Buffett says market's fall good news for long-term investors

It's always good to hear something from people who are successful, even though you may never be able to happen upon the exceptional chances that made them what they are.

This may be part of the reason why many books written about Warren Buffett, one of the world's most successful investors and now one of its richest men, have been so popular.

As its name suggests, "The Essays of Warren Buffett: Lessons for Investors and Managers" is not only for investors, but also for business managers.

Buffett doesn't often talk to the media, so many other books about the legendary investor have arisen from interpretations of Buffett's philosophies and actions on the part of various authors. However, this book distills Buffett's wisdom from annual letters the billionaire wrote to shareholders of his company, Berkshire Hathaway, and from some other essays authored by Buffett.

"The Essays of Warren Buffett: Lessons for Investors and Managers", published by John Wiley & Son, is the result of fine work by Lawrence A Cunningham, research professor of law at George Washington University in Washington DC.

It highlights Buffett's ideas on the basic principles involved in sound business practices, selecting managers and investments, valuing businesses and using financial information profitably.

Prominent in Buffett's wide-ranging advice is his "we eat our own cooking" philosophy. Most of Berkshire Hathaway's directors have a major portion of their net worth invested in the company. Buffett himself has about 99 per cent of his net worth in Berkshire's shares.

"Charlie [vice chairman Charlie Munger] and I feel totally comfortable with this eggs-in-one-basket situation because Berkshire itself owns a wide variety of truly extraordinary businesses," he wrote.

The supreme irony in business management, Buffett wrote, is that it is far easier for an inadequate chief executive to keep his job than it is for an inadequate subordinate.

"If a secretary, say, is hired for a job that requires typing ability of at least 80 words a minute and she turns out to be capable of only 50 words a minute, she will lose her job in no time. Similarly, if new sales people fail to generate sufficient business quickly enough, they will be let go. However, a CEO who doesn't perform is frequently carried indefinitely."

 Buffett suggests that boards of directors should comprise ten or fewer members and most of them ought to come from outside the company. Then the outside board members should establish standards for the chief executive's performance and should also periodically meet, without his being present, to evaluate his performance against those standards.

The requisites for board membership should be business savvy, interest in the job, and owner-orientation. Too often, he wrote, directors are selected simply because they are prominent or add diversity to the board.

On investing, Buffett said he continually sought "large businesses with understandable, enduring and mouth-watering economics that are run by able and shareholder-oriented managements". His goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price. "I have found that making silk purses out of silk is the best that we can do. With sow's ears, we fail," Buffett wrote.

Buffett sticks only to businesses he understands. He believes that what counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things right, as long as he or she avoids big mistakes, he wrote.

"Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now," he wrote, and added: "If you aren't willing to own a stock for 10 years, don't even think about owning it for ten minutes."

 Buffett emphasises the differences between intrinsic value, book value and market price; economic goodwill and accounting goodwill; "owner earnings" and account earnings; and value versus growth.

"Common yardsticks such as dividend yield, the ratio of price to earnings, and even growth rates, have nothing to do with valuation. Indeed, growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years," he wrote.

According to Buffett, the formula for valuing all assets that are purchased for financial gain has been unchanged since it was laid out by Aesop 2,600 years ago: "a bird in the hand is worth two in the bush".

To flesh out this principle, one must answer only three questions: how certain are you that there are indeed birds in the bush? When will they emerge and how many will there be? What is the risk-free interest rate (compared to longer-term US bonds)?

Buffett jokes that Aesop's investment axiom could be adapted by his grandsons as "a girl in a convertible is worth five in the phonebook".

Buffett said he and his vice chairman mainly attended to capital allocation and the selection and compensation of their key managers. All other tasks were then left to these managers. He also wrote about his succession plan and the qualifications of his successor, who he said had to be someone "genetically programmed to recognise and avoid serious risks, including those never before encountered".

"Temperament is also important. Independent thinking, emotional stability and a keen understanding of both human and institutional behaviour are vital to long-term investment success. I have seen a lot of very smart people who have lacked these virtues," he wrote.

 Considering the current bearish investment sentiment, it is heartening to read a Buffett book. As a long-term investor, Buffett wrote, "when the market plummets - as it will from time to time - neither panic nor mourn. It's good news for Berkshire".

Investors, he wrote, should try to be fearful when others are greedy and greedy only when others are fearful.

pichaya@nationgroup.com