Four Legs and a टेढ़ी Tail

“Abraham Lincoln once posed the question: ‘If you call a dog’s tail a leg, how many legs does it have?’ and then answered his own query: ‘Four, because calling a tail a leg doesn’t make it one,'” Buffett writes.

Our broker friend Jigneshbhai was reading from Warren Buffett’s latest annual letter to his shareholders. He continued as he read further.

“Buffett then sarcastically adds: “Abe would have felt lonely on Wall Street.””

The lazy skeptic in our broker friend seemed to have loved this. I saw that he had a wide grin on his face as he looked up at us after reading this.

Swami and I were just digesting this leg-tail business when our broker friend continued.

“Not just on Wall Street, Lincoln would have felt lonely at so many places, with so many bent on calling a tail a leg, isn’t it?” Jigneshbhai asked, with, maybe, a slight sense of resignation.

“No wonder Lincoln is said to be one of their greatest Presidents. While everyone saw their version of reality, he saw reality as it was,” our broker continued, still excited about what he had read.

Swami and I were wondering which tails and legs and their ‘mis-calling’ was our broker friend referring to.

Swami was the first to ask, as usual.

“Buffett is probably referring to the accounting shenanigans that so many companies indulge in – when they don’t call some expenses as expenses. I read his latest letter” he remarked proudly.

Jigneshbhai was pleasantly surprised with Swami’s comment.

“Indeed. Reality doesn’t change when you call it something else” he said, and then after a few moments of silence, added, “All that you manage is an illusion.”

Swami looked at me and wondered if our broker friend was talking about expenses or something else.

Swami was definitely thinking about only accounting. “You need to be careful about such companies and such managements. The ones who regularly indulge in calling a tail a leg. Expenses need to be represented correctly to shareholders,” he proclaimed confidently.

He was probably right about being careful of managements that do such misrepresentation. But Jigneshbhai was probably talking about misrepresentations of reality by some other entities.

“If you don’t see and accept reality as it is, and keep calling it something else, reality itself doesn’t change, isn’t it?” he continued again.

“And that’s true of not just companies and managements, but also of people, political parties and even countries, of late, isn’t it? If you repeatedly call a tail, a leg, it doesn’t become a leg.”

“It is better to maintain some distance from them – because anyone who repeatedly calls a tail a leg will hardly change that habit. And actually start believing it.”

“After a while, even you can forget that what you call a leg is actually a tail.”

Jigneshbhai stopped and looked at us with a sigh. Swami and I started thinking about what our broker friend had just said – perhaps Lincoln’s statement applied not just to accounting, we thought.

But Swami was still not sure what to do and how to deal with those who call a tail a leg, repeatedly (though our broker friend had advised a safe distance!)

Just as we were thinking about it, the wealthy man in the sprawling bungalow, who had been listening to our conversation, came across to our table. Jigneshbhai smiled at him as he saw him coming.

And as we finished our coffee, the wealthy man looked at Swami and said “कुत्ते की दुम टेढ़ी की टेढ़ी – कभी सीधी नहीं होती. You must deal with them assuming this!”

Book Synopsis: The Warren Buffett Way by Robert G Hagstrom Jr

warrenbuffettwayA slightly old-ish book (first published in 1994), I chanced upon this book and picked it up again at the library recently, though I had read it a few years back.

While after so many years, it may not seem to have anything new, given that there is so much written about Buffett since 1994 and there are so many books with ‘Buffett’ in the title because it sells; at the time it was first published, it was quite well received.

A lot of the first half of the book is honestly quite disappointing, as it is essentially a repetition of what Buffett himself has already said in his letters to his shareholders over the years. The author himself is said to have confessed later though, that the book was actually meant to be marketing material for a hedge fund based on Buffett’s investment principles which he planned to launch later.

Nevertheless, setting that apart, the book contains quite a detailed analysis of the business, financial and market metrics of many of Buffett’s principal investments through his early partnerships and via Berkshire till then; as well as a detailed description of the circumstances under which some of these investments were actually made. Definitely till it was published, and perhaps even later, no other book seems to have done such an in-depth analysis so far of Buffett’s investments individually.

This includes not only major holdings like GEICO, Washington Post, Capital Cities and Coke, but also other equity holdings like Gillette, Wells Fargo, Freddie Mac, as well as significant fixed income or bond investments that Buffett made till 1994. That part alone makes it decent learning for anyone interested in trying to emulate them.

