12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

Warren Buffetts 10 Lessons for Investors

WarrenBuffetts10LessonsforInvestors(Part1of11)

The Buffett Letters: 10 Commandments to Investors

BySaulPerez Apr 1, 2015 9:39 am EST

Buffett is a once-in-a-lifetime investor

WeallknowwhatagreatinvestorWarrenBuffettis.Hisinvestingprowessisunmatched.HisinvestmentsincompaniessuchasIBM(IBM),
CocaCola(KO),andWellsFargo&Co.(WFC)arepartofinvestmentfolklore.HehasconsistentlybeatbenchmarkssuchastheS&P500
andoutperformedETFsthattracktheS&P500suchastheiSharesCoreS&P500ETF(IVV).

Hesalsooneoftherarefewwhoregularlysharetheirwisdomwithinvestors.Muchofthiswisdommaybefoundinhisfamousannualletters.
Theselettersareaddressedtoshareholdersofhisholdingcompany,BerkshireHathaway(BRKB).But,theselettersarealsoavailableto
investorsonline,andcanbedownloadedforfree.

Buffets 2014 annual letter has many firsts

Someofuswillhavereadhisannualshareholderletterfor2014.Othersmayhavereadanewsarticleaboutit.Thisletterincludesmanyfirsts.
BerkshirecompletedfiftyyearsunderBuffettsstewardshipthisyear.So,thiswashisfiftiethannualletter.Init,hesummarizedthe
performancerecordofBerkshireunderhisleadership.TheletteralsoincludesawriteupbyCharlieMunger,hiscopartneratBerkshire,on
thefutureexpectationsforBerkshire.

Buffets cornerstones of investing

EachoneofBuffetslettersispackedwithwordsofwisdomforinvestors.Yet,therearesomethingshekeepsonrepeatingregularly.What
arethey?Fretnot.Youdonthavetoreadallfiftyletterstofindout.Wevedonethehardworkforyou.Aftercarefullygoingthrough
Buffettsletters,wevepickedoutthetenmostimportantcharacteristicsofhisinvestingstyletosharewithyou.Tolearnmore,keepreading.

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

1/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

WarrenBuffetts10LessonsforInvestors(Part2of11)

Long-Term Investing Pays the Best

BySaulPerez Apr 1, 2015 9:40 am EST

Buffetts investing style

TherearethreebroadaspectsofWarrenBuffettsinvestingstyle:
1. investmentphilosophy
2. securityselection
3. psychologyofinvesting

Hehasimportantthingstosayaboutallthree.Inthisseries,wellcoverBuffettstenmostimportantcommandments.

Buffetts 50-year record is all the proof you need

ThebiggestinvestinglessontobelearnedfromBuffettsfiftyyearsatBerkshireHathaway(BRKB)isthislongterminvestingisgood.
Buffetthasaveragedanannualcompoundgainof21.6%overthesefiftyyears.Inabsolutetermsthisis,holdyourbreath,areturnof
1,826,163%!Howdidhedoit?Byinvestingingoodcompanies,holdingthemforalongtime,andlettingcompoundgainsdotherest.

The power of compoundgainsis exponential

AssumeyoureasgoodaninvestorasBuffett.Youwantyourportfoliotogrow50times.AtBuffetts21.6%rateofreturnitwouldtakeyou
approximately20yearstoachievethis.Now,youdecidetoreduceyourinvestmenttimehorizonto15years.Whatwillbetheimpactonyour
returns?In15years,atBuffettsrateofreturns,yourportfoliowillgrowonly19times.Canyouseetheimpactjustfiveyearshasonyour
investments?Thisisthepowerofcompoundgains.
MostofthemoneyBuffettmadeinstocksincludingWellsFargo&Co.(WFC),CocaCola(KO),andIBM(IBM)istheresultofmultidecade
investing.

