Transcript for:
Principles of Effective Investment Strategies

We would never have cash around just to have cash. I mean, we would never think that we should have a cash position of X percent. And frankly, I think these asset allocation things that tacticians in Wall Street put out, you know, about 60 percent stocks and 30 percent...

We think that's total nonsense. So we want to have all our money... Working in decent businesses, but sometimes we can't find them, or sometimes cash comes in unexpectedly, or sometimes we sell something, and we have more cash around than we would like. And more cash around than we would like means that we have 10 or 15 cents around, because we want money employed, but we'll never employ it, just employ it.

And you will find us quite unhappy over time if cash just keeps building up. And I think one way or another we'll find ways to use it. You may have trouble believing this, but Charlie and I never have an opinion about the market because it wouldn't be any good and it might interfere with the opinions we have that are good. If we're right about a business, if we think a business is attractive, it would be very foolish for us to not take action on that because we thought something about what the market was going to do or anything of that sort because we just don't know.

And to give up something. something that you do know and that is profitable for something that you don't know and won't know because of that, it just doesn't make any sense to us and it doesn't really make any difference to us. There's nothing magic.

We like to put a lot of money in things that we feel strongly about. And that gets back to the diversification question. We think diversification as practice generally makes very little sense for anyone that knows what they're doing.

Diversification is a protection against ignorance. I mean, if you want to make sure. that nothing bad happens to you relative to the market.

You own everything. There's nothing wrong with that. I mean, that is a perfectly sound approach for somebody who does not feel they know how to analyze businesses. If you know how to analyze businesses and value businesses, it's crazy to own 50 stocks or 40 stocks or 30 stocks probably because there aren't that many wonderful businesses that are understandable to a single human being in all likelihood.

And to have some super wonderful business and that's what I'm talking about. then putting money in number 30 or 35 on your list of attractiveness and forego putting more money into number one just strikes Charlie and me as madness. It's conventional practice. And if all you have to achieve is average, it's a confession in our view that you don't really understand the businesses that you own. On a personal portfolio basis, I own one stock, but it's a business I know.

And it leaves me very comfortable. Do I need to own 28 stocks in order to have proper diversification? be nonsense. Three wonderful businesses, it's more than you need in this life to do very well.

The average person isn't going to run into that. I mean, if you look at how the fortunes were built in this country, they weren't built out of a portfolio of 50 companies. They were built by someone who identified with a wonderful business.

Much of what is taught in modern corporate finance courses is twaddle. Volatility does not measure risk. And the problem is that the people who have written and taught about risk do not know how to measure risk. And the nice thing about beta, which is a measure of volatility, is that it's nice.

and mathematical and wrong in terms of measuring risk. It's a measure of volatility, but past volatility does not determine the risk of investing. I mean, actually take it with farmland here in 1980 or in the early...

1980s, farms that sold for $2,000 an acre went to $600 an acre. I bought one of them when the banking and farm crash took place. And the beta of farms shot way up.

And according to standard economic theory, market theory, I was buying a much more risky asset at $600 an acre than the same farm. was at $2,000 an acre. Now people, because farmland doesn't trade often and prices don't get recorded, you know, they would regard that as nonsense, that my purchase of $600 an acre of the same farm that sold for $2,000 an acre a few years ago was riskier. But in SOX, because the prices jiggle around every minute, and because it lets the people who teach finance use the mathematics they've learned, they have, in effect, the...

They would explain this away a little more technically, but they have, in effect, translated past volatility in terms of all kinds of measures of risk. And it's nonsense. Risk comes from the nature of certain kinds of businesses.

It can be risky to be in some businesses just by the simple economics of the type of business you're in. Thank you. And it comes from not knowing what you're doing.

And, you know, it is if you understand the economics of the business in which you are engaged, and you know the people with whom you're doing business, and you know the price you pay is sensible, you don't run any real risk. And I don't think Charlie and I, certainly at Berkshire, I don't think we've ever had a permanent loss in marketable securities that was, what, 1%, maybe? Half a percent of net worth. I made a terrible mistake in buying Dexter Shoe, which cost us significantly more than 1% of net worth, where I bought an entire business then.

But I was wrong about the business. It had nothing to do with the volatility of shoe prices or leather or anything else. I just was wrong. But in terms of marketable securities, I— I cannot recall a case where we've lost a guy. I mean, we've done a lot of things in things in securities that had a very high beta.

We've done a lot of things in securities that had a low beta. It's just the whole development of volatility as a measure of risk, we've never found a way for it to be useful to us. Both corporate finance and investment management courses, as taught in the major universities, we would argue it's at least 50 percent twaddle.

