In general, it is considered nonsense to leave with a business interest that is both understandable and durable.
Those interests are hard to replace. It is worth seeing that corporate managers clearly understand this point when they are concentrated on a business they operate: A parent company owning a subsidiary that is performing great will be unlikely to sell the entity regardless of the price.
The CEO would ask himself whether he should leave with that jewel or not. However, if that CEO were operating his own portfolio, he will undoubtedly move from a business to another if he has the sufficient arguments to do so.
According to Warren Buffett, what makes sense in business also makes sense in stocks. An investor should treat his position in a business in a similar manner as an owner of a business.
Buffett and his colleague have long ago decided that in a lifetime investment it is hard to make smart decisions all the time. With Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) capital boom and with a group of investments that shrank dramatically, that statement became more crucial.
That is why Buffett turned to a strategy which required him and his staff to be smart but not at large. Only a few times. Warren and his colleague, Charlie, now settle for one idea a year.
This strategy requires them to be restrained in terms of following diversification. Of course, many would think that their strategy is riskier than the one used by ordinary investors. Buffett does not agree with this. Conversely, he thinks that a portfolio concentration policy may in fact decrease risk if it increases the intensity an investor puts in a business and the level of contentment with its economic characteristics before engaging in it.
Buffett fosters his strategy based on the definition of risk: “the possibility of loss or injury.” A dictionary definition, this is clear.
But academics prefer to define investment risk as such risk related to a stock or portfolio volatility. These academics use the beta of a stock – its past relative volatility, which enables them to build capital-allocation and investment theories regarding said calculation.
Buffett considers that they forget an extremely important point in their urge for a single statistic: It is better to be approximately right that precisely wrong.
For shareholders, or owners of a business, as Buffett likes to call them, the academics, strategy is astray, to such an extent that it is absurd. For academics based on the beta calculation, a stock that has dramatically dropped is riskier at lower price than at a higher price.
However, this has no sense for someone who is offered an entire company at a drastically reduced price.
Buffett leaves no doubt: The true investor welcomes volatility.
His mentor, Ben Graham, explains why investors prefer volatility. For such purpose he introduces Mr. Market, a fellow who comes every day to buy or sell, as you wish. If Mr. Market is off his rocker he will bring better opportunities to the investor.
Graham is true. In a fluctuating market, irrationally low prices tend to be matched with solid businesses. Buffett finds it hard to believe how the availability of such prices can increase the hazards for an investor who can either ignore the market or exploit it.
A beta follower usually cherishes the price history of a stock. On the other hand, investors like Buffett prefer to search for any other information that will make them understand the business, for instance, what a company produces, what its competitors are, what they are doing, how much borrowed money the company uses, among other issues.
From Buffett’s standpoint, the investor must assess whether his aggregate after tax profits after an investment will return him the purchase power he had before investing plus a rate of interest on that initial stake. This is the real risk.
Of course this risk cannot be determined exactly. It can be determined with a degree of accuracy.
Buffett provides five primary factors to evaluate risk:
1) The certainty with which the long-term economic characteristics of the business can be evaluated;
2) The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;
3) The certainty with which management can be relied upon to channel the reward from the business to the shareholders rather than to itself;
4) The purchase price of the business;
5) The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor's purchasing-power return is reduced from his gross return
Those interests are hard to replace. It is worth seeing that corporate managers clearly understand this point when they are concentrated on a business they operate: A parent company owning a subsidiary that is performing great will be unlikely to sell the entity regardless of the price.
The CEO would ask himself whether he should leave with that jewel or not. However, if that CEO were operating his own portfolio, he will undoubtedly move from a business to another if he has the sufficient arguments to do so.
According to Warren Buffett, what makes sense in business also makes sense in stocks. An investor should treat his position in a business in a similar manner as an owner of a business.
Buffett and his colleague have long ago decided that in a lifetime investment it is hard to make smart decisions all the time. With Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) capital boom and with a group of investments that shrank dramatically, that statement became more crucial.
That is why Buffett turned to a strategy which required him and his staff to be smart but not at large. Only a few times. Warren and his colleague, Charlie, now settle for one idea a year.
This strategy requires them to be restrained in terms of following diversification. Of course, many would think that their strategy is riskier than the one used by ordinary investors. Buffett does not agree with this. Conversely, he thinks that a portfolio concentration policy may in fact decrease risk if it increases the intensity an investor puts in a business and the level of contentment with its economic characteristics before engaging in it.
Buffett fosters his strategy based on the definition of risk: “the possibility of loss or injury.” A dictionary definition, this is clear.
But academics prefer to define investment risk as such risk related to a stock or portfolio volatility. These academics use the beta of a stock – its past relative volatility, which enables them to build capital-allocation and investment theories regarding said calculation.
Buffett considers that they forget an extremely important point in their urge for a single statistic: It is better to be approximately right that precisely wrong.
For shareholders, or owners of a business, as Buffett likes to call them, the academics, strategy is astray, to such an extent that it is absurd. For academics based on the beta calculation, a stock that has dramatically dropped is riskier at lower price than at a higher price.
However, this has no sense for someone who is offered an entire company at a drastically reduced price.
Buffett leaves no doubt: The true investor welcomes volatility.
His mentor, Ben Graham, explains why investors prefer volatility. For such purpose he introduces Mr. Market, a fellow who comes every day to buy or sell, as you wish. If Mr. Market is off his rocker he will bring better opportunities to the investor.
Graham is true. In a fluctuating market, irrationally low prices tend to be matched with solid businesses. Buffett finds it hard to believe how the availability of such prices can increase the hazards for an investor who can either ignore the market or exploit it.
A beta follower usually cherishes the price history of a stock. On the other hand, investors like Buffett prefer to search for any other information that will make them understand the business, for instance, what a company produces, what its competitors are, what they are doing, how much borrowed money the company uses, among other issues.
From Buffett’s standpoint, the investor must assess whether his aggregate after tax profits after an investment will return him the purchase power he had before investing plus a rate of interest on that initial stake. This is the real risk.
Of course this risk cannot be determined exactly. It can be determined with a degree of accuracy.
Buffett provides five primary factors to evaluate risk:
1) The certainty with which the long-term economic characteristics of the business can be evaluated;
2) The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;
3) The certainty with which management can be relied upon to channel the reward from the business to the shareholders rather than to itself;
4) The purchase price of the business;
5) The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor's purchasing-power return is reduced from his gross return
