Focus on Net Worth
In my investment fund I tell my shareholders what they should be focusing on:
Our focus is on Net Worth not Profit or Loss. If we sell a share that has capital gain, the gain will show up as profit. We may have given up, however, the future potential of the company. There are times we must sell the share and perhaps precipitate a loss. The future potential of the company has changed and it can go to zero or a mistake was made. There are times when selling one share and buying another is a sensible thing to do. The shareholder should look pass the noise and focus on the long term Net Worth of the company.
This is also true of the individual investor.
What to pay attention to?
"What I pay attention to is earning power. Coca-Cola has no tangible common equity. But they've got huge earning power. And Wells ... you can't take away Wells' customer base. It grows quarter by quarter. And what you make money off of is customers. And you make money on customers by having a helluva spread on assets and not doing anything really dumb. And that's what they do"
Warren Buffett - talking about Wells Fargo, CNN Money interview
"What I pay attention to is earning power. Coca-Cola has no tangible common equity. But they've got huge earning power. And Wells ... you can't take away Wells' customer base. It grows quarter by quarter. And what you make money off of is customers. And you make money on customers by having a helluva spread on assets and not doing anything really dumb. And that's what they do"
Warren Buffett - talking about Wells Fargo, CNN Money interview
Price is what you pay, value is what you get.
When you buy a stock there are three things that determine ultimate success:
What you buy?
Buy stocks that you know will be significantly larger over the long run.
How you behave?
Look at the business not the market and make sensible decisions.
What price you pay?
Look for a margin of safety.
When you buy a stock there are three things that determine ultimate success:
What you buy?
Buy stocks that you know will be significantly larger over the long run.
How you behave?
Look at the business not the market and make sensible decisions.
What price you pay?
Look for a margin of safety.
Focus on the emotional cycle
The market goes through four emotional cycles :
Pessimism, Skepticism, Optimism and Euphoria
Market commentators during times of pessimism and skepticism tend to advise their pubic that they should trade the market. Articles appear about how the buy and hold strategy is dead. The rapid swings of the market make their arguments convincing and because the period is characterized by a great deal of fear, the strategy offer's a feeling of safety and for a few profitability. In reality thou executing successfully is almost impossible. The irony about the advise is the fact that stocks offer the greatest margin of safety during these periods. Just about nothing creates the best prices then fear. It is precisely during these times that the buy and hold strategy should be applied.
Optimism and euphoria have the opposite effect. Stocks lose their margin of safety due to inflated prices. It is because foolishness can go on for what feels like eternity, especially if you are out of the market, that the buy and hold strategy takes hold backed by advice from those in the know. In reality the sensible thing to do, during this period, is to sell and trade. By reducing stocks and moving into other assets you then prepare for the eventual decline.
The market goes through four emotional cycles :
Pessimism, Skepticism, Optimism and Euphoria
Market commentators during times of pessimism and skepticism tend to advise their pubic that they should trade the market. Articles appear about how the buy and hold strategy is dead. The rapid swings of the market make their arguments convincing and because the period is characterized by a great deal of fear, the strategy offer's a feeling of safety and for a few profitability. In reality thou executing successfully is almost impossible. The irony about the advise is the fact that stocks offer the greatest margin of safety during these periods. Just about nothing creates the best prices then fear. It is precisely during these times that the buy and hold strategy should be applied.
Optimism and euphoria have the opposite effect. Stocks lose their margin of safety due to inflated prices. It is because foolishness can go on for what feels like eternity, especially if you are out of the market, that the buy and hold strategy takes hold backed by advice from those in the know. In reality the sensible thing to do, during this period, is to sell and trade. By reducing stocks and moving into other assets you then prepare for the eventual decline.
Economic forecast and why they are seldom correct both in predicting a crash or recovery
There is a axiom about stock market crashes:
"The causes are always different but the results are always the same"
In fact if you think about it this makes complete sense. Because the causes are unknown and come out of the blues that they cause so much panic and fear, such as the credit crisis. No one knows what to expect. The mind conjures up dire consequences, some of which do happen. Recovery happens in the stock market when the fear of the unknown abates either because the market becomes numb to the consequences or that they feel the consequences won't be as bad as they think. This would explain why the market almost always recovers before the economy does.