Yet these people Most people have very high IQs. One of the reasons we've been able to do pretty well is that we early recognized that very smart people do very dumb things, and we tried to figure out why. And I also wanted to know who so we could avoid them.

It's a temperamental quality, not an intellectual quality. You don't need tons of IQ in this business. I mean, you have to have enough IQ to get from here to downtown Omaha, but you do not have to be able to play.

three-dimensional chess or be in the top leagues in terms of bridge playing or something of the sort. You need a stable personality. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd, because this is not a business where you take polls.

It's a business where you think. And Ben Graham would say that you're not right or wrong because a thousand people agree with you. And you're not right or wrong because a thousand people disagree with you. You're right because your facts and your reasoning are right.

By far the better. best investment you can make is in yourself. For example, communication skills.

I tell those students that come that they're going to graduate schools and business and they're learning all these complicated formulas and all that. If they just learn to communicate better, both in writing and in person, they increase their value at least 50%. If you can't communicate, somebody says, it's like winking at a girl in the dark. Nothing happens, basically.

And you have to be able to get forth your ideas. And that's it. That's relatively easy.

I did it myself with the Dale Carnegie course. Some people wish I'd taken a shorter course now in terms of my talking later on. But it's just hugely important. And if you invest in yourself, nobody can take it away from you.

If I gave you a car, and it'd be the only car you'd get in the rest of your life, you'd take care of it like you can't believe it. Any scratch, you'd fix that moment. You'd read the owner's manual.

You'd keep a garage and do all these things. You get exactly one mind and one body in this world. And you can't start taking care of it. care of it when you're 50. By that time, you'll have rushed it out if you haven't done anything. So you should really make sure that you just remember that you just got one mind and body to get through life with and to do the most with it.

We think the best way to minimize risk is to think. And the idea that you have, you know, you'll say I've got 60 percent in stocks and 40 percent in bonds and and then have a big announcement. Now we're moving it to 65, 35 as some.

Strangely enough, I don't know if you've heard of that. strategists or whatever they call them in Wall Street. I mean, that has to be pure nonsense.

I mean, 60-40 or 65, it just doesn't make any sense. What you ought to do is have your default position as always short-term instruments. And whenever you see anything intelligent to do, you should do it.

And you shouldn't be trying to match up with some goal like that. I found it entertaining. I was just reading yesterday an article, I think it was, about the two fellows. at Google and all of the problems they're going to have because they're each going to get a few billion dollars. I mean, I wanted to send a sympathy card.

I almost went down a Hallmark store because this article went on. They've got this terrible problem and that terrible problem, and they're going to need lawyers, and they're going to need financial aid. They don't need anybody. Those guys are smarter than the people that are coming to them, and they do not have a big problem, and they're very capable of thinking it through themselves. The people that have the problem are the people who want to sell their services to them.

and are going to have to convince them that they have a problem. So much of what you see when you talk about asset allocation, it's just merchandising. It's a way to make you think that if you don't know how to determine whether it should be 60-40 or 65-35, that you need these people. And you don't need them at all in investing.

I mean, most of the professionals that... Tell you you're gonna get in great trouble unless you listen to them and sign up for their services. You know, they're good at selling but My brother-in-law former brother-in-law that worked at the Shockards used to say was that people would bring in cattle or something and I'd say to him, you know, how do you get? how do you get the farmer to Employ you to sell the Swift or armor or cut a hay instead of them Guy right next to you, I mean, you know, it's a cow is a cow and armor is going to buy it the same way. And he gave me this disgusted look and he said, Warren, it's not how you sell them.

It's how you tell them. Well, there's a lot of that in Wall Street. People have always had this craving to know the future.

You know, the king used to hire. the magician or the forecaster and he'd look in sheep guts or something for an answer as to how to handle the next war. And so there's always been a market for people who reported to know the future based on their expertise. And there's a lot of that still going on.

It's just as crazy as when the king was hiring the... the forecaster who looked at the sheep guts. And people have an economic incentive to sell some nostrum. It can be sold over and over and over again.

The really interesting figures are when you combine the underperformance of the market, say, by the mutual fund industry, which is probably a couple of points per annum. That understates it. Now if you take all of the investors in the mutual funds who are constantly whipsawing, sawing from one fund to another by a bunch of brokers who want commissions. Now you take a subnormal performance and it goes down another three or four percentage points due to the shuffling of the mutual fund investments.

So the poor guy in the general public is getting a terrible result from contacting the experts. And these guys are hitting the scout troop and the community chess drive. Locally reputable people.

I think it's disgusting. It's much better to make a living by being part of a system that delivers value to the people who are buying the product. But nobody refrains from creating gambling casinos or something on my theory.

