Lessons from Warren Buffett - II - 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 - II

Jun 28, 2007

Last week, we had started a series on the study of annual letters that legendary value investor Warren Buffett wrote every year to the shareholders of his investment vehicle, Berkshire Hathaway. We discussed some key points in the letter for the year 1977 in the previous write up. In this write up, let us see what the master has to say to his shareholders in the 1978 letter: "The textile industry illustrates in textbook style how producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage. As long as excess productive capacity exists, prices tend to reflect direct operating costs rather than capital employed. Such a supply-excess condition appears likely to prevail most of the time in the textile industry, and our expectations are for profits of relatively modest amounts in relation to capital. We hope we don't get into too many more businesses with such tough economic characteristics."

The above paragraph once again highlights the fact that no matter how good the management, if the economic characteristic of the business is tough, then the business will continue to earn inadequate returns on capital. This can be further gauged from the fact that despite all the capital allocation skills at his disposal, the master was not able to turnaround the ailing textile business that he had acquired in the early years of his investing career. He further adds that such businesses have little product differentiation and in cases where the supply exceeds production, producers are content recovering their operating costs rather than capital employed.

REVEALED: The Secret to potentially Making Rs 18,870, Rs 9,425 and Rs 7,315 in a Single Day...

While the comment is reserved for the textile industry, we believe it can be extended to all commodities like cement, steel and sugar. Infact, the current downturn the sugar industry is facing has a lot to do with supply far exceeding demand and this in turn is having a great impact on returns on capital employed by these businesses. The only hope for them is a scenario where demand will exceed supply.

"We get excited enough to commit a big percentage of insurance company net worth to equities only when we find (1) businesses we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively. We usually can identify a small number of potential investments meeting requirements (1), (2) and (3), but (4) often prevents action. For example, in 1971 our total common stock position at Berkshire's insurance subsidiaries amounted to only US$ 10.7 m at cost and US$ 11.7 m at market. There were equities of identifiably excellent companies available - but very few at interesting prices."

Those of you, who are regular readers of content on our website, the above paragraph must have rang a bell or two. Indeed, time and again, in countless articles, we have been highlighting the importance of investing in good quality businesses run by honest and ethical management. That the master himself has been looking at similar qualities does go a long way in further reinforcing our beliefs. Buffett then goes on to make a very important comment on valuations and says that no matter how good they are, there is a price to pay for businesses and he in his investing career has let many investing opportunities pass by because the valuations were just not right enough.

Comparison can be drawn to the tech mania in India in the late nineties when good companies with excellent management like Infosys and Wipro were available at astronomical valuations. While these companies had excellent growth prospects, investors had become far too optimistic and had bid them too high. Thus, investors who would have bought into these stocks at those levels would have had to wait for five long years just to break even! Hence, no matter how good the stock is, please ensure that you do not pay too high a price for it.

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 - II". Click here!

  

More Views on News

Beware of the Oil Rally (Fast Profits Daily)

Mar 8, 2021

Don't jump on to the bullish crude oil bandwagon.

Are Investors Losing Confidence in Franklin Templeton Mutual Fund (Outside View)

Mar 8, 2021

PersonalFN highlights the outcome of forensic audit report ordered by SEBI and checks if investors are losing trust in Franklin Templeton Mutual Fund.

The Bubble Noise is Getting Louder. Should You Be Fearful? (Profit Hunter)

Mar 8, 2021

With the smart money passing its verdict, should you be fearful of a stock market crash?

The Best Stocks in a Volatile Market podcast (Views On News)

Mar 5, 2021

Rahul Shah on the qualities that make for a good investment in an up and down market.

A New Super Cycle in Metals? (Fast Profits Daily)

Mar 5, 2021

In this video, I'll tell you if there is huge money to be made in metals or if there is more to the super cycle story.

More Views on News

Most Popular

It's the Beginning of a New Bull Phase in Smallcaps (Profit Hunter)

Feb 24, 2021

Last time the smallcap index crossed 19k a big correction followed. Here's what makes it different this time.

Make Rs 5,000 Per Day Trading the Market (Fast Profits Daily)

Feb 25, 2021

In this video, I'll show you how to get started on the path to daily trading profits.

The Hidden Tesla in My Great Indian Wealth Project (Profit Hunter)

Feb 23, 2021

An Indian company founded three decades ago in a garage caught my attention...

Gold 65,000 and Silver 84,000 in 2022

Feb 26, 2021

In this episode of the Investor Hour, India's #1 trader, Vijay Bhambwani, talks to us about the stock market, his new targets for gold and silver, the best long-term investment opportunity, and a lot more.

More

India's #1 Trader
Reveals His Secrets

Secret To Increasing Your Trading Profits Today
Get this Special Report,
The Secret to Increasing Your Trading Profits Today, Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Mar 8, 2021 (Close)

MARKET STATS