Buffett Letter: 1961 semi-annual 1


Semi-annual 1
  • I have lost count of the times Buffett says that he will look good in a down market and bad or average in an up market.
  • Despite 1961 being a good year for both the general markets and his fund he holds onto his view above. He actually beats the DJIA by 23% odd!
  • This letter marks 5 years of compounding. His fund has a staggering 251% vs 75% of the index.
  • He again highlights how tough it is to beat the index. He quotes a result of 32/38 mutual funds losing to DJIA and 6 who were ahead were only by a few percentage points. I think in the Indian context the story is the same. Though we do not have index funds (of such popularity) I think they could be the real deal of the future.
  • Buffett again explains his methodologies which is divided into three types of investments
      • Generals - Buying undervalued securities
      • Work Outs - Where he can unlock some value with some corporate action
      • Controls - Where Buffett can have a say in running the operations of the company
    • On Generals he says they have large positions of 5% to 10% of their assets and they have major positions in 5 to 6 securities. Then there is a long tail of 15 odd stocks. This is a good way to visualize his portfolio. Personally for me as a retail investor Generals is what we are looking for and this gives a good idea of portfolio size. 
    • Buffett is not worried about timing the market. He says he is good at entering but not that good in selling. He doesn't want to haggle over nickels. This is an important lesson for us - we must not be stuck to a number of our valuation of a company.
    • He is confident the generals will outperform the index. I guess this stems from the fact that he has bought at a fair or under valuation.
    • The second case study so far is presented: Dempster Mill Manufacturing Company
      • Buffett bought Dempster Mill Manufacturing Company as an undervalued security 5 years ago but later obtained a majority control with 70% holding.
      • This is a company which manufactures farm implements and water systems. It has $9 million worth of operations in 1961.
      • Buffett feels the company deserves a higher valuation. He holds 21% of the fund value in this company.
    • In a raging bull market control situations is a method to insulate the partnership from the markets as per Buffett.
    • Buffett makes a very important point when he says few years ago people were buying bonds and that those bonds have led to severe depreciation of capital. Now he says people are buying blue-chip shares not knowing that this too is not conservative which the public has assumed to be. He feel people are speculating and justifying higher multiples. This is so true today in the Indian market scenario of mid 2019. All the money is flowing into a handful of stocks which are essentially the bluest of the blue chip stocks. People are thinking they are safe havens. This might turn out to be a major pain point in the future.
    • An important quote - You will not be right simply because a large number of people momentarily agree with you. You will not be right simply because important people agree with you. In many quarters the simultaneous occurrence of the two above factors is enough to make a course of action meet the test of conservatism. You will be right, over the course of many transactions, if your hypotheses are correct, your facts are correct, and your reasoning is correct. True conservatism is only possible through knowledge and reason.
    • Buffett then lets out two very important quantitative numbers about his fund management approach
      • Stop loss equivalent: They have never realized a net loss of 0.5% of 1% of total assets of the fund. 
      • Win ratio equivalent: Total dollars realized from a win to a loss is 100 to 1. 
    • In my understanding the win ratio is brilliant. Stop loss is a good metric here. I personally am more open with a broader stop loss but I have a lot of endowment bias. A major area of improvement. 
    • Another brilliant idea he puts forward as a prediction. He says that anyone thinking he will beat the index handsomely will face disappointment. He is focusing more on the number of years in the market than the annual growth rate. He makes this explicit. Buffett says there will be years of +25% and then -25% and it could happen number of times in any order but his focus is to add on the years with some positive growths. Beautiful prediction indeed.
    • Buffett continues to add that in a bad year for the Dow he hopes he would have not such a bad year. And over time this cushioning effect would lead him to beat the index by 10% odd.
    • This letter has some core ideas - time in market is critical, focus on long term rather very long term, protect capital like a fanatic, cut your losers, run your winners, save your portfolio in a down market and always be humble. This is a very good letter indeed.


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