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Tuesday, May 6, 2008

55 Learnings from Warren Buffett and Charlie Munger

Friends, after attending the Berkshire Hathaway shareholder meeting last year, I went back again this year with my friend, Shriniwas. Once again, it was a wonderful experience. Please see the notes/learnings below:


1. Read everything in sight. It is the best way to learn.

2. You only have to remember three principles to become a good investor:

i) You are buying part of the business when you buy stocks (so, understand the business you are buying)
ii) Leave margin of safety (i.e. if you think a business is worth $100, buy it at $60 and not at $99)
iii) Market is there to serve you and not to instruct you (use the market to buy undervalued businesses)

3. The reason good investing principles are not taught in business schools and the complex formulas are taught is that people like to teach what they know and not necessarily what the students need to know. E.g. If someone told you that all biblical studies boil down to 10 commandments and that is all you need to be taught then you would not need many teachers.

4. The business schools only need to teach two things in investing:

i) how to value a business
ii) how to use the stock market to serve you

5. When hiring people look for passion and communication skills. Most candidates know what the interviewer wants to hear. Retention contracts with employees do not work. Passion works. At Berkshire, people are hired when a business is bought and we (Warren/Charlie) focus on retaining employees by providing an environment to keep their passion alive. The reason people stay with Berkshire is more than money.

6. Never trade reputation for money.

7. A lot of game playing occurs in Corporate America and Wall-Street via quarterly guidance and pressure to meet targets. Businesses should be focused on long term. Berkshire managers have no pressure to meet any EPS targets or to meet any budgets.

8. Do what you like and you will always be mentally and physically healthy.

9. Don't sleep-walk through life. Find your passion and you will live a much happier life.

10. Work for people you admire.

11. Communication skills are extremely important in life and they are under-taught at the universities.

12. Berkshire made all its money on "longs" and no money on "shorts."

13. Do what you understand and do it consistently. Overtime, you will become very successful.

14. It is the nature of things that most small businesses will remain small and most big businesses will become mediocre and die.

15. The best investment Berkshire ever made was the recruitment fee paid to the executive research firm to hire Ajit Jain (he manages Berkshire's reinsurance business).

16. Buy businesses that produce cash (no continued reinvestment of cash is required to sustain the business)

17. Stock market gives you bargain price but the individual owners don't.

18. Price is always important.

19. US$ will weaken further in future and Euro is not likely to depreciate anytime soon.

20. Investment possibilities are inversely proportional to the amount of money you have i.e. more money = less possibilities and less money = more possibilities

21. Invest in a business which an idiot can run because sooner or later one will.

22. Political process in the US is corruptive. You have to make the other guy look bad. However, it works. If you don't follow the process you may win a medal for bravery but you will not win the presidency.

23. With small sums of money it is a mistake for a professional investor not to put most of it in one good idea.

21. The best investment for a "know nothing" investor is a diversified index fund with a low fee. Diversification does not make sense for a professional investor.

22. Oil production will be down from the current levels in 25 years (and energy demand will be tremendously higher).

23. Corn fuel is the dumbest idea.

24. Live within your income.

25. CEO is the chief risk officer of the company as well. It is the CEO's job to manage risks the company is exposed to.

26. "Derivatives" are very hard to manage.

27. The accounting profession has failed us (Americans). The accounting standards should not be designed to please everyone. They should be designed like engineering standards.

28. If you have to carry the value of a deal/investment to three decimal places then it is not a good idea.

29. In a complex environment, you can not make a fine grade decision. Try to be in the right ball park.

30. Due diligence by external partners is a waste of time. No one knows your business better than you do. Risk evaluation can not be farmed out.

31. A brand is a promise which stays in your subconscious. Hence, a branded product with a leadership position over a long time in the market is a good investment.

32. To understand the qualities Berkshire is looking for in Warren Buffett's replacement, read Berkshire 1996 annual report.

33. In the complex business world we live in today, one of the most important attributes of a CEO is to contemplate scenarios/problems which have never happened before.

34. The people who are supposed to warn CEOs of risks try to make CEOs feel good while CEOs do dumb things. And these people try to modify reality to fit it into complex financial models. Despite all the risk modeling, Bear Sterns failed.

35. It is OK to sacrifice a little bit of earnings to minimize risk.

36. Berkshire is run like an engineering company.

37. Don't worry about the things you have missed.

38. Punishing China via Olympics boycott is a mistake. China is moving in the right direction and people who move in the right direction should be encouraged and not punished. US has had its share of human rights violations. US constitution used to say that blacks are 3/4 of a person.

39. There are more banks than bankers.

40. The secret of nuclear power has been leaked. The ability of "nuts" to inflict massive damage is increasing. The world is becoming a more dangerous place.

41. The best investment you can make is in yourself. Human potential is not realized in most people. Any investment in learning always pays off.

42. Warren Buffett tells this story to high schools grads. Imagine you can buy any car you like with a catch that you can not get another car for thirty years. What will you do? You will change the oil more than required. Get it washed regularly. In a nutshell, take very good care of it. Now, why wouldn't you do the same thing with your body.

43. Beware of vendors and lenders.

44. Don't give away the money you need.

45. In Wall Street there is no testing done before launching a new product. Wall Street operates very differently than the drug industry where rigorous testing is done before a product is launched.

46. Even though US consumers live on credit unlike Asians who save half their earnings, the US has become a richer nation in the last ten years.

47. Current US trade deficit is $700B and $47k/person GDP.

48. Assets of the Investment Banks have become "good until reached for."

49. The phrase, "financial innovation that will diversify risk", should be banned. It will tremendously help the financial industry.

50. Americans have love affairs with their cars. It is unlikely that we will see expansion in mass transit in the US."Human nature does not change. "

51. Credit Default Swap (CDS) are a negative sum game.

52. The company should only provide dividends if it does not have the ability to convert a $1 into $1.1 or more.

53. You teach children by what you do and not by what you say. There is no reverse button in children's learning.

54. The press has more influence on executive behavior than regulation since the "big shots" don't like to be embarrassed.

55. Copy the qualities of people you admire.

You may notice that both Warren Buffett and Charlie Munger used the word complex many times. In my opinion, for anyone to understand the world and solve any complex problem-business, social, scientific, etc, it is critical to understand Complex Systems. To learn more about Complex Systems, please visit http://necsi.org/

Your thoughts?