A Personal Multibagger Buffett Has Rarely Talked About - The 5 Minute WrapUp by Equitymaster
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A Personal Multibagger Buffett Has Rarely Talked About

Jul 14, 2016

In this issue:
» Five sectors that account for nearly 75% of India Inc's profits
» The contrasting views on US treasury bonds
» ...and more!
Rahul Shah, Co-Head of Research

It's fun to hear Buffett talk about investing.

His talks are filled with homespun analogies and generous doses of wit. But here's the thing...even when talking about some of Berkshire Hathaway's biggest investments, say Coke or Gillette, he hardly ever gets into the details of his analysis.

It's mostly the same 'fun to hear' kind of talking.

So today, let me break in to a personal investment Buffett made for himself, and give you the juice on the nitty-gritties of his analysis.

The story of this investment takes us to Buffett's home state of Nebraska in Midwestern United States. During the eight years leading up to 1981, farm prices in this region exploded, led by the popular belief that inflation was going out of control. This, coupled with the lax lending policies of small banks in those areas, meant that many fell head over heels for farmland.

Like many before, and many more to come, the situation turned out to be a classic bubble. When it burst, prices of farmland crashed more than 50%. Both leveraged farmers and their complacent lenders were devastated. Five times the number of local banks failed in the aftermath as did in the 2008 credit crisis.

But what Buffett saw was opportunity. In 1986, a 400-acre farm close to Omaha was selling for US$280,000. This was far less than what a failed bank had loaned against that farm just a few years back.

Now Buffett didn't know anything about operating a farm. But it was common knowledge that these areas of the US are great for growing corn and soybeans. So he found out from his son (who loves farming) just how much of these crops a farm of that size could produce and the operating expenses involved. He calculated that the annual profits the farm could produce to be about 10% of the US$280,000 cost of the farm.

Further, as farming methods improve and crop varieties undergo changes, farm productivity typically goes up over time. Buffett thought it likely that this would happen on this farm too. And of course, crop prices too move up over the long term. It was a no brainer: That 10% annual profit yield on his cost price would go up over time.

Buffett bought the farm. He reckoned that there was no downside and potentially a large upside to be had. Now, of course, there would be an occasional bad crop, and corn prices would sometimes be a let-down. But there would be some bumper years as well. And in the interim, if farm prices went lower, it wouldn't make any difference to these calculations of his returns from the farm.

And that was the heart of his analysis.

Fast forward to 2013. That farm now makes three times the annual profit it made when he bought it, and is worth more than five times what Buffett paid for it. This is over and above all the money that farm spun-out for Buffett every year over this entire period.

Needless to say, a highly successful investment.

What is most instructive about this investment is what Buffett focused on while making his decision. He focused on the profits the farm would turn in for an owner, and not on the what the farm's price would be next week, next month, or next year.

By his own admission, he thought only about what the farm would produce and cared not at all about its daily valuation. 'Games are won by players who focus on the playing field - not by those whose eyes are glued to the scoreboard,' quips Buffett.

Whether farmland, stocks, or anything in between, Buffett does his analysis exactly the same way. He focuses on what matters, and the rest he knows will automatically fall in place. And if you thought a minute-to-minute update on stock prices was necessary for making successful investments, Buffett has a suggestion for you: 'If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.'

What is your mantra for keeping your focus on the facts that are truly important while investing? Let us know your comments or share your views in the Equitymaster Club.

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02:42 Chart of the day

If you are a value investor and you are looking to identify sectors for great long term returns, today's chart of the day could perhaps lend you some help. It highlights the sectors that have accounted for nearly 75% of India Inc's profits in the year 2015. As you can see, IT, Auto, Utilities, Healthcare and Auto Components contributed three fourths or close to 1.3 lakh crores to the profits if data by a leading business daily is to be believed.

This is in sharp contrast to the year 2010 where sectors such as metal and mining, construction and telecom were some of the biggest contributors. However, with these sectors struggling to make profits on account of one factor or the other, they got pushed out of the top five list. Looking ahead, which is the sector you would like to bet your money on from a five-year perspective? Well, everything that goes up has to come down. And therefore, if this rule is to be applied, sectors that have been out of favour could again come in favour.

However, one needs to identify definite signs of turnaround and only then invest in these sectors. Also, valuations need to be taken into account. Investing in a fundamentally sound stock with good margin of safety in valuations could turn out to be a good long term move.

Will You Bet on These Sectors for the Next Five Years?


Here's a small query. Would you invest in a stock that's among the safest out there but is trading at such a high PE that it has no room to go higher? Chances of the stock coming down are also not that high given that its high quality and not many investors would want to exit in case a crisis strikes. Well, the answer would depend on what you need to do with your money? If you want to protect your capital, then the stock is perhaps a good investment. However, if profits are what you are looking at, you are more likely to give the stock a complete miss.

Change the name of the asset from stocks to US Government treasuries and you will understand the context of the contrasting views held by some of the biggest names in the US bond market. As per article on newsmax.com, while bond giant PIMCO is loading up on treasuries, other bonds titans such Jeffrey Gundlach and Bill Gross are cautioning people against investing at these yields. Where do we stand in this debate? Well, while we have little understanding of US treasuries, what is obvious to us is there's little point in investing in something where the gains from being right pale in comparison to losses from being wrong. From a risk reward perspective, we would stay of assets just because they provide safety of capital. Yes, you can have a small percentage of portfolio in such assets but to make them the cornerstone of your strategy strikes as dangerous to us.


Indian stock markets were trading marginally in the positive today with the Sensex higher by around 60 points at the time of writing. BSE Mid and Small Cap indices were also amongst the gains. Amongst sectors, banking and consumer durables were seen attracting the maximum interest.

04:56 Investment mantra of the day

"Focus on the future productivity of the asset you are considering. If you don't feel comfortable making a rough estimate of the asset's future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn't necessary; you only need to understand the actions you undertake." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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