But the last chapter of this book titled ‘ An Unreasonable Man’ makes good reading for anyone interested in a summary of what constitutes the Warren Buffett way – even after 19 years.

Here are some excerpts from this summary chapter:

The Warren Buffett Way

Step 1: Turn off the stock market

Step 2: Don’t worry about the economy

Step 3: Buy a business, not a stock

Step 4: Manage a portfolio of businesses

And in evaluating businesses, the author describes what he calls Buffett’s Tenets:

1. Business Tenets

– Is the business simple and understandable?

– Does the business have a consistent operating history?

– Does the business have favorable long-term prospects?

2. Management Tenets

– Is management rational?

– Is management candid with its shareholders?

– Does the management resist the institutional imperative?

3. Financial Tenets

– Focus on return on equity, not earnings per share

– Calculate ‘owner earnings’

– Look for companies with high profit margins

– For every dollar earned, look for at least one dollar of market value created

4. Market Tenets

– What is the value of the business?

– Can the business be purchased at a significant discount to its value?

It seems like an oft-repeated but decent set of common factors if one were to evaluate Buffett’s purchases over the years. Though of course, a lot of these can be said to be qualitative and imprecise beyond a certain point, and seem to have changed a bit in recent years.

Of course, it is not necessary (in fact, not even recommended) for every investor to imbibe these in their investing approach as such – that will only make investing complex for normal individual investors. It is not required for most investors to even attempt it.

But for those who have formulated their investing approach, and are interested in studying Buffett’s methods, though the book title promises more, The Warren Buffett Way does have a decent analysis of past investments and a checklist for the enterprising investor.

Running to Stay at the Same Place: Tum Kisliye Bhaagta Hai Bhai?

“Aisa to Aadmi Life mein Doich time bhaagta hai. Olympic ka race ho, yaa Police ka case ho. Tum kisliye bhaagta hai bhai?” asked Amitabh Bachchan in ‘Amar Akbar Anthony’.

I felt like asking this to a friend of mine who I met a few days back.

Despite the fact that he worked in the financial services industry (or perhaps because of it maybe?), he was dreadful of investing his money anywhere. No stocks or mutual funds for him, no property too because he was afraid of loans. All that he ever bought was fixed deposits and government bonds, and sometimes, some gold.

He said ‘I have been running a lot, I seem to have a good life and my income seems to have multiplied many times too, but one thing has not changed. When I started I could not afford a house in Mumbai, and even today, I cannot afford a house in Mumbai.’

Prices of houses in Mumbai is another matter. But like Anthony, I felt like asking him ‘Tum kisliye bhaagta hai bhai?’

In the book ‘Through the Looking Glass’, which is a sequel to Alice in Wonderland, there is a scene where the Red Queen drags Alice and both of them run fast over a chess board. After a while, Alice realizes that they are at the same spot, and starts wondering where she is going; and asks the Red Queen for an answer.

“Well, in our country,” said Alice, still panting a little, “you’d generally get to somewhere else — if you run very fast for a long time, as we’ve been doing.”

“A slow sort of country!” said the Queen. “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

Inflation is the reason why we keep running fast but still stay at the same place.

It is an invisible tax, a not-felt-directly kind of penalty. No matter how many times your earnings grew, or how many times an investment multiplied, the real returns on an investment are represented only by the gains in purchasing power it provides. And inflation is all out after you, your earnings and your investments to make sure that doesn’t happen. And like cancer, you don’t realize it is eating you.

Read Warren Buffett’s classic article written in 1977 on how inflation swindles even equity investors here – like so many of his timeless writings, it is as relevant in today’s times as it was 35 years back.

In his letters to his shareholders, he has often warned typical individual investors of the effects of inflation and how it slowly erodes capital, and is an invisible tax. As per Buffett, the only solution to inflation is to invest, at a reasonable price, in businesses that earn return of equity consistently and have pricing power to beat inflation over long periods of time.

High rates of inflation create a tax on capital that makes much corporate investment unwise – at least if measured by the criterion of a positive real investment return to owners. This “hurdle rate” the return on equity that must be achieved by a corporation in order to produce any real return for its individual owners – has increased dramatically in recent years. The average tax-paying investor is now running up a down escalator whose pace has accelerated to the point where his upward progress is nil.

