Each March, investors around the world pore over Warren Buffett’s annual letter to Berkshire Hathaway shareholders to glean nuggets of investing wisdom. In this year’s letter the legendary-investor highlighted two successful investments he made, a farm in 1986 and a property investment in 1993, to illustrate certain fundamentals of investing.
Both investments took place following a severe correction in prices of farms and commercial real estate respectively and both were yielding 10% at the time of consideration. Based on rough estimates of each asset’s future earnings, Buffett believed that over time the yield of each asset had the potential to improve substantially. In both cases Buffett’s expectations proved true; the farm tripled its earnings and its value has increased over five times, whereas the property now yields over 35% of the original investment and has returned special distributions more than 150% of what was invested.
Buffett’s examples were provided to illustrate that when considering an investment, whether it be property, farm or shares in a company, the focus should be on the future earnings and cash flows of the underlying assets, not on the possible price change of the contemplated investments as this, according to Buffett, is speculating. Buffett highlights that he “thought only of what the properties would produce and cared not at all about their daily valuations”. Following Buffett’s rules, an investment should only be made if earnings can be sensibly estimated for five years out (and more), and if the offered price is reasonable relative to the estimated value of the investment.
Consistent with his philosophy of investing in companies/assets with good long-term prospects, Buffett believes that “forming macro opinions or listening to the macro or market predictions of others is a waste of time”.
According to Buffett, investors don’t need to be experts in order to achieve satisfactory returns, but instead need to recognise their limitations. If investors do not know enough about specific businesses to estimate future earnings’ power, it’s advisable to move on to other prospects.
Not to discourage investment, Buffett also provided advice for the non-professional investor: “The goal of the non-professional should not be to pick winners but should rather be to own a cross section of businesses that in aggregate are bound to do well." Highlighting the importance of timing, Buffett went on to say, “The main danger is that the timid investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur. The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never sell when the news is bad.”
In summary, invest in what you know and understand, focus on the long-term earnings’ potential of investments and try not to be fazed by daily or short-term noise. And last but not least, aim to hold a diversified portfolio of investments.
Zoie Regan
Senior Investment Analyst at Fisher Funds
www.fisherfunds.co.nz
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