If it'll work to make money, why we tend to do it in this country. Desire of people to gamble, and they gamble in stocks, incidentally, too. Day trading, I would say, very often came very close to gambling as defined.

But people like to gamble, you know, I mean. It's if the Super Bowl is on or even better yet, if a terribly boring football game is on, but you don't have anything to do and you're sitting there with somebody else, you're probably going to enjoy the game more if you bet a few bucks on it one way or the other. The human propensity to gamble is. is huge. Now, when it was legalized only in pretty much in Nevada, you had to go to some distance or break some laws to do any serious gambling. But as the states learned to, you know, what a great source of revenue it was, they gradually made it easier and easier and easier for people to gamble.

And believe me, the easier it's made, the more people will gamble. I mean, when I was, my children are here, and 40 years ago, I bought a slot machine and I I put it up on our third floor. And I could give my kids any allowance they wanted as long as it was in dimes. I mean, I had it all back by nightfall. I thought it would be a good lesson for them.

And now, they weren't going to Las Vegas to do it. But believe me, when it was on the third floor, they could find it, you know. And my payout ratio was terrible, too. But that's the kind of father I was. But gambling, you know, people are always going to want to do it.

And for that reason, I particularly think... that to quite an extent, gambling is a tax on ignorance. I mean, if you want to tax the ignorant, people who will do things with the odds against them, you know, you just put it in, and guys like me don't have to pay taxes.

And I really don't. I find that kind of socially revolting when a government preys on the weaknesses of its citizenry rather than acts to serve them. And believe me, when a government...

six lines. I've really said that growth and value they're indistinguishable. They're part of the same equation.

Or really growth is part of the value equation. So our position is that there is no such thing as growth stocks or values. stocks the way Wall Street generally portrays them as being contrasting asset classes.

Growth usually is a positive for value, but only when it means that by adding capital now, you add more cash availability later on at a rate that's considerably higher than the current rate of interest. We calculate into any business we buy what we expect to have happen in terms of the cash that's going to come out of it or the cash that's going to go into it. So if you tell me that you own a business that's going to grow to the sky and isn't that wonderful, I don't know whether it's wonderful or not. until I know what the economics are of that growth, how much you have to put in today and how much you will reap from putting that in today later on.

And the classic case, again, is the airline business. The airline business has been a growth business ever since Orville took off, but the growth has been the worst thing that happened to it. It's been great for the American public, but growth has been a curse in the airline business because more and more capital has been put into the business at inadequate returns. Now, growth is wonderful at See's Candy.

because it requires relatively little incremental investment to sell more pounds of candy. So it's growth, and I've discussed this in some of the annual reports, growth is part of the equation, but anybody that tells you you ought to have your money in growth stocks or value stocks really does not understand investing. Other than that, they're terrific people.

The real point is that we're trying to put out capital now to get more capital, or money, we're trying to put out cash now to get more cash back later on. And... If you do that, the business grows, obviously, and you can call that value or you can call it growth, but they're not two different categories. And I just cringe when I hear people talk about now it's time to move from growth stocks to value stocks or something like that because it just doesn't make any sense.

In general terms, unless you find the prices of a great company really offensive, if you feel you've identified it, and by definition, a great company is one that's going to remain great. for 30 years. If it's going to be a great company for three years, it ain't a great company. So you really want to go along with the idea of something that if you were going to take a trip for 20 years, you wouldn't feel bad leaving the money in with no orders with your broker and no power of attorney or anything, and you just go on the trip and you know you come back and it's going to be a terribly strong company.

I think it's better just to own them. I mean, we could attempt to buy and sell some of the things that... we own that we think are fine businesses, but they're too hard to find. We found See's Candy in 1972, where we find here and there we get the opportunity to do something, but they're too hard to find.

So to sit there and hope that you buy them in the throes of some panic, that you sort of take the attitude of a mortician waiting for a flu epidemic or something, I mean, I'm not sure that that's the right thing to do. That will be a great technique. That's a lot to count on. And, you know, if you start with the Dow at X and you think it's too high, you know, when it goes to 90% of X, do you buy?

Well, if it does and it goes to 50% of X, it gets, you know, you never get the benefit of those extremes anyway unless you just come into some accidental sum of money at some time. So I think the main thing to do is find wonderful businesses. So we've had our share of flu epidemics, but you don't want to spend your life waiting around for them. When people said cash is king a year ago, I mean, that's...

That's crazy. I mean, cash wasn't producing anything and it was sure to go down in value over time. And then you always want to be sure you have enough. I mean, it's like oxygen.

You want to be sure it's around, you know, but you don't need to have you don't need to have excessive amounts of it around.