The Essays of Warren Buffett: Lessons for Investors and Managers
Author: Warren E. Buffett, essays selected, arranged, and introduced
by Lawrence A. Cunningham
At Berkshire our carefully-crafted acquisition strategy is simply to wait for the phone to ring. – Warren Buffett
EVERY once in a while a book is written which offers real advice to those who are involved in the practice – underline the word “practice” – of investment, finance and management. This book, in its third edition, is one of them.
There are gems of wisdom, wit and wonderfully good writing on every page. This has been accumulated and distilled from Warren Buffett’s essays over the years from the annual reports of Berkshire Hathaway, the most successful investment company of all time.
One thing that this collection shows is that it was no fluke that Buffett was the greatest investor of all time.
He was simply because he understood the workings of business, was very good at numbers, and more importantly excellent at uncovering the stories behind the numbers.
As a practitioner, he debunked a number of widely accepted finance theories such as the efficient market hypothesis (EMH).
The very fact that he consistently outperformed the market over many years puts paid to any notion that the market is perfect and cannot be beaten over the long-term – living proof that the EMH is a great theoretical notion fatally flawed in practice.
He is famous for challenging the usefulness of a lot of accounting policies too. He spoke loudly against the policy at one time of not regarding options as expenses.
He is against granting options to CEOs as rewards for performance without built-in safeguards. Options can often become more valuable without improved performance simply by retaining earnings in the business.
Here is his fatal stab to those who were against options expensing: “So if you’re a CEO and subscribe to this ‘no cash-no cost’ theory of accounting, I’ll make you an offer you can’t refuse: Give us a call at Berkshire and we will happily sell you insurance in exchange for a bundle of long-term options on your company’s stock.”
There was much that Buffett did which was unconventional and he did this not to break with convention but because convention did not agree with those principles that he believed were vital to good business.
The great usefulness of this book is that Buffett’s writings over the years were ordered according to topics by an academic, Lawrence Cunningham, an effort described by Buffett himself as “First class. A great job in collating our philosophy.” Buffett’s partner, Charlie Munger, however, is typically less effusive. “Very practical,” he says. And indeed it is.
Buffett himself would have had no time to write a book like this. Cunningham has truly done a great job in putting it all together and grouping the writing under seven main subjects: corporate governance, corporate finance and investing, alternatives to common stock, common stock, mergers and acquisitions, accounting and valuation, and finally, accounting policy and tax matters.
That about covers most of the topics that a person in finance and investing needs to know. The writing is really sharp and witty, and is in very plain and understandable language.
If you never read a finance book in your life, you could still make considerable sense of the points that Buffett makes.
If you studied finance, investment and management, then you will really appreciate what he tries to say and convey because in many ways they directly contradict the usual thinking and teaching on these matters.
It also illustrates the value of sticking to cold hard facts and analysis when making decisions without actually disregarding the human dimension to these things.
Examples: “When we buy a business, the sellers go on running it just as they did before the sale: we adopt to their methods rather than vice versa.”
And then this, which is the epitome of good advice: “We’ve never succeeded in making a good deal with a bad person.”
And a couple more on acquisition strategy: “Even so, we do have a few advantages, the greatest being that we don’t have a strategic plan. Thus we feel no need to proceed in an ordained direction (a course leading almost invariably to silly purchase prices) but can instead simply decide what makes sense for our owners.”
“At Berkshire our carefully-crafted acquisition strategy is simply to wait for the phone to ring.”
He candidly discusses his own mistakes over the years and confesses that at times he and Berkshire have not followed his own advice. And some of the best lessons come from this distillation of his experience.
Here are some valuable lessons anyone can learn from:
“In a difficult business, no sooner is one problem solved than another surfaces – never is there just one cockroach in the sink... Time is the friend of the wonderful business, the enemy of the mediocre.”
“After 25 years (this was in 1989) of buying and supervising a great variety of businesses, Charlie (Munger – his partner) and I have not learned how to solve difficult business problems. What we have learned is how to avoid them... We’ve done better by avoiding dragons than by slaying them.”
“I thought then (when he entered business) that decent, intelligent and experienced managers would make rational business decisions. But I learned over time that isn’t so. Instead, rationality frequently wilts when the institutional imperative comes into play.”
Some of the things that Buffett has said about business practices were truly prophetic and were ignored when he said them. Here are some quotes made between 2002 and 2006, which encapsulate the problems derivatives are and their potential for damage.
“When Charlie and I finish reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we don’t understand how much risk the institution is running... these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear.”
“In our view derivatives are financial weapons of mass destruction, carrying dangers that, while now are latent, are potentially lethal.”
The greatest investor of all time predicted the greatest financial disaster of all time.
My own humble prediction: This book will eventually become a classic which will be as famous as Buffett’s teacher Benjamin Graham’s Security Analysis, co-written with David Dodd.
But don’t wait for that to happen – read it now, pick up some pointers and put it into practice.