Long-term investing helps keep costs low

Anotherbenefitoflongterminvestingisthatyouspendlessmoneyonbrokeragefeesandothercostsassociatedwithfrequenttrading.The
moneysavedaddstotheportfolioandearnshigherreturns.InvestinginETFssuchastheiSharesCoreS&P500ETF(IVV)canalsohelpyou
keepcoststoaminimum.
http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

2/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

WarrenBuffetts10LessonsforInvestors(Part3of11)

Stocks Beat Bonds over the Long Run By a Big Margin

BySaulPerez Apr 1, 2015 9:40 am EST

Bonds are considered safe

Themajorityofinvestorsbelievebondsaresaferthanstocks.Themainreasonisthatbondspayregularinterest.Bondsissuedbythe
governmenthavetheaddedallureofbeingguaranteedbythegovernment.But,isstablealsosafe?

Buffett emphatically declares stocks to be safer

Buffetthadthistosayinhis2014BerkshireHathaway(BRKB)lettertoshareholdersTheunconventional,butinescapable,conclusiontobe
drawnfromthepastfiftyyearsisthatithasbeenfarsafertoinvestinadiversifiedcollectionofAmericanbusinessesthantoinvestin
securitiesTreasuries,forexamplewhosevalueshavebeentiedtoAmericancurrency.Thatwasalsotrueintheprecedinghalfcentury,a
periodincludingtheGreatDepressionandtwoworldwars.Investorsshouldheedthishistory.Toonedegreeoranotheritisalmostcertainto
berepeatedduringthenextcentury.
Now,youcantbemoreemphaticthanthat.

Stocks add to purchasing power over the long run

Oneofthemainreasonsthatstocksaresaferisthattheirreturnsbeatinflationoverthelongterm.Highgradebonds,ontheotherhand,at
bestmatchinflation.So,bondsarentabletokeepyourpurchasingpowerintactinthelongrun.Stocks,ontheotherhand,addtoyour
purchasingpower.
Theperformanceofstocksagainstbondsorthedebtofthesamecompaniesisalsoagoodindicator.Hereaswell,stocksbeatthebondsof
companiessuchasWellsFargo&Co.(WFC),IBM(IBM),andCocaCola(KO).Thesethreestocksaccountfor3.08%oftheiSharesCore
S&P500ETF(IVV).

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

3/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

WarrenBuffetts10LessonsforInvestors(Part4of11)

Price Is What You PayValue Is What You Get

BySaulPerez Apr 1, 2015 9:40 am EST

Price and value are two distinct concepts

Tobuyanyinvestmentyouneedtopay.Buthowmuchshouldyoupay?Therearemanycompaniesbelongingtomanydifferentindustrieson
thestockmarket.Someofthem,suchasWellsFargo&Co.(WFC),belongtoacyclicalindustry.Somecompanies,suchasIBM(IBM),
belongtothetechnologysectorthatsdrivenbyverydifferentfactors.Thenthereareconsumercompanies,suchasCocaCola(KO),thatare
completelydifferent.

Two problems forinvestors

Aninvestorfacestwomainquestionsasaresultofthisvariety.First,whichsectorsorindustriestochoosetoinvestin.Andsecond,whatprice
topayforshares.Buffettiscrystalclearonhowtoapproachthesequestions.

Invest in what you understand

Buffettisemphaticonthequestionaboutwhatsectorsorindustriestochoose.Hebelievesitdoesntmatter.Itsbettertoinvestinagood
companyinanotsogoodsectorthantoinvestinanotsogoodcompanyinagoodsector.Investorsneedtoinvestinsectorsandcompanies
withbusinessmodelstheyunderstand.

Focus on value and dont look at price

IntrinsicvalueisaconceptthatwasintroducedbyBenjaminGrahamthatreferstothetrueworthofabusiness.Itcanbeestimatedwiththe
helpofacompanyshistoricalfinancialstatements.Youdontneedtoestimateintrinsicvalueaccurately.Aroughestimateisgoodenough.
Youthenneedtorelateittogrowth.Willthefuturegrowthjustifythecurrentprice?Ifthepriceismuchhigher,thenitsbesttoavoidinvesting.
ThisfocusiswhyBerkshireHathaway(BRKB)hasbeenabletobeatthereturnsofETFsliketheiSharesCoreS&P500ETF(IVV).

