I spend a fair amount of time studying the greatest investors in the world. I believe that studying successful people in your field is one way to speed up your own success. In some ways, it's never been easier than today to be successful because of the availability of information to help you find your road to success.
One of the learning projects that I'm working on is studying all of the investor letters of Warren Buffett. In his 1958 letter to partners (he had five partnerships at this time), Buffett discusses the current market, the partnerships' results and spends a bit more time discussing his investing philosophy.
As to his discussion of the general stock market in 1958, Buffett observes that there seem to be a great many more people who have entered the stock market and that their behavior has been "mercurial" or unpredictable. When many people enter the market (or switch their holdings from cash equivalents to equities) this behavior pushes equity prices higher. Here, Buffett believed that people in 1958 used any reason to justify entering the market. As this behavior caused prices to rise, it also caused more and more of the herd to enter into the market - thus continuing to push up prices. Indeed, the market entered into bull territory in 1958 - and didn't slow down:
Buffett closes his discussion of the 1958 market by reiterating one of his core principles:
"I make no attempt to forecast the general market - my efforts are devoted to finding undervalued securities."
This is a principle that Buffett has stuck to for quite a long time. If you go back and read over his letters and watch videos of the Berkshire Hathaway meetings, Buffett refuses to give forecasts for the general market's future performance. I tend to follow Buffett on this point. The ability to predict the future - or, at the very least, the macroeconomic future - is an ability that sadly was not divined upon me at birth. The trait seems to be second nature to some and while I feel a pang of envy at the adoration received by those who make predictions which end up being true, I am more so inclined to focus on finding cheap stocks in any market. Focusing on the micro and not worrying about the macro cuts my work down by half and I've not yet been convinced that worrying about the other half has a commensurate amount of upside. Additionally, my own experience operating a business in the oil and gas industry has led me to observe that predictions rarely reflect my own observations, thus leading me to the conclusion that either I'm missing some key piece of evidence or that it's difficult to observe the key levers needed to make an accurate prediction, further proof that I ought to stay out of that business.
Next, discussing partnership results in 1958, the Dow-Jones Industrial Average gave an overall gain of about 38.5%, and the partnerships' performance ranged from 36.7% - 46.2%. Here, Buffett repeated another of his principles from the previous year's letter:
"I will continue to forecast that our results will be above average in a declining or level market, but it will be all we can do to keep pace with a rising market."
This is a bold forecast by Buffett - perhaps it reflects an unwavering confidence in his investment strategy at the time, where he was buying into companies very, very cheap (as we'll see below).
Next, Buffett dives into his investment philosophy by examining the partnerships purchase of Commonwealth Trust Co. of Union City, New Jersey. This holding made up 10-20% of his partnerships.
Commonwealth was purchased by Buffett for $50/share, and he estimated that its intrinsic value was $125/share. The bank was, in his opinion, well-managed and had earnings of $5/share, but was undervalued by the market due to it not paying a dividend. Additionally, Commonwealth was 25% owned by a larger bank, which had desired a merger, though Buffett believed it could take as long as ten years for that merger to happen. If successful, he believed that the stock would be worth $250/share. The partnerships acquired enough stock to hold 12% of the company and therefore able to lobby for and consent to a merger. Interestingly, this was a very illiquid stock - Commonwealth had only around 300 shareholders. It had assets of about $50 million.
Buffett sold the stock for $80/share, earning a 46% total return on that investment. He wrote in the letter that he would have been happy to continue acquiring the company at $50/share but that the partnerships' performance relative to the market would appear poor because a merger was likely, but the timing of it was unknown. He also wrote that he sold this Commonwealth investment because he found an opportunity to become the largest shareholder of a different company at an attractive price where he is putting 25% of the partnership assets.
On the one hand, we have Buffett writing that "...a program of investing in such undervalued well-protected securities offers the surest means of long-term profits in securities." However, he also writes that they sold their investment in Commonwealth for a better investment where they are the largest shareholder which "...has substantial advantages...in determining the length of time required to correct the undervaluation."
This letter and the distinction drawn between "buying the stocks of undervalued companies" and "buying controlling positions of undervalued companies where you can control the timeline of the workout" is important, in my opinion, because it illustrates that one might consider flexibility in an investment strategy. Investing, like life, does not always follow neat rules. A well-defined investment strategy is important, but occasionally opportunities can arise that are better than your strategy and a prudent investor ought to have the mental flexibility to recognize them and act on them.
Zachary Oliva is the: