Warren Buffett part 6 Managers

Buffett has often said, “When a good manager and a bad business meet, the reputation of the bad business remains, but the reputation of the good manager goes.” Finding a sustainable competitive advantage for the business is always more important to Buffett than that of good managers. The latter come in handy for him. The most important individual in a company is the CEO. He must always prioritize the interests of the company. His ego must not demand much higher rewards even when his earnings are sufficient. The CEO must constantly fight against arrogance, bureaucracy and complacency, because they are the worst enemies of business.

A good manager has three special characteristics:

1. Reasonableness

2. Owner-friendliness

3. The ability to resist conformity, i.e. following others

The most important task of a manager is to allocate capital. Many CEOs fail Buffett in this task because they do not have enough experience in it before being elected as CEOs. This lack makes many fail even when the quality of the business is high. Capital allocation can be done in the following ways:

1. Investing in current operations

2. Repurchasing own shares

3. Paying dividends

4. Acquisitions

5. Paying off debts

The above allocation methods are not mutually exclusive. Many companies allocate their capital in all ways. The differences in their emphasis depend partly on where in the company's life cycle they are. In the development phase, the company loses money, so all the money goes to improving current operations. The company will probably also need to borrow money. In the rapid growth phase, most or all of the money goes to growth, i.e., current operations. A company that has reached the mature phase generates positive cash flow, which can also be used for alternatives other than investing in current operations. In the final, fourth phase, the company's turnover and profit begin to decrease as the company increases its capital, until the capital also starts to be lost and the company has to cease operations. In the last two phases, capital allocation has many options.

Berkshire invests mainly in companies at a mature stage. Let's start with investing in current operations. According to Buffett, a company should allocate its capital primarily to its current operations, i.e., efficiency, expansion of its scope of operations, expansion or improvement of current operations, and other measures aimed at increasing the moat. In reality, the situation is rarely such that a company should allocate all of its distributable assets to its own business. Investing in current operations only makes sense when the cost of capital acquisition is lower than the returns.

Buffett is considered to favor the purchase of its own shares as the best way for companies to distribute their excess capital to their owners. The most important criterion for Buffett is price. An owner or investor should favor this allocation method only if the company's shares are highly likely to be undervalued. Another reason for management to buy its own shares is that it signals that it has the best interests of its owners in mind. Buffett has two reasons for the wisdom of buying its own shares below their true value alternative. The first is when investments in the company's own business make more sense and debt growth does not make sense. The second, but less common, option is when the acquisition offers clearly more value to the owner than buying undervalued own shares.

The most important aspect of dividend distribution from Berkshire's perspective is whether the management of the acquired company can make more money for Berkshire by investing in its own business than Berkshire's ability to reinvest the same money elsewhere after taxes. There is no clear answer to this question, because company management has different abilities to allocate capital. In addition, the level of taxation affects the interest rate. Buffett favors buying sufficiently large shares of companies, because Berkshire's taxes are then lower. In that case, reinvesting the profits is more profitable from a tax perspective.

Buffett is skeptical about buying growth through takeovers or mergers. In his opinion, these take place on average at the expense of the current owners. The seller knows the value of his business better than the buyer on average. Sometimes, the seller may be in such a difficult situation that that the acquisition makes sense. For a company, managing a new business and merging it with its own business increases the likelihood of mistakes by management. It is better for it to distribute profits to owners, either as dividends or by buying back its own shares. The most important question a CEO can ask is “will the acquisition or merger make our current owners wealthier on a per-share basis than before?”

Berkshire focuses on investing mainly in companies with no net debt, so paying down debt as an alternative to allocating capital is rare for it. Paying down debt can be worthwhile when investing the company's capital cannot generate returns that are greater than the interest paid on the debt. In theory, the opportunity costs of paying down debt can be determined, but in reality they are difficult to calculate, at least if you believe Charlie Munger, who has said that no one at Berkshire knows how to calculate them.

