HOW TO INVEST WHEN THERE’S FIRE EVERYWHERE – WARREN BUFFETT LECTURE AT TERRY COLLEGE OF BUSINESS

Warren Buffett gave one of his best lectures on July 18, 2001, at Terry college of business. In that lecture, he speaks about a myriad of investing-related topics and he throws so many bones to chew on for those who are interested in value investing. He talks about how investing is a game of temperament and not intelligence, one’s circle of competence, why an investor should think and act like a businessman, the stock market in 20th CE etc. In this post, I will try to enumerate and discuss some of the interesting topics that Mr Buffett covered in that lecture.

Warren Buffett asks the students if they were given the choice to pick one of their classmates who would have to share 10% of their earnings for the rest of their lives then who would that be and what characteristics would you look for?

Warren Buffett answers the question himself; he says it is not the person who has the highest grades, or the one who is athletic or the most handsome rather it is the one who has Integrity, generosity, honesty and willingness to do more than one’s share. On the other hand, who you would short is not the person with the least grades but the one who lacks in the character department. Warren Buffett goes on to list the things he looks for when he hires an employee, he wants a person who is intelligent, has energy and integrity and he says that a person who lacks the latter will kill you because his/her wit or grit will only come at your enterprise’s cost. 

 

ON CIRCLE OF COMPETENCE

Warren Buffett says that he has an old-school way of looking at investing and that he only invests in the companies whose business he understands, when he says understands he doesn’t only mean what they do or sell but the economics of the business, the competitive environment of that business.

To nail in his point, he gives an example of the automaker industry at the dawn of the 20th CE, there were over 2000 car makers when the industry came into existence, cars changed the lives of people and cars are still a product that people buy but out of those 2000 companies only 3 survived and their business is a lousy one. So, how do you pick 3 winners out of 2000? It is easy in hindsight but was not so easy looking forward because the economics of the automaking business was difficult to predict when the industry was still in its nascent change. Think of how many EV manufacturers have already come and gone bust. He also alludes to the “second-order effect”, he talks about how shorting horses would have been a more intelligent move to explain how picking losers would have been a much more profitable and easier exercise.

“Defining your circle of competence is the most important aspect of investing, it is not important how large your circle is, you do not have to be an expert at everything. knowing the perimeter of that circle, knowing what you understand and what you do not understand and staying inside of it is important.”

He also defines what “intrinsic value” is, but I will not discuss that here because it has been dissected and studied a billion times. The most imperative skill is to convert stocks into bonds.

Aesop in 600BC said, “A bird in the hand is worth two in the bush”. Warren Buffett says that this is incomplete, he says the real questions to ask are how many birds are there in the bush and how long would it take to get them. Here the birds represent cash, when you invest you are giving up what you have in hand in the hopes of getting back, even more, you would be willing to give up the cash in hand if you knew when and how much you would get back in the future. In the case of bonds, it is apparent how much you will get and when but in the case of stocks it is the job of the investor to figure that out and you can do it with a high degree of confidence only if you thread in familiar waters.

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BIGGEST MISTAKES

Warren Buffett says that buying Berkshire itself was a mistake because the textile business (Ah! It hurts …. Filatex) is a lousy business. He juxtaposes the way he used to invest with how he invests now. When Warren was under the tutelage of Ben Graham, he had taught him to buy “Cigar buts” (bad businesses which were so cheap that you could make a quick buck or so without much downside risk) but Warren understood that this was not the best way to make money so, he made up his mind to rather “buy a great business at a fair price than a fair business at a great price”. I don’t know whether I agree with that or not, I am certainly not been in the business to make up my own mind so, take this with a pinch of salt. I can see why he would say that when I put myself in his shoes, he runs billions of dollars and buying great businesses once or twice a decade would be the ideal way (also considering taxes) to invest such copious sums but I don’t know I just feel like price matters the most (I know he is not saying to pay egregious multiples). Or maybe I am just biased that all the great companies are outside my circle of competence or I am just dumb to understand and value those businesses.

He also states that time is a friend for a business that compounds well but an enemy for a bad business. He also talks about one of his investments where he paid for it with Berkshire stock and how the opportunity cost of that deal was and still is in Billions. That mistake is a unique one because it is open-ended and it will become bigger and bigger as Berkshire grows and becomes bigger. He says the biggest mistakes are the ones out of “omission and not Commission.” In investing great opportunities do not come regularly and the biggest mistake one could do is to not grab them (given that it is within your circle of competence) and not just grab them but grab them good i.e., to invest a significant portion of your portfolio. Warren Buffett, for investors to follow this approach, insists that investors should imagine a punch card with 20 slots and every time they buy a stock, they would have to punch a hole. If you approach investing with this mindset you would never gamble or buy crappy businesses because every time you make a move you would think long and hard before doing it.

