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5 investment lessons from Warren Buffett’s 2016 letter to shareholders
Warren Buffett is considered one of the best investors of our times. His company and his investments have delivered consistently high profits time and again. This can be seen in his yearly letter to shareholders, where he details his company’s performance.
But if you go beyond the numbers and read between the lines, there can be some investment lessons that every investor can follow.
Here are five such gems:
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Partial Diamond better than full Rhinestone
"At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business. It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone."He wrote this while talking about increasing Berkshire’s stakes in its ‘Big Four’ investments – American Express, Coca-Cola, IBM and Wells Fargo. There’s a lesson to be learnt – even a small investment in a great company can reap better returns than a large investment in an average company. Consider this example: suppose a company A with a share price of Rs 250 gave you 12% return every year and a company B with a share price of Rs 100 gave 20% return every year. You still end up gaining more from Company A than the latter – Rs 30 v/s. Rs 20.
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Retained earnings are good
Companies – and thus, investors – often benefit when the company reinvests its profits instead of distributing them as dividends. “The retained earnings of these companies also fund business opportunities that usually turn out to be advantageous,” Buffett wrote. So, high dividends may not always be better for shareholders. Secondly, you could benefit from higher returns if you reinvest your own interest/dividend income. Think about it: you can earn a higher return by buying one additional share with your dividend money than the 4% returns from a bank account.
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Churn your investments
Searching for the stock with the best potential can take time. In the meanwhile, you can invest your money in small tranches in stocks that can be considered safe. In the market, this usually translates to high-dividend, low-volatility stocks like blue chip companies. You can then sell these stocks to buy quality stocks. This way, you can use the money from your investments to fund future investments. “Having a huge portfolio of marketable securities gives us a stockpile of funds that can be tapped when an elephant-sized acquisition is offered to us,” Buffett wrote.
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Measure your investment risk
Buffett mentioned four disciplines for insurance companies: understanding exposures to risks, measuring the probability of loss, setting a premium that covers losses, and walking away if the appropriate premium can’t be obtained. “Many insurers pass the first three tests and flunk the fourth. They simply can’t turn their back on business that is being eagerly written by their competitors,” he said. This can easily be extended to any investment. Your job does not end with just measuring your risk conservatively. This is when you take in account the maximum loss possible. You also need to regularly monitor your investments to ensure it serves you well. Otherwise, you should be ready to sell and cut losses. In these cases, patience may not be a virtue.
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Price matters
If you buy a great stock at a time when it is priced high, you are less likely to make a great profit. “A business with terrific economics can be a bad investment if it is bought at too high a price,” Buffett wrote. While this sounds simple, it is hard to put into use. This is because investors often buy when the market rallies and sell in panic when it falls. In fact, the down market should be considered a ‘discount festival’ and used to increase shareholding.
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19.2%
In the last 51 years, the book value of Warren Buffett’s company Berkshire Hathaway increased to $155,501 from $19 on a per-share basis. Book value is the theoretical amount you, the investor, would receive if the company were to be liquidated (and sold off) tomorrow. So for every share you hold, you could receive a whopping $155,501 if Berkshire were to be liquidated. This is a jump of nearly 8100 times the original value of $19. On a yearly basis, this translates to a growth of 19.2%.