Owner-friendliness is an important characteristic for managers. Corporate management is most likely to be owner-friendly when it has a large portion of its assets tied up in the company's shares. An even better situation is when management has purchased the shares with its own money and has not acquired them at the expense of other owners, such as through stock options. Corporate management must be absolutely honest and always tell the owners the truth. This also applies to its own mistakes. The most important things to tell financially literate owners help answer three questions:

1. What is the value of the company's business?

2. What is the probability that it will meet its future commitments?

3. How well has the management done compared to the opportunities given to it.

Business leaders must have the courage to openly talk about their mistakes, because they will make them sooner or later. Overly optimistic managers pursue their interests in the short term, but everyone suffers from exaggeration in the long term. An investor can examine the admission of mistakes and the extent of optimism by looking at what management has said about the future prospects in its previous reporting. The words can then be compared to the company's success after the reporting.

Capital allocation should be logical and simple. Why do so many business leaders still fail? According to Buffett, the main reason is the tendency of business leaders to conform, i.e. to follow and repeat what others do. For some reason, management rationality disappears as soon as herd mentality strikes. This has several consequences. The first consequence is the company's resistance to change. The second is the waste of funds generated by the company's projects or takeovers. The third is the need of the company's manager for acquisitions. He is supported by producing useless and detailed reports that confirm the damage caused by his stupidity. The fourth consequence is following other companies in the industry by expanding the business unnecessarily, by having similar option programs or by any other stupidity that has been imitated by others.

Unfortunately, few business managers dare to look stupid at a time when other companies are jumping off a cliff to their deaths. Changing direction or making decisions that seem different is not easy. It is easier for business owners to accept the inevitable short-term losses than to make the necessary changes in the management of the company. Instead of making changes, many managers do stupid things, believing that acquisitions will help them achieve better results. Three factors best explain Buffett's follies: First, most CEOs can't control their urges to do something that leads to acquisitions. Second, most CEOs compare their companies to others, whether they're in the same industry or something else. Third, most CEOs have too much confidence in their own abilities.

This is all a result of following other CEOs unreasonably. Part of the reason may also be the operating environment, where CEOs have to be able to justify their compensation while owners pursue short-term interests. Berkshire's unique corporate culture does not encourage this kind of behavior, so it has helped the company succeed. Buffett has never had to fear being fired, so he has been able to facilitate similar activities.

Warren Buffett part 5, Selling

 Selling

Buffett believes in long-term investing in companies that enjoy enduring competitiveness. His ideal holding period is eternity. Buffett has said that he is not prepared to sell any of the companies that Berkshire owns outright. This does not mean that he is not prepared to sell his minority stakes in publicly traded companies or other investments, such as bonds. Selling is a rarer event for Buffett. His motivation to sell is primarily due to the following events:

1. The market bubble has grown too big

2. A better opportunity arises

3. A change in the business or its operating environment

4. The target price is met

Market bubbles are rare. They do not come many times in a century. A bubble takes a long time to form. It can be characterized by a period when companies with P/E ratios normally below twenty rise to forty or fifty. Corporate valuations have risen to levels that are untenable. During a bubble, bonds are likely to yield more than stocks, so it’s a good time to sell. As I write this in March 2017, bonds are in an even bigger bubble, so buying them is not recommended. Stocks are not suffering from bubble prices as I write, even though they are high.

Sometimes you may find yourself in a situation where you don’t have enough cash when you find a buying opportunity in an investment other than your holdings. In this case, you may have to sell your holdings if you can’t leverage them. Buffett sees this as a valid reason to sell so that you can invest your money in a better-performing asset. The expected return must be significantly higher for a switch to be justified. As I write this, Berkshire has so much cash on hand that it has no need to sell its holdings to buy better assets.

A market economy is a constantly changing system, which means that change is a natural part of it. Companies' business operations change, but they must not go in a direction where a permanent competitive advantage is lost or an entire industry melts away. Buffett's Berkshire Hathaway was a good example of the latter when its textile business moved to cheaper countries in the 1950s and 1960s. Banks and other financial institutions are the most dangerous investment targets because they are able to hide changes that threaten them on their balance sheets. This applies to companies in the industry whose profits and return on equity are disproportionately high. Berkshire sold Freddie Mac shares for this reason.

