Warren Buffett, CEO of Berkshire Hathaway and once the richest person in the world, is renowned for both his business empire and teaching abilities. “The Essays of Warren Buffett” offer insights from his annual reports to shareholders, where he shares the inner workings of Berkshire, investment strategies, and fundamental principles for building wealth.
Buffett’s essays provide a unique perspective into the mind of a successful investor, with ideas that challenge the norm in high finance. This guide covers Buffett’s writings on investing practices, comparing his views to those of Wall Street firms, and examining other financial experts’ opinions. We’ll also place Buffett’s ideas in their historical context and explore their relevance in modern investment.
How to Invest
Buffett’s essays offer insights for all investors, emphasizing that owning a stock is owning a business. He advises on best practices, pitfalls to avoid, and suggests investing in well-run businesses at a discount and holding indefinitely. He believes in ignoring market emotions and avoiding short-term trading, which can drain finances through fees.
Buffett’s essays provide valuable advice not only for Berkshire Hathaway shareholders but also for individual investors. He emphasizes the importance of investing in industries you understand, recognizing market volatility, and using simple index funds to benefit from the market’s upward trend.
By owning a piece of a business, you should use any industry knowledge you have to your advantage and invest in well-managed companies with good future prospects. When investing, focus on the long-term gains as an owner, rather than short-term gains from trading.
Lastly, Buffett recommends avoiding industries that lack predictability and instead favors companies with essential products that are always in demand, such as food, clothing, insurance, and utilities.
The Upside of Volatility
Buffett believes market volatility provides buying opportunities for investors. Low stock prices benefit buyers, and he recommends investing in S&P index funds for those without resources for thorough research. Day trading and trying to outperform the market should be avoided due to trading fees.
Buffett’s viewpoints may seem obvious, yet they are different from those of many financial experts. He specifically criticizes diversified portfolios, the Efficient Market Theory, and the alleged worth of financial advisors.
Efficient Market Theory
Efficient Market Theory (EMT) suggests that stock prices always reflect the true value of a company, rendering deeper analysis pointless. However, Buffett rejects this notion, arguing that researching a company reveals its true worth, and that stock fluctuations offer opportunities. He finds it frustrating that EMT is still taught in business schools despite being discredited.
Buffett questions the idea that diversifying a portfolio reduces risk, preferring to invest in a few safe companies with strong management and excellent long-term economics.
He defines risk as the likelihood of suffering financial harm and ignores short-term stock fluctuations in favor of a long-term investment strategy. While Berkshire Hathaway’s holdings appear diversified, its majority shares reflect Buffett’s personal investment approach.
Buffett disapproves of the financial industry’s focus on creating and selling complex products, encouraging frequent trading, and obscuring market clarity. He believes brokers and advisers benefit the most and often exploit investors with unnecessary trades and products while bearing none of the risks. Instead, Buffett suggests investing in low-cost index funds instead of relying on financial professionals.
What to Avoid
Buffett prefers stocks and bonds and dislikes unproductive assets, junk bonds, financial derivatives, and using debt for acquisitions. Money market funds and bonds have low-interest rates, losing value over time. Investing in unproductive assets, such as jewelry or gold, is foolish, and junk bonds pose a high risk of default.
Buffett warns against financial products like derivatives and borrowing to invest, both of which can lead to financial ruin. He strongly favors equities over other investments and suggests investing only with cash to stay safe in the market.
How to Run an Investment Business
Buffett offers investment advice and insights into Berkshire Hathaway’s operations, praising its transparency, rational investing, and shareholder commitment. He contrasts its values and culture with typical practices in corporate America.
This section compares Berkshire Hathaway to other large investment groups, exploring differences in corporate governance, accountability, acquisition principles, and shareholder interests.
The Wall Street Way
Buffett draws attention to the shortcomings of several investment organizations, such as CEO culture, dubious bookkeeping, expensive mergers and acquisitions and financial derivatives. He views a lack of genuine responsibility as the main issue, with directors having little to no accountability and CEOs being rewarded for incompetence.
Buffett is particularly critical of awarding stock options as CEO compensation, as they are often not tied to performance and carry none of the risk. He lobbied for a change in accounting rules, but lost.
Takeovers, Debt, and Danger
Buffett values companies bought for the right reasons but warns against buyouts that harm shareholders. Corporate growth without adding meaningful value often results in the issuance of new shares, reducing the value of existing shares. Leveraged buyouts, which put livelihoods at risk, create a dangerous concentration of risk that could lead to an economic collapse if defaults occur.
The Berkshire Way
Buffett praises Berkshire Hathaway for its unique business practices that prioritize increasing overall value per share by acquiring financially sound companies.
Shareholders receive transparent financial and managerial information and earnings are reinvested to maximize the corporation’s worth. Instead of dividends, Berkshire uses capital allocation to maximize shareholder value. Buffett views investors as partners and is accountable to a board of directors who hold at least $4 million in Berkshire stock.
Growing the Berkshire Family of Businesses
Buffett’s favorite part of his job is acquiring new businesses, but he’s no longer interested in mid-range businesses for cheap. Instead, he seeks high-quality companies at fair prices, without setting acquisition targets. Every opportunity is compared to other conservative investments to remove the pressure for growth that drives many CEOs to rush into acquisitions based on arbitrary goals.
Once Berkshire acquires a controlling share, Buffett lets new acquisitions conduct their business with minimal interference. Berkshire never sells off an acquisition as long as it can produce even a modest return on investment, recognizing the importance of these businesses for their employees and families.
Berkshire never leverages debt to buy new businesses, maintaining cash from subsidiaries for acquisitions or stock buybacks if trading below actual value. Buffett has carefully cultivated an owner-centric culture at Berkshire, which he believes will endure after he’s gone. Although he doubts that Berkshire’s gains in the next 50 years can match its first half-century, he has full confidence in the business he created to thrive and endure.