Investing Lessons from Buffett and Lampert
Following up yesterday’s piece on lessons in business analysis that could be gleaned from this year’s Warren Buffett and Eddie Lampert shareholder letters, we’ll be looking at what investing specific lessons offered by these two mavens. After all, most of us aren’t looking for controlling ownership of the companies we invest in and, as a result, our investment goals might not always be driven by hard core business analysis.
Lampert has not quite begun to use his Sears Holdings cash hoard for stock investments so this post will likely be a little Buffett heavy.
Don’t Be Afraid of Cash
I admit this is a fallacy I often fall into. When investing, you often feel like you have to have your money “working for you” and thus stay 100% allocated at all times even if it isn’t a good idea – for example when markets are falling or when you haven’t had time to properly vet an investment idea. This often results in subpar returns or, worse yet, the loss of capital. Let’s see what Lampert has to say about the use of cash:
Let’s look at a hypothetical example. Imagine that we invested $200 million to remodel or improve 100 stores, or $2 million per store. If the store profitability after that investment is exactly the same as before, then the $200 million investment generates 0% in return. By simply keeping our money in cash, we could have earned anywhere from 3-5% over the past several years, which is better than the 0% return in this case.
Mr. Lampert offers an important lesson in capital allocation both for a business manager and for an investor. Often times, our cash accounts earn us more than just 0% return. Furthermore, they offer this return sans risk. When we decide to make an investment, we are assuming risk and we must look to be properly rewarded. This is why Mr. Lampert did not rush to spend cash that Sears Holdings generated in 2007.
Quality Above All Else
Extending the idea of investing only where you can find acceptable return, Warren Buffett offers up a line that should probably go on your wall.
When control-type purchases of quality aren’t
available, though, we are also happy to simply buy small portions of great businesses by way of stockmarket purchases. It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.
Or, if you’re sitting at home trying to figure out how to allocate your portfolio, you can read this as “It’s better to have part interest in the Hope Diamond than own many rhinestones.” Diversification is not a bad thing. I’ve discussed the importance of diversification on this blog many times. But, diversification for diversification’s sake is not an end in itself. Actively seeking high quality businesses whose stocks are trading at high value prices is the real game being played.
Invest in What You Know
Warren Buffett has listed his investment strategy time and again. Surprisingly, many of us rarely follow his advice even when it boils down to just four criteria:
- Understandable business
- Favorable long-term economics
- Able and trustworthy management
- Sensible price tag
Too often, we make our investments not based on a true understanding of the companies we’re investing in and without giving enough credence to the fundamental reasons for investing in said companies – their economics and their management.
Disciplined Sell Strategy
Berkshire Hathaway made one major sale this year and that was of its stake in PetroChina. Buffett did not do this because of waning momentum in the Chinese markets or bad press as a result of criticisms of PetroChina’s political affiliations. He did it because he believed that PetroChina’s valuation had reached the intrinsic value he set on the business. He sold his shares for over a 7-fold gain from when he bought stake in PetroChina in 2002.
It would seem that he was prescient in his sale given that Chinese stocks, particularly that of PetroChina, have tumbled quite a bit since last year. But, the lesson here is not that Warren Buffett can predict the future, but that he was able to sell his share in the face of relentless buying. In fact, in the letter he mentions selling at a time when PetroChina’s stock had reached $275 billion in market cap. Over the rest of 2007, the company’s market cap zoomed to in excess of $400 billion. Yes, Buffett may have left money on the table. But, a disciplined investor is willing to do so in order to lock in profits in lieu of playing the dangerous game of attempting to time Mr. Market.
Don’t Sweat the Small Stuff
I should emphasize that we do not measure the progress of our investments by what their market
prices do during any given year. Rather, we evaluate their performance by the two methods we apply to the
businesses we own. The first test is improvement in earnings, with our making due allowance for industry
conditions. The second test, more subjective, is whether their “moats” – a metaphor for the superiorities they possess that make life difficult for their competitors – have widened during the year. All of the “big four” scored positively on that test.
If you are rigorous in your screening, confident in your investment thesis, and have set reasonable sell targets, you’re probably on your way to becoming a great investor. The last lesson is to learn to calm your nerves even in the presence of great ire on CNBC and, sometimes, even truly in the broader markets.
Warren Buffett didn’t make money in every investment he made this year. But, to him, that’s not always the point. While market value fluctuates from day to day and year to year, it’s not the market price that you should fret over. It’s whether or not the businesses you invest in are continuing to perform as you expected. When this is the case, you can be confident that in the long-term, the market’s weight machine will supersede the market’s voting machine.
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