Meeting the target price is perhaps the rarest reason to sell, and this mainly applies to Berkshire's arbitrage trading, which is almost non-existent today. When the target price is met, it is good to sell because there is not much to gain, but even more to lose. Buffett engaged in this type of trading more when he had a private investment firm. Today, Berkshire's capital is so large that the benefits of such activity are not sufficient.

Warren Buffett part 4. Prices

Finding a sustainable competitive advantage in a company's business is important, as is valuation. Finding one is not something an investor can take advantage of unless they can buy shares at the right price. Opportunities don't come along often. Not even every year. An investor needs a significant margin of safety to ensure that the price paid is right. This requires a price decline that is the result of recurring events in the stock market, in a single industry, or in a single company's business. Each of these events has unique effects on the stock prices of individual companies. Understanding and recognizing the following events will help you get shares at the right price:

1. Bear/Boom Market Cycles

2. Business Recessions

3. Single Major Setbacks in Business or Society

4. Structural Changes

5. Wars

Buffett takes advantage of price declines to buy shares. He understands that investors need them to buy great businesses at reasonable prices. A bear market is the best time to buy shares. In addition, Buffett buys businesses when investors experience a temporary panic or a temporary downward correction in stock prices during a bull market. A bear market is generally considered to be a situation where the market has fallen 20% or more from the previous peak.

According to my sources, according to Buffett's definition, bear markets require a larger price decline from the peaks. During his lifetime, there have been price declines in the early 1930s, the early 1970s, the late 1990s, and 2008/2009. In each bear market, prices have corrected tens of percent after a large price increase. Large price declines create the best situations for buying. In bear markets, you can buy the businesses of companies that benefit from a permanent competitive advantage cheaply. These peak opportunities are rarely taken advantage of.

The bear markets defined by Buffett are rare, so an investor cannot rely solely on them to expect reasonable prices. In addition, investors should be prepared for moments when the market panics for a short period of time. These moments rarely lead to changes in the profitability of the business. The best individual buying moments come when short-term market panics combine with bad news about the company's business, such as a momentary drop in earnings.

All bull markets end and a decline in prices begins. At true peaks, P/E ratios have increased from single digits to at least thirty. Eventually, the stock prices of companies whose results do not improve experience a significant increase in price. Eventually, the investment community announces that results do not matter. The result can be a bursting of a stock bubble or a long and steep decline in prices. A bear market is fast compared to a bull market, so it takes a long time for collapsing prices to return to their previous peaks.

Industry downturns offer good buying moments. When the entire industry suffers, the stock price of each company falls. The depth and length of recessions vary. A recession can lead to major difficulties or a temporary drop in profits. It helps the best companies in the long run while the worst ones are destroyed. The best companies get to buy the most profitable businesses of the worst ones at a deep discount or replace them with their own. All industries have their own cycles, so investors can prepare for the bottoms of cycles.

Sometimes even great companies make stupid mistakes that generate losses or something unexpected happens to them, such as a serious illness of the CEO. These can lead to price drops that are usually too large for the damage. Your task is to assess whether this is an isolated event or whether it causes irreversible damage to the business. A company with a lasting competitive advantage will almost always overcome such difficulties. Such losses come from lawsuits, such as price cartels.

Structural changes, such as mergers, takeovers or the establishment of new factories, can produce temporary and unexpected losses. Large project schedules sometimes get stretched. They cause a short-term decline in earnings. Investors may interpret the changes as permanent, even though they appear as earnings improvements over a longer period. This is not always the case, so investors cannot assume that this will be the case.

The threat of war can cause investors to panic. It causes them uncertainty and fear of a major armed incident. The threat of war often causes a market-wide price reaction, which causes investors to collect cash by selling their shares, leading to a temporary market disruption. Most threats do not materialize.

Warren Buffett Part 3 Sustainable competitive advantage

 Sustainable Competitive Advantage

Competitive advantage refers to a company's ability to produce products or services that its customers want more than its competitors. It can also refer to the ability to produce them more cheaply, or both. The more sustainable a competitive advantage is, the harder it is for competitors to achieve it. A company with a sustainable competitive advantage generates more money for its owners than companies that compete fiercely with others. Companies with a sustainable competitive advantage use business models in which they offer unique products, services, or buy and sell products or services that people use constantly at a low price.