WarrenBuffetts10LessonsforInvestors(Part5of11)

Management Is of Paramount Importance

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

4/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

Management Is of Paramount Importance

BySaulPerez Apr 1, 2015 9:40 am EST

Evaluating management is the next step

Onceaninvestorhasfoundagoodbusinesstoinvestinatareasonableprice,heneedstolookatthemanagementofthatbusiness.Investor
WarrenBuffetbelievesthatmanagement,especiallytheCEO,playsaveryimportantroleinacompanyssuccess.

Wouldyoutrustathoroughbredtowinifithadanaverageorworse,apoorjockey?No,youwouldnt.Itsthesamethingwiththemanagement
ofacompany.Buffettalwayslooksforcertainqualitiesinmanagement.

Qualities ofan excellent manager

TheCEOshouldhaveademonstratedhistoryofexceptionalperformanceinhiscareer.TheCEOshouldhavealongtermvisionforthe
companyandbeabletoexecuteitwiththehelpoftrustedsubordinates.
Youmaythinkwell,BuffettcanalwaystalktoaCEO.ButhowdoyoujudgeaCEO?Forone,youcanlookatCEOrankingstoseehowwell
regardedaCEOis.Remembertolookatafewyearsworthofrankingstogetabetterideaaboutconsistency.Youcanalsoread
managementdiscussionsinannualreportstodetermineiftheCEOhasvision.

Buffett believed in some excellent CEOs

BuffetthasputstockinsomeexcellentCEOsatBerkshireHathaway(BRKB).RichardKovacevichofWellsFargo&Co.(WFC),Roberto
GoizuetaofCocaCola(KO),andLouisGerstnerofIBM(IBM)weresomeoftheCEOsBuffetttrusted.TheywereabigreasonwhyBuffetts
portfolioreturnsbeatindicesandETFsliketheiSharesCoreS&P500ETF(IVV).
Nevertheless,youshouldalwaysfocusfirstonthequalityofthebusinessandthentheCEO.RememberBuffettsfamouslinesWhena
managementwithareputationforbrilliancetacklesabusinesswithareputationforbadeconomics,itisthereputationofthebusinessthat
remainsintact.

WarrenBuffetts10LessonsforInvestors(Part6of11)

Free Cash Generating Businesses Are Best

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

5/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

BySaulPerez Apr 1, 2015 9:40 am EST

Free cash generation makes the best business

InvestorWarrenBuffettbelievesthattheprimaryobjectiveofanygoodbusinessshouldbetogeneratelotsoffreecash.Thisfreecash,along
withareasonableamountofdebt,ifrequired,canthenbeusedtofundtheexpansionofthebusiness.Expansionleadstomorefreecash
beinggenerated.Thisshouldbethevirtuouscycleabusinessaimsfor.

Berkshire was once a cash guzzler

Buffettabhorsanybusinessthatconstantlyneedsfreshcapitaltogrow.Suchbusinessesarejustcashguzzlersinhisopinion.Berkshire
Hathaway(BRKB)wasacashguzzlerbeforeBuffetttookoveritsmanagement.Berkshirewasatextilecompanythatconstantlyrequired
capitalinfusion.Buffettsoldthetextilebusinessandturneditintoaninvestmentandinsurancecompany.
Onceabusinessgetsintothisvirtuouscycle,itsabletomaintainstrongearningsperformanceforalongtime.Butgettingthereisdifficult.
Fewcompaniesareabletodoit.MostofthecompaniesinBuffettsportfoliomaintainthisvirtuouscycle.

