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Lessons from Warren Buffett's -XXXI

Feb 28, 2008

Executive compensation was the focal point in our previous article on Warren Buffett's 1994 letter to shareholders. In this concluding discussion based on letter from the same year, let us see what other investment wisdom the master has on offer.

It is said that we human beings are endowed with certain quaint characteristics that force us to make a mess of simple and easy to understand things and turn them complex. And nowhere do these habits hurt us the most than in the field of stock investments. We liken it to some IQ testing event like the Math or the Science Olympiad. Tempted by stories that they could be potential multi baggers, we tend to invest in companies with the most obscure names having the most complex business models.

But unfortunately, our rewards, which in this case are the returns, are not linked to the degree of success we have had in unraveling complex business models but the extent to which we have correctly identified its intrinsic value and obstacles that have the potential to erode the same. Not surprisingly then, these pre-requisites call for businesses, which are simple and easy to evaluate. Thus, as in life so also in investing, easy does it. This is precisely what the master has to say in his 1994 letter to shareholders. Laid out below are his comments on the issue.

"Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn't count. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables."

Another habit that we often fall prey to is conforming to the herd mentality and this habit too deprives us of attractive money making opportunities. One look at the attitude of people towards investing before and after the recent correction in the Indian stock market and you would know what we are talking about?

Before the recent correction, when the market was trading at its peak and most of the business way above their intrinsic values, investors were queuing up to buy stocks in the hope that since the times are good, there will always be buyers ready to buy from them what they themselves have bought at exorbitant prices. But alas, that was not to be the case and they had to pay dearly for their mistakes.

On the other hand, when quite a few businesses have now come down to a fraction of their intrinsic value after the correction, investors seem to be running away under the pretext that the time is not good to buy equities. These people could take a lesson or two from Warren Buffett who has the following to say on this tendency among investors.

"We try to price, rather than time, purchases. In our view, it is folly to forego buying shares in an outstanding business whose long-term future is predictable, because of short-term worries about an economy or a stock market that we know to be unpredictable. Why scrap an informed decision because of an uninformed guess?"

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