This would also explain Sir John Templeton's observation:
"Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria"
There is a axiom about stock market crashes:
"The causes are always different but the results are always the same"
In fact if you think about it this makes complete sense. Because the causes are unknown and come out of the blues that they cause so much panic and fear, such as the credit crisis. No one knows what to expect. The mind conjures up dire consequences, some of which do happen. Recovery happens in the stock market when the fear of the unknown abates either because the market becomes numb to the consequences or that they feel the consequences won't be as bad as they think. This would explain why the market almost always recovers before the economy does.
This would also explain Sir John Templeton's observation:
"Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria"
Warren Buffett has called derivatives "weapons of mass financial destruction" but then he went and wrote a whole bunch of derivative contracts. Is he being disingenuous?
On the surface the answer is yes. If you look at it from the point of view of the 'margin of safety', the concept Buffett learned from Benjamin Graham, the answer is no.
The derivative positions are "put options" on at least three world wide Indexes. This means that for an up front fee, Berkshire will pay out a very large sum of money, many years from now on a particular day, if the indexes are below a specific value on that day. That specific value is called a strike value. Unlike the derivative contracts written by AIG there is no requirement to post a collateral if the "mark to market" value varies which almost surely it will. Collateral in finance means a security or guarantee (usually an asset) pledged for the repayment of a loan. In this case it's cash. The term "mark to market" means the contract is given a value daily even thou the contract matures many years from now. Having to payout a collateral pushed AIG into bankruptcy.
Furthermore, to completely lose all the money, all three indexes would have to go to zero. It just won't happen.
All these factors : 1. the lack of collateral required 2. the time to maturity 3. multiple indexes 4. the choice of indexes 5. the up front fee all constitute a "margin of safety".There is one other "margin of safety" not so obvious and that is of a manager that has both the experience and good judgment backed by a sound mental framework for decision making.
Perhaps the analogy is the use of explosives. If used without skill, experience and good judgment, it could blow up in your face. But used with skill and only in selected situations such as demolition it is the only solution.
On the surface the answer is yes. If you look at it from the point of view of the 'margin of safety', the concept Buffett learned from Benjamin Graham, the answer is no.
The derivative positions are "put options" on at least three world wide Indexes. This means that for an up front fee, Berkshire will pay out a very large sum of money, many years from now on a particular day, if the indexes are below a specific value on that day. That specific value is called a strike value. Unlike the derivative contracts written by AIG there is no requirement to post a collateral if the "mark to market" value varies which almost surely it will. Collateral in finance means a security or guarantee (usually an asset) pledged for the repayment of a loan. In this case it's cash. The term "mark to market" means the contract is given a value daily even thou the contract matures many years from now. Having to payout a collateral pushed AIG into bankruptcy.
Furthermore, to completely lose all the money, all three indexes would have to go to zero. It just won't happen.
All these factors : 1. the lack of collateral required 2. the time to maturity 3. multiple indexes 4. the choice of indexes 5. the up front fee all constitute a "margin of safety".There is one other "margin of safety" not so obvious and that is of a manager that has both the experience and good judgment backed by a sound mental framework for decision making.
Perhaps the analogy is the use of explosives. If used without skill, experience and good judgment, it could blow up in your face. But used with skill and only in selected situations such as demolition it is the only solution.
Investing Successfully
Success requires the work of generating ideas and capital. It requires the wisdom to differentiate between good and bad ideas. It requires the patience to wait for opportunity, then for results. The courage to act when your data and logic tell you and not what the market says. The temperament to do nothing when there is nothing you should be doing. The competence to manage the business and above all luck.
Success requires the work of generating ideas and capital. It requires the wisdom to differentiate between good and bad ideas. It requires the patience to wait for opportunity, then for results. The courage to act when your data and logic tell you and not what the market says. The temperament to do nothing when there is nothing you should be doing. The competence to manage the business and above all luck.
The difference between an Economist and an Investor
The economist looks at the forest and glances at the trees. The investor looks at the trees and glances at the forest.
Furthermore, the more prevalent practice in economic forecast is to look at the recent past and project forward almost in a straight line.
The practice should be to look at the recent past, temper that within historic and overall trends and provide a weighted judgment of different possibilities.
The lesson here is that if a investor relies on economic forecast to invest, he will likely miss out on opportunity.
The economist looks at the forest and glances at the trees. The investor looks at the trees and glances at the forest.
Furthermore, the more prevalent practice in economic forecast is to look at the recent past and project forward almost in a straight line.
The practice should be to look at the recent past, temper that within historic and overall trends and provide a weighted judgment of different possibilities.
The lesson here is that if a investor relies on economic forecast to invest, he will likely miss out on opportunity.
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