Most of Buffetts holdings are virtuous

CocaCola(KO)generatesenoughcashtofunditsexpansion.Ithasalwaysmaintainedamanageabledebttoequityratio.Anotherexample
ofacompanywiththisvirtuouscycleisIBM(IBM).Ithasacomfortabledebtpositionandahighdebtservicingcapacity.Thishighdebt
servicingcapacityisindicatedbyastellarinterestcoverageratio.ThisfocusoncashisoneofthemajorreasonsthatBerkshiresreturnshave
beatenindicesandETFssuchastheiSharesCoreS&P500ETF(IVV)andtheiSharesRussell2000ETF(IWM).

WarrenBuffetts10LessonsforInvestors(Part7of11)

Big Investors Have No Real Advantage over Small Investors

BySaulPerez Apr 1, 2015 9:40 am EST

Size of investment is irrelevant

Often,smallinvestorsthinkthatbiginvestorsarebetterequippedtoinvest.InvestorWarrenBuffetsaysthisisntso.Thiswayofthinkingisjust
apsychologicalbias.

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

6/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

Whenyouseesomeoneintroducedasanexpertonnationaltelevisionyouaremorelikelytobelievehim.Thekeywordhereisbelieve.You
believebecausehesontelevisionandhasbeenintroducedasanexpert.Itmaywellturnoutthathedoesntknowmuchaboutinvestingatall.
Buffettbelievesthatsoftenthecase.

Benefits of being a smaller investor

Infact,smallerinvestorshaveonebigadvantage.Theirbuyingsizeissmall.Thismeanstheycanbuyandsellsharesonthestockexchange
withoutimpactingthepriceofthestock.Biggerinvestors,whosebuyorsellvolumesoftenaccountforasubstantialpartofadaysvolume,
cantdosowithoutimpactingthemarketforthatparticularstock.
AsmallerinvestorcanbuildapositiononanydayinCocaCola(KO),WellsFargo&Co.(WFC),orIBM(IBM).Abiggerinvestorneedstoplan
hispurchasesduetolargeportfolioallocations.Asaresult,thesmallerinvestorcanbemorenimble.
Biginvestorsarealsolikelytohavemorebiases.Themostimportantofthesebiasesisthebiggerinvestorsselfperceivedauthoritytoinvest.
AsBuffetalwayssays,veryfewpeoplearehumbleenoughtoacknowledgetheirlimitations.
Buffettalwaysremindshimselfofthisbiasasabiginvestor.Hetriestoremaingrounded.ThishashelpedBerkshireHathaway(BRKB)
achieveastellarperformancerecord.BerkshirehasbeatenthereturnsoftheiSharesCoreS&P500ETF(IVV)andtheiSharesRussell2000
ETF(IWM)overthelongrun.Remaininggroundedshouldhelpsmallerinvestorstoo.

WarrenBuffetts10LessonsforInvestors(Part8of11)

Investment Mistakes Are CommonAdmit It and Cut Your Losses

BySaulPerez Apr 1, 2015 9:39 am EST

No one is superhumanweall make investment mistakes

InvestorWarrenBuffettthinksmakingmistakesarepartandparcelofinvesting.Itshouldcomeassomesolacetonormalinvestorsthateven
hemakesmistakes.Nevertheless,whatBuffettsaysisthathowyoudealwiththemistakesisthemoreimportantpartofinvesting.

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

7/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

Buffetts investment in Tesco

BuffetmentionsoneofhisbiginvestmentmistakesinoneofhisBerkshireHathaway(BRKB)letterstoinvestors:Attheendof2012we
owned415millionsharesofTesco,thenandnowtheleadingfoodretailerintheU.K.andanimportantgrocerinothercountriesaswell.Our
costforthisinvestmentwas$2.3billion,andthemarketvaluewasasimilaramount.In2013,Isouredsomewhatonthecompanysthen
managementandsold114millionshares,realizingaprofitof$43million.Myleisurelypaceinmakingsaleswouldproveexpensive.Charlie
callsthissortofbehaviorthumbsucking.(Consideringwhatmydelaycostus,heisbeingkind).During2014,Tescosproblemsworsenedby
themonth.Thecompanysmarketsharefell,itsmarginscontractedandaccountingproblemssurfaced.Intheworldofbusiness,badnews
oftensurfacesserially:Youseeacockroachinyourkitchenasthedaysgoby,youmeethisrelatives.