Here is a nice and insightful collection of Buffett’s writings on inflation: Collection of Buffett’s writings on Inflation

So the real issue in investments in not whether bonds are safe or equity is volatile or property is illiquid or gold is a hedge. The real issue is whether the rate of return of your investments is faster than the down escalator of inflation over the long-term?

Other-wise, like my friend, we are all running to stay at the same place.

Somewhat like this woman on the escalator. Funny, but then, may be not – if you are trying to beat the down escalator of inflation.

Book Synopsis: Think like Graham, Invest like Buffett and Buffettology

thinklikegrahamA few days back I read a book with a title similar to this – Think Like Graham, Invest Like Buffett. While I had great expectations from it, honestly, beyond the title, there was not much in terms of depth in it. Of course, the title is a great message in itself, so I thought there would be examples of that and other stuff like that in the book. But there was not much of it in there. Lawrence Cunningham’s other book which is essentially a great collection of excerpts from Buffett’s letters to his shareholders is so much better. So while the thought of having this book and the title were great, the overall execution did not seem to make it as great a reading as I had expected.

But there was one small section in it which was absolutely like a flash of brilliance in an otherwise ordinary and repetitive book. It is a metaphorical story about a person who wants to sell his apple tree, and how he goes about evaluating various offers that people make for the apple tree. The story takes us through various stages of valuing the apple tree, starting with offers so low that they basically account for the cost of the wood one would get if the tree were cut down – something akin to scrap value. And then goes on to give examples of how one could arrive at various subjective ‘intrinsic values’ for the tree, methods based on the cost that went into planting the tree, or the value of fruits one gets from it today, or the value one could arrive if one could grow fruit yield in the future, as well as how it is important to take into account the cost of maintaining the tree farm and replanting the seeds from the fruits. Essentially taking us from the Graham thinking of ‘paying to avoid losses’ to the Buffett approach of ‘paying for high returns from predictable earnings’ in the form of a wonderful set of conversations between the tree owner and various bidders. So that was quite a nice section in the book to get the point across – Think like Graham, Invest like Buffett.

buffettology-previously-unexplained-techniques-that-have-made-warren-mary-buffett-paperback-cover-artLater, a few days back, I chanced upon another book named ‘Buffettology’ – written by his daughter-in-law. Honestly I did not have great expectations from that book, specially from the investing techniques point of view. I thought it would be more a general essay on Buffett as a person, and his style from a personal view. But surprisingly, it turned out to be a good set of writings on investing techniques. While there are a lot of writings in layman terms – but the message and detail on the source of Buffett’s success are quite surprisingly crisp. The examples on what forms a great business, how to identify great businesses, and how to value them in a manner where you don’t pay too much make quite decent reading. And the details on how Buffett started with Graham’s methods, and then graduated to a combination of Fisher’s and Munger’s techniques with Graham’s soul behind them are quite a treat to read. There are also a set of writings around how he gathered exceptional wealth primarily due to combining his acute investing acumen with an access to long-term insurance float over long periods of time. It may not be news for a serious investor, but nevertheless not bad for the layman.

So two books mostly around the same topics, both trying to distil some learning from past masters, two books with different levels of good reading.  But both of them with essentially a similar message – Think like Graham, Invest like Buffett.

डर के आगे जीत है: Why Long Term Investors should not fear Market Crashes

canwepanicnow“Can we panic now?” asked Ron Weasley to Harry Potter in “The Chamber of Secrets” when they suddenly find themselves surrounded by giant spiders in the Forbidden Forest. That is how a lot of us feel in the current market situation, perhaps. It is one of those times when everyone seems to ask everyone else this question. Is it time to panic?

Like so many things in finance, this is the wrong question with many answers that seem right. The reality is everyone may have a view, but no one can claim to know the answer for sure. The fact is that it is the wrong question to ask.

There is no doubt that in stomach churning times of volatility, the first thought that strikes you may be – sell everything and run. Sometimes, the second thought may be – buy everything quick, because things have gotten cheaper. Both the views are wrong because they depend on timing activities based on market events, rather than based on a plan.

