Buffett Partnership Letters by Warren Buffett
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The Buffett Partnership Letters are classic reading for any value investor. Readers get an inside view of Warren Buffett’s investment philosophy — seeing where it did and did not evolve — early in his career.
The Notes
- From 1957 to 1968, the Buffett Partnership earned a 31.6% annual return (25.3% for limited partners), with no losing years, compared to 9.1% for the Dow.
- Buffett saw a satisfactory return as one that beat the Dow by 10% over the long term. And if he could not beat the Dow, it was best for the partners to invest through someone else.
- His goal was to outperform in bear markets with average performance in bull markets — targeting a half percent decline for each 1% decline in the Dow. He constantly reminded the partners of it — tempered their expectations — every time he handily beat the Dow.
- “I would consider a year in which we declined 15% and the Average 30% to be much superior to a year when both we and the Average advanced 20%.”
- He favored a conservative approach, avoiding permanent capital loss.
- “I make no attempt to forecast the general market — my efforts are devoted to finding undervalued securities.”
- 3 years is his minimum time needed to judge good performance (5 years is better), assuming the period saw both strong and weak markets.
- “At all times, I attempt to have a portion of our portfolio in securities as least partially insulated from the behavior of the market, and this portion should increase as the market rises.”
- Buffett’s Fees: one-fourth of profits above 6% per year, with any year falling short of 6% in profits would be carried forward against future profits.
- Indexes are tough competition to beat:
- Buffett annually compared four of the largest mutual funds at the time against the Dow: “I present this data to indicate the Dow as an investment competitor is no pushover, and the great bulk of investment funds in the country are going to have difficulty in bettering, or perhaps even matching, its performance.”
- The lack of outperformance from the funds was due, in his opinion, to a combination of group decisions making it harder to come to a consensus decision, desire to conform (herd mentality) to what other funds are doing, that average performance is safer than the risk of being different, broad diversification, and inertia.
- That said, Buffett does see a benefit in mutual funds despite their lack of alpha — ease of use, freedom from decision making, automatic diversification, and a better alternative than the speculative trouble an investor can get into on their own.
- Assume the voyage of Columbus had been underwritten with $30,000 in venture capital. Had the money been invested differently, say at 4% compounded annually to the present (i.e. 1962), Spain would have watched it grow to $2 trillion.
- Assume Francis I of France paid $20,000 for Leonardo da Vinci’s Mona Lisa in 1540. Had he instead invested the money at 6% compounded annually (after-tax, of course), his estate would worth $1 quadrillion.
- Manhattan was sold in 1626 to Peter Minuit for the rough equivalent of $24. Who got the better deal? A 1965 appraisal, at $20 per square foot puts the value at $12.5 billion. But had the Indians invested that $24 at 6.5%, it would be worth $42 billion over the same time. If they got a half point better — 7% instead — they’d have $205 billion!
- “It is always startling to see how relatively small differences in rates add up to very significant sums over a period of years.”
- Generals:
- Undervalued securities, with a wide margin of safety, no view on corporate policy or when price appreciation might occur.
- Bargain price is a must, but also good management or new management in a decent industry.
- He likes to see companies with improving earnings/increasing asset values, that the market hasn’t recognized yet.
- It’s the largest portion of the portfolio with the best total returns.
- Individual position size: 5% – 10% for each of 5 or 6 generals, with small positions in 10-15 others.
- More concerned about buying at the right price then selling at the best price — squeezing the last penny out of a deal. He was happy selling below fair value.
- Tend to move with the market — performing well in rising markets, poorly in declining markets.
- In the 1964 letter, he split Generals into two groups: “Private Owner Basis” and “Relatively Undervalued.” The “Private Owner Basis” were the typical Generals as described above. The “Relatively Undervalued” were securities selling cheap relative to other similar securities.
- Are dependent on a specific corporate action or event in order to profit, making it easier to predict when and how much could be earned, and the risk of it falling through.
- Usually the result of corporate sales, spinoffs, mergers, liquidations, tenders, reorganizations, etc.
- The risk is that something — anti-trust issue, shareholder disapproval — causes management to abandon the planned action or event making any potential profit impossible. Misjudging the risk can be expensive.
- Tend to perform independently to the stock market.
- Workouts are used to insulate a portion of the portfolio from the short term (mis)behavior of markets. Typically, performing better in bear markets but lagging in bull markets.
- The second-largest portion of the portfolio.
- Typically in 10-15 workouts at any time.
- Buffett used borrowed money in workouts — a borrowing limit of 25% of the portfolio’s net worth — because of the higher degree of safety due to predictability of results and lower chance of short-term declines.
- The activist role: Buy a controlling interest in a company or a large enough position to influence corporate policy (he would rather others did the work).
- It requires a wide margin of safety and a large profit potential to be worthwhile.
- Each situation is expected to take several years — to gain enough shares to assume control and to realize a profit.
- Generals may become control situations if the price remains low for a long enough time.
- It can insulate the portfolio from short-term market moves, like workouts.
- Tend to move independently to the market.
- Once controlled, market price was irrelevant. Operating performance of the business was all that mattered.