Cut your losses as soon as you realize your investment mistake

Themostimportantlessonforinvestorsisthis.Analyzeyourselectionscarefullybeforeinvestinginthem.Keepawatchonthem,andifyou
madeamistake,getoutratherthanwait.
Havingsaidthat,ifyouthinkthatthecompanyremainsgoodforthelongtermbuthasatemporaryproblem,stayinvested.CocaCola(KO),
IBM(IBM),andWellsFargo&Co.(WFC)allhadtemporaryproblemsovertheyears,butBuffetstayedinvested.Thatsbecausetherewasno
longtermproblemwiththesecompanies.Thesethreestocksaccountfor3.08%oftheiSharesCoreS&P500ETF(IVV).

WarrenBuffetts10LessonsforInvestors(Part9of11)

Borrowing to Invest Does More Harm Than Good

BySaulPerez Apr 1, 2015 9:39 am EST

Overconfidence leads to borrowing

Whenthemarketsareonatear,manyinvestorsgetcarriedaway.Theybegintothinkthattheonlywaymarketswillmoveisup.Thisiswhen
emotionsgetthebetteroflogic.Manyinvestorsbegintoborrowtoinvest,thinkingthereturnswillbeatthecostofborrowing.

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

8/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

InvestorWarrenBuffett,anastuteobserverofhumanbehavior,hasoftenseenotherinvestorsmakethismistake.Hesaysasmuchinoneof
hisBerkshireHathaway(BRKB)letterstoinvestors.Investors,ofcourse,can,bytheirownbehavior,makestockownershiphighlyrisky.And
manydo.Activetrading,attemptstotimemarketmovements,inadequatediversification,thepaymentofhighandunnecessaryfeesto
managersandadvisors,andtheuseofborrowedmoneycandestroythedecentreturnsthatalifelongownerofequitieswouldotherwise
enjoy.Itisgoodwhileitlasts.Butsooner,ratherthanlater,realitybitesandbringsyoucrashingtotheground.

Borrowing to invest reduceslong-term returns

Buffettoffersanotherstrongpieceofcautionaryadvicetoinvestorsaboutborrowing.Indeed,borrowedmoneyhasnoplaceintheinvestors
toolkit:Anythingcanhappenanytimeinmarkets.Andnoadvisor,economist,orTVcommentatoranddefinitelynotCharlienorIcantell
youwhenchaoswilloccur.Marketforecasterswillfillyourearbutwillneverfillyourwallet.

Buffett doesnt borrow to invest

Buffettusesfloattoinvest.Float,insimpleterms,ismoneyyougetbeforeyouuseaservice.Oneexampleoffloatisatravelerscheque.The
moneyisalreadypaidbeforeyouuseanycheques.Theinsurancebusinessisanotherexampleoffloat.
BuffettusedBerkshiresfloattoinvestinhislargeholdingssuchasCocaCola(KO),IBM(IBM),andWellsFargo&Co.(WFC).Thesethree
stocksaccountfor3.08%oftheiSharesCoreS&P500ETF(IVV).

WarrenBuffetts10LessonsforInvestors(Part10of11)

Risk Is a Permanent Loss of Capital

BySaulPerez Apr 1, 2015 9:40 am EST

Buffett has unique views on risk

Measuringriskisdifficult.Inacademicfinance,whatcantbemeasuredisoftenmeaningless.So,financeacademicsusevolatilityinpricingas
aproxyforrisk.InvestorWarrenBuffettdoesntbelieveinthisdefinitionofrisk.Buffettdoesntthinkpricedropsmatter.Ifyourcompany
selectionisrightandyoucanholdinvestmentsforalongenoughtime,eventually,youllprofitfromthem.