Buffett describes a company's competitive advantage compared to companies in the same industry as a moat. The wider the moat, the greater and more sustainable its competitive advantage. For Buffett, the most important task of an investor is to assess a company's competitive advantage and its sustainability. The moat rarely stays the same. Every action a company or its representative takes either increases, decreases, or keeps the width the same.

A friendly smile from a customer service representative increases the moat, and bad customer service narrows it. A wide moat is reflected, among other things, in a company's high profit margins and stable financial situation. Just because you can't see a company's moat doesn't mean it can't exist. According to Buffett, you have to find it if you want to invest in a company. A company's competitive advantage has two requirements: It must generate more than its cost of capital and it must have higher profit margins than its competitors on average.

The sustainability of competitive advantage excludes many companies and industries from consideration. A company must have at least a decade of history of demonstrating its competitive advantage so that an investor can distinguish it and assess the width of the moat. According to Buffett, an investor must believe that the competitive advantage will likely exist for another 25-30 years for the company to be worth investing in. New technologies offer opportunities for fabulous returns, but finding the companies that best utilize them is a guesswork for him. The prospects for long-term competitive advantage are largely obscure. In the early 1900s, there were a couple thousand different car manufacturers in the United States, and today there are only a handful. Choosing the right companies has been a matter of luck.

A company’s moat can have one or more sources. The following things can form a moat:

1. Supply-side economies of scale

2. Demand-side economies of scale

3. Brand

4. Regulation

5. Intellectual property

6. Corporate culture

When a company’s costs decrease as it increases the number of services or products it produces, supply-side economies of scale come into play. This gives the company greater purchasing power, which lowers unit costs. Large companies can specialize in products or services. In addition, larger size offers geometric advantages. A brewery can use larger tanks to brew beer, which lowers unit costs. In a market economy, industries tend to move toward a smaller number of market participants. Before long, a few players will share almost all of the turnover, with a few smaller companies competing in their own areas of specialization. Investors should focus on the market leaders or number twos. They share the majority of the market and are likely to be the most profitable companies in the industry. Even leaders in small areas of specialization have relative economies of scale.

When a product or service becomes more valuable to customers as more people use it, the company benefits from economies of scale on the demand side. Facebook and Twitter, among others, have this advantage. The same is true for credit card companies, which get more revenue the more companies accept their cards. Some companies benefit from economies of scale on both the supply and demand sides, such as Amazon. As its business grew, the prices of the products it sold dropped, which increased the number of customers. This increased revenue, which attracted more sellers, which lowered prices further, increasing the number of customers. This feedback loop worked to everyone's advantage. It doesn't work forever, but it has its limits.

Products or services create images in you that you associate with their name. The more you use them, the more it influences the images your brain creates. The value of brands depends on the collective images of large groups of people and their sum. The best brands have a greater sum of positive images than other brands. The best brands don't just sell products or services, they sell experiences. Customers are willing to pay more for brands, which increases a company’s profit margins. Brands add value to a company when they increase customers’ willingness to pay or reduce company costs.

Brands not only increase profits, but they also make customers buy products and services again and again based on the brand name. They also increase customer numbers through psychological peer pressure. Many people switch to a particular brand because others use it. Brands act as moats because the images they create own part of people’s brain circuits. The more you use the same products or services, the stronger the connections are formed. The easier it is to buy products and services from the same brand. The biggest mistake a company can make with its brand is to change it. Customers need to understand what kind of image they have of the product or service. Coca Cola came close to changing its main product, which would have resulted in disaster.

Some companies have a lasting competitive advantage because regulation has created a moat for them. Regulation often helps companies more than it helps customers, which increases profits. Credit rating agencies have a moat because regulation only allows them to participate in bond ratings. Some electric utilities have a moat because they are the only players in their markets due to regulation. Regulation may end, so companies that have a moat should only be invested in if they are certain that it will last.

Intellectual property rights, such as patents, can give a company a lasting competitive advantage. They can create a monopoly, but they do not guarantee it. Most patents are evasive. The protection offered by patents is not eternal, as they are usually valid for a maximum of 20 years. Patents work best in businesses where entering the market requires large capital expenditures. Neste’s biodiesel is an example, because its production requires large amounts of capital. This does not yet guarantee a lasting competitive advantage, but strong regulation with patents reinforces it. Individual patents rarely have any real significance, but large numbers of patents can act as a moat.

