Lessons from Warren Buffett - XLIII - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Lessons from Warren Buffett - XLIII

Jun 25, 2008

In the previous article based on Warren Buffett's letter for the year 2000, we saw how the master reaffirmed his faith in the discounted cash flow approach to valuations by using one of Aesop's fables. Let us go further down the same letter and see what other things he has to say.Mother Nature's envy?
Mother Nature would be really envious of the stock markets. She has taken centuries to turn apes into rational human beings. But the same human beings and mind you, even the smartest of them turn irrational in no time when they dabble in stocks. What else could explain the dotcom boom where P/E ratios of 100 were a common sight?

In a lot of instances, the companies under consideration did not even earn a profit. Closer home, some of the power stocks and those in the infrastructure space were valued 2-3 times more than their FMCG counterparts. Now, how long does it take to realise that while FMCG companies can double their capacities in no more than 6-8 months and thus start producing cash flows immediately, power companies with even the best execution records will take no less than 3 to 5 years to come up with a new capacity, thus taking cash flows from this new capacity that many more years to fructify and hence, resulting in lower valuations. Warren Buffett has summed it up best when he has said that investors resorting to the above-mentioned investments were actually not investing but were engaging in speculation.

FREE REPLAY: Discover What Richa Revealed in Her Smallcaps Summit

Speculation: Investor's enemy no. 1
As per the master, speculation as opposed to investment is not based on valuations and margin of safety but is dependent on making assumptions about what will the second investor pay for a stock that the first investor has bought a few days or a few months ago. It brings in good money as long as the game lasts but when one ends up being the last person to hold the stock with no one else willing to buy it, losses could be painful. It is indeed such an activity that the master advises investors to avoid at all costs and be rational in one's decision making. Indeed, attractive valuations and a good track record should be the foundation upon which an investment is based and not speculation.

Master's golden words
Buffett says, "The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball."

"They know that overstaying the festivities - that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future - will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room in which the clocks have no hands."

Lessons from Warren Buffett Series - Previous article | Next article | All Articles
Try the Warren Buffett Quiz

Equitymaster requests your view! Post a comment on "Lessons from Warren Buffett - XLIII". Click here!

  

More Views on News

6 Popular Stocks that Turned into Penny Stocks (Views On News)

Nov 27, 2021

A look at popular stocks that crashed big time and never recovered, i.e. which went from 'Multibaggers to Multibeggers'.

ONGC to NMDC: Here are 5 Stocks Value Investors Should Closely Track (Views On News)

Nov 26, 2021

Before investing in value stocks, research the company and gain insight into why the market is discounting it.

Infosys vs TCS: Which is Better? (Views On News)

Nov 26, 2021

In the post pandemic era, the top two IT companies in India are fighting to capture the growing demand for IT.

Dollar Index (DXY) Headed to 100 (Fast Profits Daily)

Nov 30, 2021

This is why I think the dollar is about to get stronger.

How to Pick the Best Growth Stocks in FY22 podcast (Views On News)

Nov 30, 2021

If growth investing interests you, here's what you need to know.

More Views on News

Most Popular

Infosys vs TCS: Which is Better? (Views On News)

Nov 26, 2021

In the post pandemic era, the top two IT companies in India are fighting to capture the growing demand for IT.

This Multibagger Stock Zooms 20% After Dolly Khanna Buys Stake (Views On News)

Nov 24, 2021

Shares of this edible oil company zoomed over 50% in three days after ace investor bought around 1% stake.

Don't Sell these Stocks if the Market Falls (Profit Hunter)

Nov 17, 2021

These are the 3 types of stocks that you should not sell in a market crash.

How to Find Your Next 10-Bagger in this Market (Profit Hunter)

Nov 19, 2021

The #1 make or break factor in your portfolio you shouldn't ignore.

6 Popular Stocks that Turned into Penny Stocks (Views On News)

Nov 27, 2021

A look at popular stocks that crashed big time and never recovered, i.e. which went from 'Multibaggers to Multibeggers'.

More

Become A Smarter Investor
In Just 5 Minutes

Multibagger Stock Guide 2022
Get our special report Multibagger Stocks Guide (2022 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Nov 30, 2021 (Close)

MARKET STATS