This is the first in the series of articles about my learnings from Warren Buffet’s annual letters to shareholders of Berkshire Hathaway. The greatness of this man is in distilling his worldly wisdom in investing into simple sentences that an average investor can understand.

His annual reports, starting from 1965 to 2013, are a classic 101 to a wide range of topics. Along the way, the book value of Berkshire Hathaway, a close proxy of intrinsic business value as per Buffet, has grown from $19 in 1965 to $134,973 today. The compounded annual return of 19.7% over a period of 48 years is an astounding testimony to the investing acumen of Warren Buffet and Charlie Munger.

You will be disappointed to note that the points below are not meant to make us a great investor overnight. They are there to serve as guiding posts for a boat in a rough sea, so one doesn’t hit icebergs while investing.

Here we go.

Equity and Bond Investments

• The goal of Berkshire is to maximize average annual rate of gain in intrinsic business value on per share basis. The firm will reach this goal by directly owning a diversified group of businesses that generate cash and generate above-average Return of Capital
• Equity investments are heavily concentrated in a few companies which are selected based on
  • Favorable long term economic characteristics
  • Competent and honest management
  • Purchase price attractive when measured against the yardstick of value to private owner
  • An Industry with which we are familiar whose long term economic characteristics are easy to judge
• When buying securities in stock market with a long horizon, the criteria are no different than buying whole companies. When such criteria is maintained the investment is over a very long horizon. Stock market fluctuations are of little importance as what matters is business performance
• The only yard stick that matters over a long horizon is Return on Equity that a private owner of the firm can expect. To test economic performance, a five-year yard stick is a must
• Treat Bond investments as unusual sort of business with option to retain earnings and grow capital
• Cash flow is a meaningful measure of performance for a company with large initial outlay and very small outlay thereafter, such as a bridge or gas field owner. But for most companies needing cash to sustain business growth, this measure is meaningless.
• A fast changing industry environment can offer high returns but precludes the certainty that investor seeks
• Beware of companies displaying
  • Weak accounting principles
  • Untrustworthy management
  • Trumpeting earning projections
• A dividend policy should always be clear, consistent and rational. If this principle is not followed by the company, be wary.
• The term is ‘value investing’ is redundant. For, low p/e or dividend yield is not a true measure of market value by itself
• Market is frequently efficient and not always efficient. The difference between the propositions is night and day for an investor. Over a long horizon, understanding this difference is essential.
• Portfolio concentration can even sometimes reduce risk if the investor can think intensely about those businesses and has comfort level with the economic characteristics