Corporate culture can be one source of sustainable competitive advantage. Corporate culture determines, among other things, whether mandatory personnel changes affect success. It is shaped over time. It is about ways of thinking. Focusing on long-term success, emphasizing simplicity, and other values ​​that are less often cherished in companies can act as part of the sources of sustainable competitive advantage. They rarely guarantee sustainable competitive advantage.

Warren Buffett part 2 Return on Equity (ROE) and inflation

 Return on equity and inflation

A high return on equity is one of Buffett's most important requirements when looking for investment targets. It tells you how well a company is using its capital. Buffett wants a consistently high return on capital. He studies the returns on equity for the last ten years in companies' earnings data. In the United States, the average returns on equity for the last 10 years have varied between ten and fifteen years. Buffett demands a higher-than-average return on equity in the long term.

Buffett does not see return on equity as a reasonable alternative to measuring the efficiency of financial institutions. Instead, he uses the return on total capital. He hopes this figure is above one percent. Too high a percentage tells Buffett that banks' businesses are too risky. Average returns on equity do not vary significantly over 10-year periods, so the magnitude of inflation directly affects average returns. The higher the inflation, the more it eats into investors' returns. It can also be seen as a tax that eats into profits. A company can improve its return on equity in five different ways:

1. By increasing the turnover rate of capital

2. By using cheaper loans

3. By increasing external capital

4. By reducing income taxes

5. By increasing the profit margins on its sales

Return on equity will decrease if any of the above goes wrong. In the first case, the most important things to consider are accounts receivable, inventory, and fixed assets such as factories and real estate. Accounts receivable increase in proportion to sales growth regardless of whether the reason is inflation or an increase in unit sales, so there is no room for improvement. In the long run, unit inventories follow sales growth, although in the short run the size of the physical inventory may vary. The inventory valuation method LIFO increases the stated inventory turnover rate during inflation. When sales increase due to inflation, inventory valuation either remains constant (if unit quantities do not increase) or follows sales growth (when unit quantities increase). In both cases, sales increase.

In the case of fixed assets, inflation increases the turnover rate, assuming that it affects all products equally. Machinery and other fixed assets must be replaced, but this happens slowly when sales grow faster. The slower fixed assets are replaced, the more the turnover rate increases. This activity stops when the replacement cycle is over. If inflation is constant, sales and the value of fixed assets increase at the same rate. Inflation increases the turnover rate slightly, but it does not matter much. Its size does not produce a large improvement in return on equity.

A company can improve its return on equity with cheaper loans. In the current situation at the end of 2016, this is hardly possible in Finland, as the ECB is buying bonds, which keeps loan prices low. Higher inflation makes borrowing more expensive on average. Strongly accelerating inflation quickly increases the need for capital. In this case, the replacement of existing loans is done at a higher price. This leads to a small decrease in the return on equity.

Additional debt increases returns, but it has its risks. In reality, the best investment targets need a small amount of debt or none at all, but the worst ones never get enough of it. Inflation is therefore irrelevant to the returns of the best companies. On average, the increasing costs of debt override the returns generated by a larger amount of debt. Investors should be wary of large amounts of debt. They should be a warning sign for investors. The average return on equity without debt is superior to the average return obtained with debt leverage.

Corporate taxation is in an interesting situation. The movement of capital around the world is becoming easier all the time and corporate taxation is experiencing downward pressure. This development can also be seen in Finland, where the tax rates paid by companies are on a downward trend. I do not see an end to tax competition. Rising inflation can raise corporate tax rates and reduce returns on capital. It is highly likely that this will have little effect.

Higher profit margins improve returns. The biggest margin reducers are raw materials, employees, energy and many taxes or tax-like charges. The relative share of these costs is unlikely to decrease during inflation. Rising inflation will probably reduce margins slightly. Most large companies, even large ones, cannot get their customers to pay for their inflation-increased costs by raising their prices sufficiently. Only a few companies are able to do this, and Buffett tries to focus on finding such companies.

