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  • SEPTEMBER 24, 2008

Lessons from Warren Buffett - LV

In the previous article, we went through the master's letter for the year 2005 and discussed how frictional costs are nothing but self-inflicted wounds. Let us now turn to the letter for the succeeding year and see the investment wisdom contained therein.

Succession planning
With Warren Buffett getting older with each passing year (and mind you, also smarter), it became important that succession planning got its due. And as with most of the other aspects of his life, the master was right on the button on this one as well. By the time the letter for the year 2006 arrived, Buffett along with his company's board had already zeroed in on three candidates that were best placed to replace the master if something were to happen to him. However, the master admitted to not being well prepared in succession planning on the investment side of Berkshire's business. Thereby emerged a plan where the master agreed to hire a far younger man or woman with the potential to manage a very portfolio and who would eventually take charge of Berkshire's investment side of the business.

It is indeed beyond anyone's doubt that the master will not have problems in finding scores of smart people who would be more than willing to associate themselves with Berkshire Hathaway. However, as per Buffett, in order to enjoy a long period of out performance, smartness alone will not do the trick. There are few other qualities that are equally if not more important. What are these other qualities? Let us find out in the master's own words.

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The golden words
The master says, "Picking the right person(s) will not be an easy task. It's not hard, of course, to find smart people, among them individuals who have impressive investment records. But there is far more to successful long term investing than brains and performance that has recently been good.

He goes on to add, "Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions."

Buffett further adds, "Temperament is also important. Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success. I've seen a lot of very smart people who have lacked these virtues."

Indeed, the events that are currently unfolding in the global financial markets, especially the US, give a real life example of how smart people, who lacked the requisite temperament could bring really big firms virtually to their knees. Years of profits at Lehman Brothers for example were completely wiped out by betting big on the wrong assumption that housing prices in the US can never fall. Fall it did and in the process, as the master so rightfully mentioned, a single, big mistake wiped out a long string of success.

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