I recently read the book Tap Dancing to Work. Compiled by Carol Loomis, Tap Dancing to Work is a collection of articles published on Fortune magazine between 1966 and 2012 that are on Warren Buffett or authored by himself.
Even though some of these articles were penned more than 50 years ago, they hold insights that are still relevant today. With that, here's a collection of some of my favourite quotes from the book.
ON WHY BUYING MEDIOCRE COMPANIES AT A CHEAP PRICE IS NOT IDEAL
"Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original 'bargain' probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces- never is there just one cockroach in the kitchen.
Second, any initial advantage you secure will be quickly eroded by the low returns that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realise a high return.
But the investment will disappoint if the business is sold for $10 million in 10 years and in the interim has annually earned and distributed only a few percents on cost. Time is the friend of the wonderful business, the enemy of the mediocre."
In his 1989 annual letter to Berkshire Hathaway shareholders, Buffett outlined some of the mistakes he made over his first 25 years at the helm of the company.
One of those mistakes was buying control of Berkshire itself. At that time, and being trained by Ben Graham, Buffett thought that buying a company for a cheap price would end up being a good investment.
However, such bargain-priced stocks may take years to eventually trade at their liquidation value. This can result in very mediocre returns, even after paying a seemingly low price for the company and its assets.
Buffett later reasoned that "it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
ON WHY BERKSHIRE DOES NOT LEVERAGE MORE
"In retrospect, it is clear that significantly higher, though still conventional, leverage ratios at Berkshire would have produced considerably better returns on equity than the 23.8 per cent we have actually average.
Even in 1965, we could have judge there to be a 99 per cent probability that higher leverage would lead to nothing but good.
Correspondingly, we might have seen only a 1 per cent chance that some shock factor, external or internal, would cause a conventional debt ratio to produce a result falling somewhere between temporary anguish and default.
We wouldn't have liked those 99:1 odds- and never will. A small chance of distress or disgrace cannot, in our view, be offset by a large chance of extra returns. If your actions are sensible, you are certain to get good results; in most such cases, leverage just moves things along faster."
It is often tempting to invest on margin (in other words, borrowing to invest) as it can accelerate your gains. However, using leverage to invest can also result in distress and bankruptcy, both for the individual investor and companies alike.
Take the 2008 crisis for instance. The S&P 500 - the US's stock market benchmark - lost approximately 50 per cent of its value. An investor who invested on a 50 per cent margin would have faced a margin call and his entire portfolio would be wiped out.
Although cases like this are infrequent, as Buffett believes, it is always better to err on the side caution.
ON THE SIMPLE ECONOMICS OF VALUING A FINANCIAL ASSET
"A financial asset means, by definition, that you lay out money now to get money back in the future. If every financial asset was valued properly, they would all sell at a price that reflected all of the cash that would be received from them forever until judgement day, discounted back to the present at the same interest rate."
In 1998, Buffett and Bill Gates spoke at the University of Washington, answering any questions that students threw at them. One of the students questioned whether the traditional way of valuing companies was still relevant at that time.
Buffett's simple method of valuation can be applied to any financial asset. For a stock, it involves coming up with a prediction of the company's future free cash flows and discounting them back to the present. This simple method of valuation is the ideal method of valuing a stock and is still used by numerous investors today.
"The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the popularity- the reasoned probability- of that investment causing its owner a loss of purchasing power over his contemplated holding period.
Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see (he goes on to describe gold), a nonfluctuating asset can be laden by risk."
In his 2011 Berkshire letter to shareholders, Buffett addressed the topic of risk. Investors are often concerned about the possibility of making a paper loss in their investments.
However, volatility should not be misconstrued as risk. Buffett instead defines risk as the chance of suffering a permanent loss or the inability of the investment to produce meaningful growth in purchasing power.
ON BEING THANKFUL AND GIVING BACK…
Buffett is not just a brilliant investor but also a terrific human being. His humility and generosity are clearly demonstrated by his philanthropic pledge to donate 99 per cent of his wealth to charity.
"My luck was accentuated by my living in a market system that sometimes produces distorted results, though overall it serves our country well.
I've worked in an economy that rewards someone who saves the lives of others on a battlefield with a medal, rewards a great teacher with thank-you notes from parents, but rewards those who can detect mispricings of securities with sums reaching into the billions. In short, fate's distribution of long straws is wildly capricious.
The reaction of my family and me to our extraordinary good fortune is not guilt, but rather gratitude. Were we to use more than 1 per cent of my claim checks on ourselves, neither our happiness nor our well-being would be enhanced.
In contrast, the remaining 99 per cent can have a huge effect on the health and welfare of others. That reality sets an obvious course for me and my family. Keep all we can conceivably need and distribute the rest to society, for its needs. My pledge starts us down that course."
THE GOOD INVESTORS' CONCLUSION
Tap Dancing to Work is a priceless collection of articles describing Warren Buffett as a person, a business owner, and an investor.
The articles that Warren Buffett penned himself, many of them excerpts from his own annual Berkshire shareholders' letters, hold immense insights into the global economy and investing. There are many more insights in the book and I encourage all Buffett fans to find the time to read it.
This article was first published in The Good Investors.