This is a multiple part article. For the previous article, please refer to this article: What we can learn from Warren Buffett? Part 1
Having a diversified portfolio
As at end of 2017, SEC 13F filing showed that Berkshire Hathaway held 40 listed companies. It also had 63 subsidiaries. With such a large number of businesses and companies it invest in, Berkshire Hathaway’s portfolio is truly diversified. It is this diversified nature of the entire portfolio that gives Warren Buffett unlimited holding power.
Many people thinks that having a diversified portfolio would just give average returns and to get good returns, a concentrated portfolios of a few holdings are required. Yet, this is far from truth. Despite Berkshire Hathaway’s diversified portfolio, its book value outperformed the S&P 500 over the long run. According to its 2017 annual report, the book value had a compounded annual gain of 19.1% per annum for period 1965-2017. The S&P 500 return in the same period was 9.9%. Do note that the book value understate the true value of Berkshire since subsidiaries are not marked to market.
No leverage & recognize the market can be down by 50%
Warren Buffett never believe in leverage. To him, leverage is too dangerous. Leverage is a means for people to get rich faster. Such a person is not contented with say $10,000. According to him, a person who is not contented with $10,000 will not be contented with $1 million nor $2 million. Due to Warren Buffett refusal to use leverage, his holding power is unlimited. He has no hurry to sell when the market turns against him. In fact, he mentioned that Berkshire Hathaway had lost half of its value a few times! You can hear what he thinks about leverage from this interview:
In Singapore context, many people use leverage without realizing it. I am not just referring to those obvious leverage instruments such as CFDs, futures and equity loans. Many people – instead of using their excess cash to pay down their mortgage loan – they use their cash to invest in hope of earning a better return compared to their mortgage interest. What they did not realise is that they are effectively using leverage for investment. By leveraging, your holding power significantly reduces when market turns against you.
Ignoring Mr Market
In the preface written by Warren Buffett for the fourth edition of the book, “The Intelligent Investor” (by Benjamin Graham - his teacher, mentor, employer and friend), he specifically point out two chapters that the readers should focus on. One of the chapter was on “The Investor and Market Fluctuations”. In that chapter, the stock market is personified as a business partner named “Mr. Market”. The following a an excerpt from that chapter:
“Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often,, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to from you own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.”
In his commentary on the same chapter, Jason Zweig described the stock market as “Dr. Jekyll and Mr. Market”. This was coined after the similar fictitious character in the novel “Strange Case of Dr Jekyll and Mr Hyde” in which a character had split personality - a good and a bad.
In order to succeed in investing, it is important that you do not listen to Mr. Market unless he offers you are low price which you can buy from or a high price you can sell to. Otherwise, it is more beneficial to ignore him.
In the next article, I will provide another reason why Warren Buffett is so successful.
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