Beruflich Dokumente
Kultur Dokumente
Norbert Lou
March 6, 2014
The Private Investment Brief
Buffetts Analytical Framework publishes live investment case
studies taken from the portfolios
Berkshire Hathaway released its annual letter to shareholders last Saturday, and as
of small, value-oriented
usual Warren Buffett used an extended section of the letter to teach a general lesson
investment managers.
on investing. In this years lesson, entitled Some Thoughts on Investing, Buffett
discussed two non-stock investments he made years ago and continues to hold: a
farm in Nebraska, and an interest in a retail property in New York City. SUBSCRIBE
Most of the medias attention has focused on the think long-term moral of Buffetts
FOLLOW OUR BLOG
lesson, and rightly so. But for me, the main takeaway was its reminder that the
Enter your name and email address to receive
worlds most sophisticated investor uses an extremely simple analytical framework
notifications of new posts by mail.
when evaluating investments. He starts with the purchase price of the asset in
Name
question, and then compares that price to the near-term income that the asset will
earn and distribute to him as owner. Dividing the latter by the former produces a
Email *
ratio he calls the current yield, which in the case of both the farm and the property
was about 10 percent. He then tries to estimate the rate at which this distributed
Subscribe
income will grow over time.
And thats it. Its certainly true that many interesting things follow from this RECENT POSTS
capitalism in the first place. Capital can be transformed into assets that are
productivei.e. that produce income, and the decision of the capitalist comes down ARCHIVES
to comparing the income produced by an asset with the capital investment required
to earn the right to receive that income. August 2016
July 2016
One of the happy paradoxes of investment life is that the more you discipline April 2016
yourself to stay within the simple frameworks, the more sophisticated and complex February 2016
your thinking can become. Staying within Buffetts framework allows you to compare December 2015
every investment to every other investment by reducing them all to their common August 2014
underlying ideas, income and capital required to produce the income, both now and March 2014
over time. It prevents you from making common analytical mistakes, such as September 2013
neglecting to penalize a fast-growing enterprise for the capital required to produce August 2013
that growth, or neglecting to reward an enterprise that can grow without additional July 2013
capital (Buffetts farm and property fall into this category). It forces you to ask June 2013
yourself where might future growth in distributed income come from?, which is May 2013
perhaps the most useful question a professional investor can ask on a day-to-day March 2013
basis.
And finally, Buffetts framework is the only framework that is both theoretically and
intuitively true. Its difficult to explain, but once the basic intuition behind all of
this clicks in your head (true confession: it didnt click for me until I was in my 30s,
and even now I often have to remind myself of it), you can see all kinds of things
more clearly. You can see how seemingly different things are really just different
names for the same thing, which allows you to read things like a stock is just like a
bond with a magic coupon that grows and feel less rather than more confused. Or
you can use this intuitive understanding to see when the normal rules dont apply:
An insurance business, for instance, can be seen as an enterprise in which the basic
framework of capitalismcapital is transformed into assets that produce income is
inverted to become income produces assets that can be used as capital.
The ability to work hard to see things clearly and simply is perhaps the ultimate
competitive advantage that one investor has over another. This ability is obviously
good for allocators, but its also good for the investor himself/herself, because its
probably the purest source of joy in investing or any other kind of analytical work.
Wall Street has many dirty secrets, and one of them is how few professional investors
think as Buffett does. The price they pay is not only worse performance, but less joy
too.
*To be more precise, it can be shown that for an investment that pays a coupon that
grows at some rate over time, the internal rate of return of the investment is roughly
equal to the sum of the initial yield and the annual growth rate of the yield. A given
internal rate of return does not mean the investor will earn exactly that rate of return
thats only true if the return on all reinvested distributions turns out to be exactly
the same as the return on the initial capital outlay, which almost never happens. But
the IRR is useful as an indifference point: If your rate of return on reinvested
distributions ends up being lower than your IRR, then youre still better off having
made the capital outlay. If on the other hand you end up earning a higher rate of
return on reinvested dividends, then your capital outlay was a mistake, but the idea
is that your IRR is high enough that its a high-class mistake.
400 Central Park West, 5T 2016 Manham Enterprises, LLC
New York, NY 10025 All Rights Reserved.