Key lessons from letters of Warren Buffett- Part II

I hope you must have enjoyed reading part I of this series

There are more than 50 letters to date which itself is a warehouse of knowledge and is a good entry point for the first time readers.

I would suggest everyone to read all the letters by carefully reading each and every single word and marking them and making notes in the process.

Following are the key lessons from 1993 letter to shareholder–

1. Market rewards long-term

Stock-market has been paradise for the long-term investors and will continue to do the same.

One or two big stock idea is just enough to change your life over a longer time frame.

One of the key element is the compound interest which plays an important role in building wealth and is considered to be the eighth wonder of the world by Albert Einstein.

There has been a number of instances to prove the same and one such event taken from the letters of Warren Buffett is stated below-

Let me add a lesson from history: Coke went public in 1919 at $40 per share . By the end of 1920 the market, coldly reevaluating Coke’s future prospects, had battered the stock down by more than 50% to $19.50. At yearend 1993, that single share, with dividends reinvested, was worth more than $2.1 million. As Ben Graham said: In the short-run, the market is a voting machine- reflecting a voter-registration test that requires only money, not intelligence or emotional stability- but in the long run, the market is a weighing machine

Also Read: Long-term investment – You Reap What You Sow

2. Owning stocks involve the same mindset as owning a business

Equity shareholders are considered to be the part owner of the business, but before associating with the company ( i.e. investing in equity) most of the people hardly carry out any research.

Warren Buffett always says that we should invest in those companies which are easy to understand.

I believe before associating with a company, it’s very important to know that whether you will be able to continue with the business for the long term say 5-10 years if you were the owner.

Warren Buffett in his letter to shareholder said-

In our view, what makes sense in business also makes sense in stocks: An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of the business.

3. Always invest in good quality business

During the bull market, blue chip and good quality stocks are always overpriced.

So people generally invest in cheap stocks (many of them are without any fundamental) in the hope that they will also outperform.

Investing in a good quality business trading at a higher price level is a better option as compared to investing in a poor quality business.

However, investing in a good business at any point in time would fetch you a decent return in the long run.

The 1993 letter to shareholder states-

Yes, competition there was in 1938 and 1993 as well. But it’s worth noting that in 1938 the Coca-Cola Co. sold 207 million cases of soft drinks and in 1993 it sold about 10.7 billion cases, a 50-fold increase in physical volume from a company that in 1938 was already dominating in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in one share had (with dividends reinvested) turned into $3277 by the end of 1938, a fresh $40 then invested in Coca-Cola stock would have grown to $25000 by year end 1993

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4. One good idea a year is enough to make a success

People often run behind every idea and try to grab each and every opportunity.

But I believe generating a few solid ideas and working upon it rigorously is enough to attain success.

Listening to every tom, dick and harry in the market is the perfect recipe of self-doom in the long term.

Warren Buffett in his letter said-

Charlie and I decided long ago that in an investment lifetime it’s just too hard to make hundreds of smart decisions. That judgement became ever more compelling as Berkshire’s capital mushroomed and the universe of investments that could significantly affect our results shrank drastically. Therefore, we adopted a strategy that required our being smart- and too smart at that – only a very few times. Indeed, we’ll now settle for one good idea a year.

5. Diversification is not always a better strategy

You must have heard people telling to diversify the portfolio in order to cut down risk.

Diversification implies increasing the number of stocks in the portfolio in order to reduce risk.

I believe diversification is a good idea for an investor who does not understand business economics but wants to invest for a long term.

On the other hand, if you are a know how investor and understand the business economics, then picking up few sensible price companies with long-term competitive advantage is a better idea and conventional diversification really makes no sense.

Warren Buffett in his letter said-

The strategy we’ve adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, bothy the intensity with which an investor thinks about a business.