Warren Buffett's Shareholder Letter 2018

Discussion in 'General Discussion' started by Kevin Lee, Feb 25, 2018.

  1. Kevin Lee

    Kevin Lee Well-Known Member

    As usual, this is a good read. http://www.berkshirehathaway.com/letters/2017ltr.pdf

    Key take aways for me -

    1. Investment is about buying the future of a business. It's not about trying to time the market through chart patterns and speculating on analyst's forecast.

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    2. Warren Buffett had a $1M bet with a hedge fund 10 years ago that no hedge fund can beat S&P over the long run. A hedge fund took up the bet and chose his favorite hedge funds. The bet ended in 2017. Totally no competition. S&P500 won hands down. http://www.businessinsider.sg/warre...s-results-of-hedge-fund-bet-2018-2/?r=UK&IR=T

    That to me is a proof that the best way for most of us to invest is long term as well as hold and forget (don't try to outsmart the market by going in and out of the market). Obviously this is not true for options trading though because options have expiration dates whereas stocks don't.

    I think what he said here is truly important. Market is NOT always rational. Seizing the opportunity when market price is way below market value is key to investment success. "A willingness to look unimaginative for a sustained period" - absolutely important but really hard to do. A mindset that is so important for us to remember during big sell offs !


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    3. Draw down is a natural part of trading and investment. Even Berkshire had huge draw downs but despite these draw downs, Berkshire managed to return CAGR of >20% for more than 50 years. We must accept draw down as a fact in order to be in the business. Trying "too-hard" to avoid draw downs may result either in poor long-term performance or other unintended consequence. The important note is NEVER trade/invest on borrowed money. Key reason is that our minds will start playing tricks on us during rough times if we are trading on borrowed money. If we only trade money that we can afford to lose, we have a much better chance to stay rational during a sell off.

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    4. This is another good one - having more bonds in our portfolio doesn't mean safer.
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    Attached Files:

    Last edited: Feb 25, 2018
    Chuck, Rick and Chris I like this.
  2. Marcas

    Marcas Well-Known Member

    Thanks Kevin. Good remainder of basics.
    The only thing I'd like to point out is importance of distinction between investing and trading.
     
  3. Tony Moore

    Tony Moore Member

    Thanks Kevin good imputs , as usual! But I think there is a crucial consideration to make regarding "long term" , in my opinion it depends on various factors
    like, level of inflation, interest rates curve taxation...all in long term has its temporal limit........money is created to devalue in time !
     
  4. Kevin Lee

    Kevin Lee Well-Known Member

    That's exactly right. We trade options. We don't invest in options. That's a very important distinction.

    But having said that, after I adopted the value investing methods for my stock portfolio (more than 10 years ago), the performance of my stock portfolio improved tremendously. Now I wear two hats : a trader's hat for my options portfolio and an investor's hat for my stock portfolio.

    Among the concepts that I learned, the most important one is the distinction between value and price. Price does not equal value. Once I understood that, sell off doesn't hurt me anymore. My job as an investor changed from watching stock price to calculating and monitoring value of stocks. This shift in perspective totally changed my psychological responses during sell off. I became happy during sell off as I no longer view price as a measure of value. I don't lose a single cent just because price goes down but instead I see sell offs as as opportunity to buy value at discounted prices (provided you have a shopping list ready and set aside capital). As Warren Buffett often said price is what you pay and value is what you get in return. That's a wonderful feeling.
     
    Last edited: Feb 25, 2018
  5. status1

    status1 Well-Known Member

    I am familiar with the concept of buying in a market selloff . I am not sure if he said this or someone else" Buy when markets are fearful "
    Sounds like a good concept but not many traders have the guts to buy when everyone else is panicking to sell
    The main thing is you don't know where the bottom is For example in this recent selloff there was an initial selloff which could have been thought of as a buy the dip but than came the rest of the selloff so what was bought at the initial dip it's still at a loss at the moment but over time I am sure it will get back to those levels again
    I guess it may be better to scale in so you buy at different levels so the lower it goes the more you buy But you would only apply it to good stocks not any stocks that are selling of for other reasons

