With the Berkshire Hathaway annual meeting right around the corner, I thought I’d dig through the site to unearth a few nuggets of Buffett wisdom that I’ve collected over the years.
On Falling Prices
We love lower prices at the grocery store, the gas station, the restaurant, and everywhere else we spend money. Yet, when it happens in the stock market people freak out. Buffett explains why market corrections are a good thing:
A short quiz: 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.
On Being Patient
Buffett likens investing to baseball. Some investors hack away at every pitch they see. Others wait for the best pitch because they realize doing nothing is an option. At least, that’s what Buffett learned from Ted Williams:
Under these circumstances, we try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his “best” cell, he knew, would allow him to bat .400; reaching for balls in his “worst” spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors.
On Pricing Power
There are a few competitive advantages that set great businesses apart from the rest. Buffett sat down with some MBA students and explained why pricing power is the biggest.
See’s Candies was a business where we had pricing power. Our product was often used as a special treat or gift for a moment. The first time I bought See’s I gave it to my future wife and got a kiss. After that, they had me for life. That’s because See’s is a product that provides happiness. On, Valentines Day, do you really care if a box costs $4 or $5? You cannot go home to your wife and tell her you got the cheap chocolates. Consumers also are not conscious of pricing one year to the next. Candy used to sell for 1.95/pound when I was young. Today it sells for $16.00/pound. See’s would always raise their prices on December 26th. I bought this business when it had $4M in sales. Today it is $83M. That’s pricing power.
The academic theories that emerged over the last several decades changed how a lot of people looked at the markets. It probably wasn’t for the best. A blind belief in efficient markets caused a few problems. And volatility is risk pushed investors to pay more attention to something that causes silly mistakes. Buffett had this to say in the 2014 annual letter:
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things.
On Investing, Speculating, and Gambling
There’s a big difference between investing, speculating, and gambling. Some people get the three confused. Buffett doesn’t define it the same way Graham does. In his FCIC interview, he defines the three based on what the investors wants out of the asset.
And I say, the real test of how you — what you’re doing is whether you care whether the markets are open.
When I buy a stock, I don’t care if they close the stock market tomorrow for a couple of years because I’m looking to the business — Coca-Cola, or whatever it may be, to produce returns for me in the future from the business.
Now, if I care if whether the stock market is open tomorrow, then to some extent I’m speculating because I’m thinking about whether the price is going to go up tomorrow or not. I don’t know whether the price is going to go up.
Gambling — but — and then gambling, I would define as engaging in a transaction which doesn’t need to be part of the system. I mean, if I want to bet on a football game, you know, the football’s game’s operation is not dependent on whether I bet or not.