A letter a day!

A letter a day!

Letter #65 2011

Key learnings:

1. The primary job of a Board of Directors is to see that the right people are running the business and to be sure that the next generation of leaders is identified and ready to take over tomorrow.

2. When is it beneficial for a company to do buyback?

1)Company has ample funds to take care of the operational and liquidity needs of its business.

2)Its stock is selling at a material discount to the company’s intrinsic book value.

“We have witnessed many bouts of repurchasing that failed our second test. Sometimes, of course, infractions – even serious ones – are innocent; many CEOs never stop believing their stock is cheap. In other instances, a less benign conclusion seems warranted. It doesn’t suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value. The first law of capital allocation – whether the money is slated for acquisitions or share repurchases – is that what is smart at one price is dumb at another. (One CEO who always stresses the price/value factor in repurchase decisions is Jamie Dimon at J.P. Morgan; I recommend that you read his annual letter.)”

3. Purchase of Bank of America shares

Bank of America was purchased by Buffett in the year 2011 for the very first time and Berkshire Hathaway still holds them.

“The banking industry is back on its feet, and Wells Fargo is prospering. Its earnings are strong, its assets solid and its capital at record levels. At Bank of America, some huge mistakes were made by prior management. Brian Moynihan has made excellent progress in cleaning these up, though the completion of that process will take a number of years. Concurrently, he is nurturing a huge and attractive underlying business that will endure long after today’s problems are forgotten. Our warrants to buy 700 million Bank of America shares will likely be of great value before they expire”

4.Investing is forgoing consumption now in order to have ability to consume more at a later date.

“Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. “

5.The riskiness of an investment is not measured by beta but rather by the probability 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.
6. Most of these currency-based investments are thought of as “safe”. In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.
(Money market instrument, bonds, mortgages)

“Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as the holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control.”