Jan 10, 2008|
Lessons from Warren Buffett - XXV
In the previous article, we rounded off our discussion on Warren Buffett's 1992 letter to shareholders by sharing with you his views on healthcare accounting and ESOPs. Let us now see what insight the master has to offer in his 1993 letter to shareholders.
Ardent followers of the master might not be immune to the fact that whenever an extremely attractive opportunity has presented itself, Warren Buffett has not hesitated to put huge sums in it. In sharp contrast to the current lot of fund manager who use fancy statistical tools to justify diversification, the master has been a believer in making infrequent bets but at the same time making large bets. In other words, he believes that a concentrated portfolio is much better than a diversified portfolio. This is what he has to say on the issue.
"Charlie and I decided long ago that in an investment lifetime it's just too hard to make hundreds of smart decisions. That judgment became ever more compelling as Berkshire's capital mushroomed and the universe of investments that could significantly affect our results shrank dramatically. Therefore, we adopted a strategy that required our being smart - and not too smart at that - only a very few times. Indeed, we'll now settle for one good idea a year. (Charlie says it's my turn.)
The strategy we've adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as "the possibility of loss or injury."
The master does not stop here. Like his previous letters, he once again takes potshots at academicians who define risk as the relative volatility of a stock price with respect to the market or what is now widely known as 'beta'. He very rightly contests that a stock which has been battered by the markets should as per the conventional wisdom bought in ever larger quantities because lower the price, higher the returns in the future. However, followers of beta are very likely to shun the stock for its perceived higher volatility. This is what he has to say on the issue.
"In assessing risk, a beta purist will disdain examining what a company produces, what its competitors are doing, or how much borrowed money the business employs. He may even prefer not to know the company's name. What he treasures is the price history of its stock. In contrast, we'll happily forgo knowing the price history and instead will seek whatever information will further our understanding of the company's business. After we buy a stock, consequently, we would not be disturbed if markets closed for a year or two. We don't need a daily quote on our 100% position in See's or H. H. Brown to validate our well-being. Why, then, should we need a quote on our 7% interest in Coke?"
In the forthcoming articles, we will discuss the remainder of the 1993 letter.
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