WARREN BUFFETT’S HUMILITY

Warren Buffett gets asked how he would give his wealth back to the society, he says that his principle when it comes to philanthropy is that he wants his trustees to concentrate on big problems that are not well funded by the government or charities. While answering the question he showcases his humility towards his success which is something that I believe everyone, especially investors should have.

He says, “I got this money not because I am a superior human being not because I have done more for the society than other people. I was wired the right way to be dropped into the US at this particular time, I mean it is a huge capitalistic society and I am wired, no credit to me I am born that way, I am better at asset allocation than other people to some degree just like other people are better all kinds of things.”  

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STOCK MARKET BOOMS AND BUSTS

“The whole century is interesting, if you take 20th CE it was an unbelievable century for the US. The GDP per capita in the 20th CE in the US went up by 610% ……just on a quantitative basis it went every single decade including the 1930s, so here you had 100 years when basically the US citizenry was improving decade after decade, in fact, it went up by 13% in the 30s, the best decade was the one with WW2, the 40s went up by 36% and the worst was the WW1. Interestingly enough there were 6 periods in there for the stock market in both directions and there were 3 big bull markets. From 1900 to 1921 the Dow went from 66 to 71, less than 10% (excluding dividends) in 20 years and from 21 to 29 it went from 71 to a high of 381 in September of 1929, went up 500%. Well, obviously the well-being of the country did not go up 500% during that period and the well-being of the country went up a whole lot more than 10% during that first 21 years. And from September 1929 until the end of 1948, the Dow went from 381 to 180 so, it was cut in half and that was 18 long years yet the GDP per capita kept moving right up during this period, the economy was doing just fine. And from 48 to 65 the Dow went again from 180 up to close to 1000, again a 5 for 1. From 65 to 81 the Dow went down literally again the per capita GDP was fine. And we have had this last period where it had gone up terrifically. If you take the whole 100 years it went up a 180 to 1, every 1000 dollars became 180,000 dollars but 43.75 years were those three big bull markets and 56.25 years were periods of stagnation all in an economy which was doing fine year after year after year…… So, you say to yourself how could it be that you could have a country that was doing better and better and better, every generation was living better than the one that preceded them but had these huge changes, big gains a few times and long periods of stagnation. The answer is that investors behave in very human ways which is that they get very excited during bull markets and they look in the rear-view mirror and say I made money last year I am going to make money this year so I am going to borrow money or the neighbour says that if that stupid neighbour made money last year, then I will too. They always look in the rear-view mirror, they look in the rear-view mirror and they see a lot of money being made there, they plough in a lot of money and they push and push on prices and when they look in the rear-view mirror and see no money being made, they just say this a lousy place to be, they don’t care about what is going on in the underlying business and that makes for a huge opportunity….. If you can stay objective throughout that, if you can detach yourself temperamentally from the crowd you will get very rich and you don’t have to be very bright.”

FIGURE 1: GDP PER CAPITA OF USA, INDIA AND WORLD BETWEEN 1900 AND 2000, SOURCE: OUR WORLD IN DATA
FIGURE 2: DOW JONES INDEX BETWEEN 1900 AND 2000, SOURCE: MACROTRENDS.NET

Warren Buffett quotes Herbert Stein “If something cannot go on forever, it will stop” and that is what we investors have to say to ourselves during times like the one we are experiencing and just stick to the process. Just dollar cost average if you are buying ETFs or index funds and if you are a stock picker then this could be a great opportunity for buying great businesses at reasonable prices. 

One of the questioners asks Warren Buffett’s view on Fed’s actions to stimulate the economy and Warren Buffett gives his opinion on Greenspan’s policies. Of course, it looks silly in retrospect given how disastrous his deregulation policies were. I am pretty sure Warren Buffett knew and knows more than me when it comes to economics so, I won’t judge his opinions.

REFERENCES

I hereby declare that the information, examples and other materials used here are referred from various papers and articles listed below. The information is used and consolidated from these resources for the purpose of disseminating knowledge. The information gathered here is credited to the authors, writers and publishers of these papers and articles. The intention of this article is not to profit off of the work of others. 

  1. Full Lecture Video
  2. GDP per Capita chart
  3. Dow Jones Chart

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DISCLAIMER

Do not interpret anything above as financial advice. The author is not a SEBI registered financial advisor. This article is prepared by the author for informational & educational purposes only. The writing contains certain forward-looking statements and opinions which are based on the Author’s analysis of publicly available information believed to be accurate and reliable. While the author believes that such forward-looking statements and opinions are reasonable, they are subject to unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. As of the date the Report is published, the author may or may not hold a position in the security mentioned. Nothing in this Report constitutes investment advice. Readers should conduct their due diligence and research and make their own investment decisions. Any financial decision made by the reader based on the information herein will be the reader’s sole responsibility.

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