These five factors do not increase returns much during high inflation. Investors have been getting roughly the same returns on equity on average from decade to decade. Inflation takes its toll. It averages around 3 percent over the long term in developed economies, but as it rises, average real returns decline at the same rate. Inflation is difficult to predict, so it has to be accepted as part of investing. During periods of average inflation, there is no need to focus on it. Buffett focuses on finding companies that have consistently high profit margins and/or high capital turnover. He also makes sure not to overpay for them.

Warren Buffett part 1 Introduction and definition of investing

Introduction

 “If I wrote a book about investing, no one would believe it was written by me because it would be so short.”

-Warren Buffett

Warren Buffett is perhaps the greatest investor of all time. His Berkshire Hathaway has returned an average of 19.2% on its capital over the past fifty years (1965-2015). During the same period, the S&P500 has returned an average of 9.7%. In reality, his personal annual returns are higher because before Berkshire he ran his own investment firm, Buffett Partnership, which returned an average of 30% per year. I have to use the word “maybe” because many investors have better average returns over several decades, but not over such a long period. After a certain point, the law of large numbers affects average returns, reducing them, so it is difficult to compare the numbers.

Buffett is certainly one of the best of all time, so his achievements cannot be underestimated.

More has been written about him as an investor than anyone else. Many have tried to find the secret to his success. In reality, there are so many reasons that few have found them all. I myself do not belong to this group. He is talented, but that is only one reason. I will not begin to guess all the reasons, but I will highlight a couple of the less understood ones. The first is that he has spent quality time understanding business and investing perhaps more than others. The second reason is that his quality time has been spent in an environment that has guaranteed maximum concentration on the essentials.

Buffett is known for spending about six hours a day studying business since he was young. He can be estimated to have spent about 100,000 hours of his life over seven decades. Such hours are not found in many other people in the world when it comes to investing. He has spent most of this time either in his office or at home in his own room. Both places have been minimally disturbed, so he has been able to focus on studying and understanding business. The benefits of this time are undeniable and he has been able to refine his talent into returns better than other investors.

Warren Buffett's most significant insight can be considered sustainable competitive advantage and its utilization in investment activities. Buffett has been able to create a method that allows him to identify sustainable competitive advantage by studying a company's financial statements over a longer period of time. In addition, sustainable competitive advantage can be sought without studying financial statements. I will focus on this issue in the chapter on Buffett's partner Charlie Munger.

Buffett has been able to simplify complex investment concepts, making things easier to understand. You can get more out of his interviews in a few hours than you ever could from high-paid investment advisors. I recommend getting acquainted with the wonderful world of YouTube. He is an almost perfect investor, but he also makes mistakes. Another way to get acquainted with his thinking is to read his annual letters to his company's shareholders. They contain a lot of useful information.

Definition of Investment

The definition of investment used by Warren Buffett and Charlie Munger can be found in Berkshire's investor letters from 2011, among others. It reads as follows: "Investing means transferring one's current purchasing power to others so that one can reasonably expect to receive greater purchasing power in the future after taxes paid." According to this definition, the risk of investment is the considered probability that an investment will cause a loss of purchasing power during the planned holding period of the investment.

From the definition, it follows that only one thing matters. The purchasing power of the capital being invested must be greater in the future than the present value of its purchasing power. To calculate future purchasing power, you need to evaluate four things:

1. How much money will the company generate for you during the investment period?

2. When will you receive that money?

3. The probabilities of the above?

4. How much will the value of the money received decrease over the entire investment period?

Things seem simple. In reality, figuring out the above-mentioned issues is not easy. Buffett's Berkshire has made most of its income from stocks. It has also invested its money mainly in bonds. He uses the same formula to calculate the future purchasing power of both. The biggest difference is that the amounts of money generated by stocks vary. The bond yields and their timing are known to the investor in advance.

The biggest differences between Buffett and theorists can be seen in what money he counts as owner returns. In addition, the time frame used differs significantly between theorists and him. The main difference is that others count only dividends as returns to owners if the shares are not sold, while Buffett uses, among other things, his own term, owner returns. Theorists use eternity as their time frame, and Buffett, according to my sources, uses ten years. This means that the probabilities are better on Buffett's side. He also doesn't believe he can know the exact numbers, so he uses Graham's safety margin in his investment decisions. In reality, most market participants operate with such a short-term perspective that they don't use calculations, although many do.