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

9/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

Fear of risk due to volatility leads to bad investment decisions

BuffettsummeditupperfectlyinaBerkshireHathaway(BRKB)lettertoinvestors.Hesaidifinvestorsfearpricevolatility,erroneouslyviewing
itasameasureofrisk,theymayendupdoingsomeveryriskythings.
Hegavetheexampleofpunditswho,sixyearsago,sawstockpricesfallingandadvisedinvestinginsocalledsafeTreasurybillsorbank
certificatesofdeposit.Investorswhoheededthisadvicearenowearningmoremeagrereturnsthantheyhadpreviouslyexpected.
Ifinvestorshadntfearedthispricevolatility,theycouldhaveearnedgoodreturnssimplybyinvestinginindexfundsorETFssuchasthe
iSharesCoreS&P500ETF(IVV)andtheiSharesRussell2000ETF(IWM).

Buffett has held stocks through down cycles

Buffettholdsontostockshesconfidentinduringdowncyclesandcomesoutthebetterforitoverthelongrun.WellsFargo&Co.(WFC)fell
duringthesubprimecrisis.IBM(IBM)fellthroughoutthedotcombubble.CocaCola(KO)tradedbelowits1998highsforthenext15years.
ButBuffettheldon.TheKOstockfinallyroseaboveits1998highsin2014.Thislongtermviewofinvestmentnegatesvolatilityintheshortrun
andearnsinvestorsgoodreturns.

WarrenBuffetts10LessonsforInvestors(Part11of11)

Acquisitions Should Be Treated with Circumspection

BySaulPerez Apr 1, 2015 9:40 am EST

Acquisitions dont normally create value

InvestorWarrenBuffetthasalwaystreatedcompaniesthatmakeacquisitionswithsuspicion.Themainreasonwhyisthatacquisitionsare
oftencarriedoutforunsoundbusinessreasons.Manyacquisitionsarealsoquickfixesthatendupdestroyinglongterminvestorwealth.In
fact,financialstudiesbearthisout.Mostacquisitionsdestroyvalueratherthancreateit.

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

10/11

12/23/2015

TheBuffettLetters:10CommandmentstoInvestorsMarketRealist

Managers envy leads to most acquisitions

Ifabusinessisntgrowingitssales,theeasiestsolutionistoacquireacompetitor.Moreoftenthannot,acquisitionsaremadetoshowgood
figurestotheboardofacompany.Sometimes,managementsalaryislinkedtotheshorttermperformanceofacompany.Thistooprovides
perverseincentiveformanagementtoacquire.
Today,leveragedbuyoutoptionsarealsoavailable.Inaleveragedbuyout,ahighamountofdebtistakenontoacquirecompanies.
Leveragedbuyoutperformanceisevenpoorer.CEOsoftenforgetthepriceversusvaluefundamentalwhenacquiring.Thepricepaidissofar
removedfromrealitythatmostacquisitionsdontevenhaveachancetosucceedattheoutset.Bysucceed,wemeanaddincrementalvalue
totheacquirer.

Wells Fargo & Co.: Asmart acquirer creating value from acquisitions
BerkshireHathaway(BRKB)alwayskeepsthepriceversusvalueequationinmindwhenmakingacquisitionsorwheninvestinginacompany
withahistoryofacquisitions.
WellsFargo&Co.(WFC)isthelargestholdinginBerkshiresportfolio.Italsoaccountsfor1.39%oftheiSharesCoreS&P500ETF(IVV).
WellsFargohasahistoryofacquiringsmallerbanks.But,WellsFargohasalwaysbeensmartaboutacquisitionsandhasconsistentlycreated
valuewiththem.ThesamecanbesaidofsomeofBerkshiresotherholdingssuchasIBM(IBM)andCocaCola(KO).
IfinvestorsfollowBuffettstencommandmentsofinvesting,theyrelikelytobecomebetterinvestors.

1Comment

2013MarketRealist,Inc.

http://marketrealist.com/2015/04/buffettletters10commandmentsinvestors/

11/11