determine exactly what is the intrinsic value of a given security. The analyst has only to establish that the value is either adequate or else that the value is significantly higher or significantly lower than the market price. But then, you can’t overpay for a business i.e., pay much more than what its reasonably assessed value is, and expect to make a great return even in the long run..
He also emphasized the point that security analysis usually cannot determine exactly what is the intrinsic value of a given security.
Here is a direct quote about the price vs value equation in his letter, “a business with terrific economics can be a bad investment if it is bought for too high a price. A sound investment can morph into a rash speculation if it is bought at an elevated price.”
- The next lesson that Warren has given in his letter is to cut your losses making mistakes. And the most important to accept your loss and cut it rather than pushing to get your money back.
Warren shared his experience in the letter about the Tesco stocks that the firm purchased. At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount. In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.) During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.
- Stocks are better than bonds in the long run. We often think bonds are safe because of the fixed interest rate given at a certain time but it is actually risky in the long run because of its inability to beat inflation.
People that invest in good quality businesses and have sat on them for 10-20 years have reaped great rewards in terms of wealth creation. Buffett predicts in his letter that stocks will continue to remain safer than bonds in the long run. In his letter he said, “the unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century. “
- According to buffet, volatility is not risk and the only risk in investing is permanent loss of capital, which can be very different from stock price volatility or fluctuation. He said a downward fluctuation is temporary, meanwhile a permanent loss which there won’t be a rebound can occur for either of two reasons: an otherwise temporary dip is locked in when the investor sells during a
downswing – whether because of a loss of conviction; requirements stemming from his time frame; financial need; or emotional pressures, or the investment itself is unable to recover for fundamental reasons. We can ride out volatility, but we never get a chance to undo a permanent loss. In his letter, Buffett stresses on this very fact of not considering volatility a synonym for risk, and thereby not getting fearful when stock prices move up and down, especially down.
“Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray. If the investor fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement. If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).”
- Invest with Multi-Decade Horizon, this should be the biggest lessons we investors can draw from Buffett’s 50 years at helm at Berkshire. During this period, Berkshire has compounded its shareholders’ wealth at an annualized rate of 21.6%, which is great. The performance becomes even greater considering that this has been achieved over a 50 year period. The lesson to draw from this is that is that ‘t’ or ‘time’ is the most important variable in the compounding formula, even more powerful than ‘r’ or the rate of return. Of course, you must earn a decent return, but you will achieve the benefits of compounding only when you maintain this decent return over a 20-30 year period.
Consider this simple math – If you want to multiply your money 100x in 25 years, you want your investment to return 20% every year. In other words, Rs 1 growing at 20% per annum will turn to Rs 100 after 25 years, excluding all dividends. But if you sell this stock after 20 years (instead of holding for 5 more years), you will get just Rs 40. The remaining Rs 60 would come only between the 21st and 25th years. That’s how compounding works. The longer you let your money grow, the faster will be the incremental return you would earn. Here is what Buffett writes in his 2014 letter about the importance of having a long-term perspective… It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits. For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.