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.