    A couple of quotes I found interesting with the key word "assuming"
    "Berkshire has been a leader in long-tail business for many years. In particular, we have specialized in jumbo
    reinsurance policies that leave us assuming long-tail losses already incurred by other p/c insurers. As a result of our
    emphasizing that sort of business, Berkshire’s growth in float has been extraordinary. We are now the country’s second
    largest p/c company measured by premium volume and its leader, by far, in float."
    and
    "I want to quickly acknowledge that in any upcoming day, week or even year, stocks will be riskier – far
    riskier – than short-term U.S. bonds. As an investor’s investment horizon lengthens, however, a diversified portfolio
    of U.S. equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible
    multiple of earnings relative to then-prevailing interest rates
    "

    Are there any sensible multiple of earnings these days ? Seems to me like a lot of the stocks have inflated multiples which is fine as long as the interest rates stay low but what happens after a few more rate hikes ?
     
  6. Kevin Lee

    Kevin Lee Well-Known Member

    I think this is exactly the point. Intuitively, most people do not have the guts to buy when market is selling off. That’s understandable. That's why Warren Buffett said "be greedy when others are fearful and be fearful when others are greedy".

    The ah ha moment for me came when I realized price sell offs DON'T hurt at all because price does not equal value. That’s how I can be greedy when others are fearful. This is a difficult concept to accept but one that is truly game changing for me. There's no way I could buy when market is selling off if I don't differentiate price and value. But...once I made that distinction, then it doesn't matter anymore where the bottom is. All the things that value investing is about started to make perfect sense. That's the biggest thing that I learned from Warren Buffett.


    This is also a key learning for me. What is a reasonable P/E? I kept hearing people talked about 16-18 being a fair PE for S&P500. I had this question - why 16 and not 10 or 26? Then I realized that's because the 10 year treasury bond yield was about 5.5% to 6% back then. Flip that ratio around and we get about 16-18 PE. So, stock PE can never be viewed in isolation but always be viewed relative to bond yield. If bond yield changes, PE expectation should change too.

    What's 10 year bond yield now ? it's about 2.9%. If Fed hike 2 more time this year and 2 more times next year, 25 bps each, we'll be at roughly 4% in 2 years time. Flip that around, we get 25. What's the PE now ? It's about 25 trailing and 18 forward. You can form your own opinion whether it's expensive or not. But to me, I think the market has already priced in the next 4 rate hikes.

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    Last edited: Feb 25, 2018
    Frank likes this.
  7. Kevin Lee

    Kevin Lee Well-Known Member

    This is a great point. Inflation and interest rates are key.

    Warren Buffett made that point too in this interview


    And Ray Dalio made similar point in Davos recently.


    The most critical thing I'm monitoring now is inflation because if inflation goes up quickly, all bets are off. But inflation has been the billion dollar mystery for the past few years. Economy has been doing well. Unemployment rate is below what is considered full employment. The Phillips curve predicted a much higher inflation rate by now. But yet inflation remains virtually unchanged. Is this a new normal ? Or is this just a delayed effect? Lots of new theories are proposed. Let's watch how it unfolds.

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    Frank likes this.
  8. Kevin Lee

    Kevin Lee Well-Known Member

    Words of wisdom.... lots of good reminder. Principle of investment is really simple. Getting it done is not. Require constant reminders and pro-actively ignore the noise.

     
  9. TraderJ

    TraderJ Member

    "2. Warren Buffett had a $1M bet with a hedge fund 10 years ago that no hedge fund can beat S&P over the long run. A hedge fund took up the bet and chose his favorite hedge funds. The bet ended in 2017. Totally no competition. S&P500 won hands down. http://www.businessinsider.sg/warre...s-results-of-hedge-fund-bet-2018-2/?r=UK&IR=T

    That to me is a proof that the best way for most of us to invest is long term as well as hold and forget (don't try to outsmart the market by going in and out of the market). Obviously this is not true for options trading though because options have expiration dates whereas stocks don't."

    While most funds/traders don't beat the market, there was also a good bit of luck/timing with that bet. They started near a market bottom and the market had an unprecedented 10-year run, fueled by multiple rounds of QE and super low interest rates. If they made the bet in 1999, some hedge funds would've won.
     
  10. Andres

    Andres Active Member

    Kevin ,
    Can you explain your method of measuring value ?
    thanks
     
  11. Kevin Lee

    Kevin Lee Well-Known Member

    For stock, value = discounted future free cash flow. Warren Buffett defines it in the following video :

     
  12. Tony Moore

    Tony Moore Member

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