More Wisdom From Warren Buffett

If you know Warren Buffett then you know that his regular letter to shareholders each year never disappoints. That’s why wanted to share some of the most pertinent quotes with you today.

As I’m sure you recognize, Warren Buffett’s quite bullish on the United States of America in general and he has ignored lots of the negative news that we’ve been hearing as of late.

To quote Mr. Buffett:

“There was a lot of hand-wringing last year among CEOs who cried ‘uncertainty’ when faced with capital allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash). At Berkshire, we didn’t share their fears, instead spending a record $9.8 billion on plant and equipment in 2012, about 88 percent of it in the United States.

“That’s 19 percent more than we spent in 2011, our previous high. Charlie and I love investing large sums in worthwhile projects, whatever the pundits are saying. We instead heed the words from Gary Allan’s new country song, ‘Every Storm Runs Out of Rain.’ We will keep our foot to the floor and will almost certainly set still another record for capital expenditures in 2013. Opportunities abound in America.”

Another Warren Buffett axiom is in regards to market timing. He doesn’t believe in it, but he does believe that there’s always an amount of uncertainty in all things investing. He finds it risky to not be invested in the stock market at this time. If you’ve been sitting on the sidelines for the last five years, then he feels that you made a mistake.

“A thought for my fellow CEOs: Of course, the immediate future is uncertain; America has faced the unknown since 1776,” said Mr Buffet. “It’s just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them (usually because the recent past has been uneventful). American business will do fine over time. And, stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor  (The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320 percent increase that materialised despite four costly wars, a Great Depression and many recessions. And don’t forget that shareholders received substantial dividends throughout the century as well.)

“Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of ‘experts,’ or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.”

Berkshire Hathaway’s core business model is its insurance operations. As always, Buffett made some very candid in Presley and comments in this regard. He said:

“If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit is earned, we enjoy the use of free money — and, better yet, get paid for holding it. That’s like you’re taking out a loan and having the bank pay you interest. Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous in most years that it causes the P/C industry as a whole to operate at a significant underwriting loss …. There are a lot of ways to lose money in insurance, and the industry never ceases searching for new ones.”

It’s been looked upon as rather odd when the insurance business talks about pricing discipline and underwriting. It often has a very poor track record in this regard. Mr. Buffett explains:

“There is very little ‘Berkshire-quality’ float existing in the insurance world. In 37 of the 45 years ending in 2011, the industry’s premiums have been inadequate to cover claims plus expenses. Consequently, the industry’s overall return on tangible equity has for many decades fallen far short of the average return realized by American industry, a sorry performance almost certain to continue.”

Coincidentally, this matches up to a research report published back in September 2011 by Citigroup. They learn that from the years 1975 through 2010, the P/C industry only generated a total of five years worth of positive underwriting income. According to Keith Walsh’s report, over that five-year period there was a deficit of $457 billion.

Today’s yields will never be able to overcome or subsidize any losses of that magnitude today.

Warren Buffett clearly states that:

“A further unpleasant reality adds to the industry’s dim prospects: Insurance earnings are now benefiting from ‘legacy’ bond portfolios that deliver much higher yields than will be available when funds are reinvested during the next few years — and perhaps for many years beyond that. Today’s bond portfolios are, in effect, wasting assets. Earnings of insurers will be hurt in a significant way as bonds mature and are rolled over.”

The truth for the insurance business does not always apply to every firm. Some of these insurance companies have incredible track records, and they consistently earn underwriting profits. Berkshire Hathaway has done this for 10 years in a row. Warren Buffett gives some advice in his regular down-to-earth style:

“At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively assess the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained.

“Many insurers pass the first three tests and flunk the fourth. They simply can’t turn their back on business that is being eagerly written by their competitors. That old line, ‘The other guy is doing it, so we must as well,’ spells trouble in any business, but none more so than insurance.”

Warren Buffett also shared some words of wisdom in regards to the newspaper industry. Here’s what he had to share:

“Newspapers continue to reign supreme, however, in the delivery of local news. If you want to know what’s going on in your town — whether the news is about the mayor or taxes or high school football — there is no substitute for a local newspaper that is doing its job. A reader’s eyes may glaze over after they take in a couple of paragraphs about Canadian tariffs or political developments in Pakistan; a story about the reader himself or his neighbours will be read to the end. Wherever there is a pervasive sense of community, a paper that serves the special informational needs of that community will remain indispensable to a significant portion of its residents … We do not believe that success will come from cutting either the news content or frequency of publication. Indeed, skimpy news coverage will almost certainly lead to skimpy readership. And the less-than-daily publication that is now being tried in some large towns or cities — while it may improve profits in the short term — seems certain to diminish the papers’ relevance over time.”

And here’s a few other quotes that are certainly worth repeating…

“More than 50 years ago, Charlie told me that it was far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price. Despite the compelling logic of his position, I have sometimes reverted to my old habit of bargain-hunting, with results ranging from tolerable to terrible … Of course, a business with terrific economics can be a bad investment if the price paid is excessive.

“But wishing makes dreams come true only in Disney movies; it’s poison in business.”

If you haven’t read it already, you should grab a copy of Warren Buffett’s letter to shareholders. You can learn plenty from this financial genius. Reading his annual letters will help greatly enhance your financial acumen. The letter is certainly worthy of your time, effort and energy.

Leave a Reply

Your email address will not be published. Required fields are marked *