Probabilities vary depending on the target, so I won't comment further on them at this stage. Everyone can make their own estimates of the depreciation of money. Buffett believes that stocks can be seen as bonds. The higher the expected real interest rate and the probability of receiving interest, the higher the present value can be calculated for the investment. The cheaper you can buy a business, the better the returns you will get, if everything goes according to plan.

This is what investing is essentially about, namely increasing future purchasing power.

In Buffett's opinion, investing is overly complicated. It has its own categories, such as value and growth investing or business investing, but the goals are the same. These categories are not needed for anything. Using them can tell you few different things, depending on the person.

1. They don't understand enough,

2. They pretend to be smarter than they are, 

3. They try to stand out from the crowd. 

4. They can also be a combination of all of these or two. 

Alarm bells should always ring when dealing with people who use many categories.

Philip Fisher Part 17, His Mistakes and Summary

 Mistakes are inevitable and no one avoids them. How you react to them is more important. Fisher made them. They were concentrated at the beginning and end of his investing career. Early mistakes are inevitable. Most investors learn nothing, but the best ones learn even more. They have learned more from mistakes than from success, and successful investors are no exception. Fisher's late-career mistakes, according to his son, were largely due to his poor health.

Fisher was also a victim of the great stock market crash that began in 1929. He thought stock prices were expensive, but he still put his money in three stocks that seemed cheap with low P/E ratios. He lost almost all of his investments by 1932. He put his money in a locomotive manufacturer, a roadside advertising company, and a taxi company. From this he learned that a seemingly cheap price does not guarantee a successful investment. It can be a sign of weakness. Fisher also tried market timing three times. Each time, he made profits, but found them too small for his time, so he stopped the business when it was unprofitable. In addition, he struggled in the early days to set a suitable purchase price. As a result, he often missed out on stocks that would have brought him big profits.

It is not easy to expose errors in thinking, but I think Fisher’s belief in the importance of top management in good investments is excessive. To quote Buffett, “when a company with a bad reputation meets a company with a good reputation, the company’s reputation is what remains.” I think Fisher never understood that human irrationality can lead to a lasting competitive advantage. This is one reason why he was not good at investing in companies that sell consumer goods. On the other hand, he was good at focusing on the companies that he understood best.

Constantly worrying about everything bad was a characteristic of Fisher. It made him feel more secure. Even small details could make him worry about the risks associated with an investment. This made him abandon many investments because he did not dare to take even small risks associated with them. His returns were lower due to this character trait. He did not dare to take as calculated risks as many other top investors.

Summary

Fisher was the father of qualitative thinking. His process was long and demanding. It is not for everyone. It is easier to implement if you are extroverted and ready to talk. For introverts, it is difficult and perhaps too demanding. I do not recommend it for them. Fisher succeeded well at it for one reason or another, so it is not impossible for those who do not care about other people. Fisher believed that luck equals in the long run, so for him, continued investment success depends on skill and sound principles. Fisher's book Developing An Investment Philosophy contains eight principles that he used, which crystallize his investment philosophy:

1. Buy stocks of companies that have disciplined plans for long-term profit growth and the inherent qualities to let others enjoy their profits.

2. Focus on the above-mentioned companies when they are not popular in the market.

3. Hold the shares until the company undergoes significant changes or has grown to a point where it cannot be expected to grow faster than the general economic situation.

4. Investors focused on appreciation should downplay the importance of dividends, because the best opportunities for returns are found in profitable companies that pay little or no dividends.

5. Making mistakes is a necessary price to pay for large investment profits.

6. There are a limited number of great companies. Their shares are usually not available at attractive prices, so the investments must be large when the opportunities arise. Investments should be concentrated only in the best targets. Owning more than 20 shares indicates incompetence.

7. The basic ingredient of investment management is not to directly accept the views of investors or to oppose them without understanding reality.

8. Success in stock investing depends on hard work, intelligence and honesty.