Mr Market can get into manic-depressive moods as well as exuberant moods at the drop of a hat. If it forces one to get either too happy or too sad, one is turning one’s basic advantage into a disadvantage. Think of stocks as a crate of coke or a basket of potato chips that you buy for weekend parties. If you bought something on Wednesday, and your neighborhood supermarket announced a 10% off sale on Friday, will you think – Oh no! I think I should sell the coke and chips I have, and conserve some cash! At best you may think, let me buy more as the prices are great, and I am going to need them next weekend anyway. If you are a rational consumer, you are likely to weigh your decision – based on whether you need more coke and chips, whether you think it is worth stocking up, and whether you think the sale is genuine or is it on old stock. Unfortunately, a lot of individual investors do not think about stocks like that, and hence the fear associated with market falls. Therefore, headlines read ‘Global Bloodbath’ instead of ‘Sale, Sale Sale!’

Take this quiz that Buffett wrote in his 1997 letter to his shareholders – “If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices. ”

And finally he adds: “So smile when you read a headline that says “Investors lose as market falls.” Edit it in your mind to “Disinvestors lose as market falls — but investors gain.” Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other.”

darrkeaagejeethaiThe really good long-term returns from equity come not despite the falls, but because of the falls. For someone who invested in US equity 10 years back and forgot it, he may look at his portfolio today and say – this has gone nowhere. Similarly, for some one who invested in Indian equity 4-5 years back, again the scenario is similar – broader market levels in August 2011 are more or less where they were in August 2007. But for someone who rode the falls, and invested at that time to whatever small degree, even partially in the right stocks or funds, the returns have come. So it is not that the long-term returns from equity have come despite the fall. The long-term returns from equity come because of the fall. The problem is no one can say for sure whether a fall is the end of the falls, or the beginning of another set of falls. Life has to be lived in forward mode, and can only be analyzed in reverse mode later.

But one thing is clear. It is during the times of sudden, big falls that fear is at its highest. It is in such times where it is most important for an investor – firstly not to sell, secondly do nothing, and thirdly buy something. Because truly, in such times, the risk of permanent loss of capital gets lower. If one manages to neglect the value of investments already made (and hence notional losses or reduction in profits), buy the right things in large proportions during times of ‘darr’, and can withstand, or better still, buy more during further falls if they happen, he is sure to be on his way to ‘jeet’  – may be not in a few weeks or months, but surely in a matter of many years. As long as one is committed for the really long haul, and makes rational choices, there is no doubt that there is truth in the saying – डर के आगे जीत है.

You Shall Not Pass: Determination and Boredom in ‘Range-bound’ markets

“You Shall Not Pass.” This was famously used in J.R.R. Tolkien’s The Fellowship of the Ring, the first volume of The Lord of the Rings. In the novel as well as in the movie based on it, the wizard Gandalf declares staunchly, “You shall not pass!” while blocking the Balrog (a demonic creature). A bit of googling reveals that the phrase was originally used during World War I, during the Battle of Verdun, by a French General, Robert Nivelle. It has since been used as a slogan or a war-cry to express determination to defend a position against an enemy.

You-shall-not-passIt was this kind of determination that was required today in the Lords Cricket Test that India lost to England. Nobody quite strongly said “You Shall Not Pass” to the English bowlers, and it was a matter of time before it was wrapped up.

For the past few months, the market too seemed to be tied in a deadlock with the bulls and the bears saying ‘you shall not pass’ to each other, and not allowing either to get the upper hand. It has been a time when most business channel anchors use the term “range-bound” so often. It is so uninteresting to them to wake up every day in the morning, cover the hectic activity minute to minute, and finally it all ends up being ‘range-bound’ activity with ‘stock-specific’ action. There have been event after event created – from seemingly important ones like release of inflation numbers, quarterly results, IIP numbers, credit policy, Greek crisis, oil prices, European debt crisis, Chinese slowdown to tactical issues like expiry of the monthly series and daily volume turnovers. But the net result for the market has essentially been status quo. The end of every event makes everyone look forward to the next one – but the market again says – You shall not pass – I stay where I am – ‘range-bound’.

For an individual investor, perhaps neglecting all the action (or net inaction if you may say so) continues to be the best strategy. Lethargy bordering on sloth remains the best policy. The formula remains the same – fix your long term asset allocation, select and regularly keep adding to those assets, and rebalance once in a while when there are major moves. To everything else that tries to distract you from this path – the response should be – You shall not pass.

Guru Speak: Warren Buffett Talk at Columbia

Despite all the books and articles written on him so far, this is one of the best Warren Buffett talks.

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