Learning from the giant (Part 2)

Authors: Abhishek Gupta & Abhishek Kumar

So much for strategy

We have been doing some reading lately and Berkshire letters are what we always think of when we want to re-read gems. No matter how many times one reads those, one is bound to read more into what’s there and to get insights which one missed the last. On that note, we present some key take-away (with reference from 1993 letter to shareholders) and try to integrate it with our own views on those:

1. Market price increase and earning increase can be highly diverging, sometime justified because investors want to pay the company a higher multiple of same earning, sometime completely unjustified. While this might result into short term out performance, earnings will need to catch up sooner or later

Our perspective: Sometimes we ourselves don’t know if we are expecting a price increase from EPS growth or a multiple growth. To which someone might argue, as long as one bought great businesses, one should just hold on to them. I believe there is merit in understanding the right reason behind price appreciation to identify the right time to exit. (Only recently I have realized the increasing important of holding period in ones returns, equal if not more important than entering a great business)

2. Management who consistently exceed expectations should be rewarded with a higher multiple for the earnings they generate. This has two important points for management, setting the expectation right, and knowing when to set the expectations. Companies, with their current pressure to report quarterly, get into providing guidance, sometimes, real sometimes out of pressure to perform.

Our perspective: Being candid about it, we haven’t done so across our investments, but if we had to, we would track commitments by management year on year with delivery on them and responses to failure

3. It is very difficult to make 100 smart decision and be right on most of them, instead focus on making a few, being confident to be right and bet big. Stick to a concentrated set where you understand growth and more importantly risks.

Our perspective: When trying to find a few investments, you want to own great businesses. We have struggled to differentiate between great and good businesses. To a retail investor, on a prima-facie, everything decent looks attractive. We have struggled of not having a checklist of what we are looking in businesses that we want to own, and even if we had one, we did not necessarily stick to following one.

Moreover, in this process, one comes across multiple companies, that need to be studied, which results into partial knowledge about so many businesses, without enough time being spent at both selecting and rejecting.

Having said that, we believe looking at businesses that one rejected (if someone did) and why can be a good starting point for your checklist and in longer term your path to your investment philosophy

4. What seems like a great idea, might turn out to be dud. This is what Buffet wrote in his 1992 SH letter: At Berkshire, we have no view of the future that dictates what businesses or industries we will enter. Indeed, we think it's usually poison for a corporate giant's shareholders if it embarks upon new ventures pursuant to some grand vision. We prefer instead to focus on the economic characteristics of businesses that we wish to own and the personal characteristics of managers with whom we wish to associate - and then to hope we get lucky in finding the two in combination. At Dexter, we did.

About the same purchase, this is what he had to say in 2008 SH letter:

What I had assessed as durable competitive advantage vanished within a few years," Buffett said. "By using Berkshire stock, I compounded this error hugely. That move made the cost to Berkshire shareholders not $400 million, but rather $3.5 billion. In essence, I gave away 1.6 percent of a wonderful business -- one now valued at $220 billion -- to buy a worthless business."

"To date, Dexter is the worst deal that I've made," Buffett went on. "But I'll make more mistakes in the future - you can bet on that. A line from Bobby Bare's country song explains what too often happens with acquisitions: 'I've never gone to bed with an ugly woman, but I've sure woke up with a few.'"

Our perspective: What we take-away from this is no matter how good one’s processes are, no matter how strong a moat you think a company has, there will always be some thorn in the bed of roses. There will be mistakes in the process of investing which will appear as once in a lifetime opportunity only to be revealed as a dud.

What’s important is to take stock of these and not repeat the same mistakes. From my personal experiences, we have invested in micro-caps with a product which we thought is a game changer. The management looked very competitive, the product had no competitor. At that time. Everything changed in a matter for 3 quarters and we was able to get out. Of course, with some loss.

The key thing to note here is that strategy is ever-changing and what once looks like to be a sure winner, might turn out to be something worth way lesser than what one initially thought it to be.

The only counter is to ensure one take stock of what one is sleeping around with. Not to change the partners, but to ensure that the reason one got into bed still remains strong.