When I started writing for BigFatPurse, I had hopes of sharing my very own experiences and insights with readers. I knew that writing down my thoughts would compel me to refine them and give me more clarity. I envision myself doing research into topics and issues that I am not totally familiar with and subsequently distilling them into a concise article for publication. I would write and before the articles go to press, I would share them with my family members and friends, seeking their opinion and comments.
And gradually I come to realize that the longer and more technical the article is, the more information I try to cram into a page, the faster people lose interest. With that I came to the realization that most people not only want to be educated, they also want to be entertained! To entertain and educate at the same time is a tall order. For a while, I am not even sure if it could be done. I started asking myself what are my favorite reads are, ones that allow me to gain pleasure and knowledge at the same time, in order to establish a benchmark for my own writings.
I had to look no further than the writings of Warren Buffet and his annual letter to shareholders.
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Warren Buffet writes a letter to all Berkshire Harthaway shareholders annually, and publishes them on the most understated website in the entire cyber universe. Allow me to quote from a page of his 2012 letter that was published just last week.
When the partnership I ran took control of Berkshire in 1965, I could never have dreamed that a year in which we had a gain of $24.1 billion would be subpar, in terms of the comparison we present on the facing page.
But subpar it was. For the ninth time in 48 years, Berkshire’s percentage increase in book value was less than the S&P’s percentage gain (a calculation that includes dividends as well as price appreciation). In eight of those nine years, it should be noted, the S&P had a gain of 15% or more. We do better when the wind is in our face.
To date, we’ve never had a five-year period of underperformance, having managed 43 times to surpass the S&P over such a stretch. (The record is on page 103.) But the S&P has now had gains in each of the last four years, outpacing us over that period. If the market continues to advance in 2013, our streak of five- year wins will end.
One thing of which you can be certain: Whatever Berkshire’s results, my partner Charlie Munger, the company’s Vice Chairman, and I will not change yardsticks. It’s our job to increase intrinsic business value – for which we use book value as a significantly understated proxy – at a faster rate than the market gains of the S&P. If we do so, Berkshire’s share price, though unpredictable from year to year, will itself outpace the S&P over time. If we fail, however, our management will bring no value to our investors, who themselves can earn S&P returns by buying a low-cost index fund.
Charlie and I believe the gain in Berkshire’s intrinsic value will over time likely surpass the S&P returns by a small margin. We’re confident of that because we have some outstanding businesses, a cadre of terrific operating managers and a shareholder-oriented culture. Our relative performance, however, is almost certain to be better when the market is down or flat. In years when the market is particularly strong, expect us to fall short.
Essentially, what Warren Buffet is saying is this.
Despite making a lot of money, 24.1 billion to be exact, Berkshire’s returns was less than S&P’s percentage gain. That is unacceptable because his job, and that of his Vice-Chairman Charlie Munger, is to increase shareholder value over and above what the market is able to. That is the alpha that they are paid to seek out. If Berkshire is unable to keep up with the market returns of the S&P, the management will bring no value to shareholders at all.
In a recent article, I wrote about benchmarking one’s investment against the Effort Free Rate. The rate of returns must commensurate with the amount of effort expended. If your investment strategy requires you to follow the news closely, analyze chart patterns, spend your evenings and weekends reading, thinking and working, then there has to be a ‘positive positive’ outcome. Making money is not good enough, it is beating the market that is the name of the game. Warren Buffet understands this point intrinsically when he bemoans his 24.1 billion gain in 2012.
Your job as an active investor is to add value, and unless you are certain of adding value to your portfolio over and above typical market returns, do as what one of the richest man in the world suggests. Take your hands off and go for a low cost index fund (or an even more stable Permanent Portfolio).
In an online interview in 2010, Nassim Taleb made a remark on Buffet.
‘I am not saying Buffet doesn’t have skill – I am just saying we don’t have enough evidence to say Buffet isn’t doing it by chance’.
His argument goes like this. Imagine an investing universe with millions of investors. At the end of the year, discard those who have lost money and keep with those who have positive portfolios. Given that the American stock market has experienced one of the greatest bull runs in history, it is imperative that someone remains standing at the end of forty years. In other words, Buffet existence is representative of statistical probability.
I am just the wee bit slightly inclined to agree with Taleb. But investing results and wealth aside, what really made me admire Buffet is his ability as a writer and communicator. He is able to inform, educate and entertain all at the same time. His letters are extremely well balanced. He blatantly sells his products and the companies he owns, yet he is always self deprecating and never fails to poke fun at his own failings. He tells the bad news as they are, yet is always able to project confidence and uphold shareholder optimism that is so crucial for a CEO. He is candid and introspective at the same time.
To benchmark against Warren Buffet is to set the bar extremely high, but here at BigFatPurse we sure will try our very best!