1983
Click here to read the letter.🧠 Key Takeaways
Short timeframes mean nothing. Many people focus on a business's performance over one or two years, but a year simply represents the time it takes for Earth to orbit the sun. If a business falls short of expectations within that span, it's hardly consequential because the two measures are unrelated.
Intrinsic value represents what can be taken out of the business in terms of its future cash flow potential, while book value tells you the current value of the net assets owned by the business.
Embracing periods of inactivity or "boredom" can be beneficial in investing. In fact, seeking boredom and avoiding unnecessary changes will likely lead to a better outcome.
“Casino-type markets and hair-trigger investment management”, which refers to frequent buying and selling of assets, act like an "invisible foot." Instead of facilitating progress, these practices disrupt and slow down economic growth, which is bad for society as a whole.
✍️ Memorable Quotes
“We never take the one-year figure very seriously. After all, why should the time required for a planet to circle the sun synchronize precisely with the time required for business actions to pay off? Instead, we recommend not less than a five-year test as a rough yardstick of economic performance. Red lights should start flashing if the five-year average annual gain falls much below the return on equity earned over the period by American industry in aggregate. (Watch out for our explanation if that occurs as Goethe observed, “When ideas fail, words come in very handy.”)”
This mirrors a similar sentiment by Terry Smith. Now I know where Terry got it from.
Basically, short timeframes mean nothing. Many people focus on a business's performance over one or two years, or some other brief period—but what does that really signify?
A year simply represents the time it takes for Earth to orbit the sun. If a business falls short of expectations within that span, it's hardly consequential because the two measures are unrelated.
However, if a business consistently underperforms over several revolutions around the sun—say, over five years—its place in your portfolio is worth reconsidering.
Underperforming in the short run can be forgiven, but the longer the timeline, the harder it is to overlook.
“We report our progress in terms of book value because in our case (though not, by any means, in all cases) it is a conservative but reasonably adequate proxy for growth in intrinsic business value - the measurement that really counts. Book value’s virtue as a score-keeping measure is that it is easy to calculate and doesn’t involve the subjective (but important) judgments employed in calculation of intrinsic business value. It is important to understand, however, that the two terms - book value and intrinsic business value - have very different meanings. Book value is an accounting concept, recording the accumulated financial input from both contributed capital and retained earnings. Intrinsic business value is an economic concept, estimating future cash output discounted to present value. Book value tells you what has been put in; intrinsic business value estimates what can be taken out.”
Book value is oftentimes mistakenly used interchangeably with intrinsic value. Here, Warren distinguishes between the two.
Book value is an accounting metric that measures the accumulated financial contributions from both capital and retained earnings. It offers a straightforward calculation without the need for subjective assessment. Yet, it's crucial to understand that book value doesn't entirely reflect a business's economic worth, AKA its intrinsic value.
Intrinsic value, on the other hand, is an economic metric that estimates the future cash output from the business discounted to present value. Unlike book value, it looks forward rather than backward, focusing on the potential future returns of the business.
Intrinsic value represents what can be taken out of the business in terms of its future cash flow potential, while book value tells you the current value of the net assets owned by the business.
“One of the ironies of the stock market is the emphasis on activity. Brokers, using terms such as “marketability” and “liquidity”, sing the praises of companies with high share turnover (those who cannot fill your pocket will confidently fill your ear). But investors should understand that what is good for the croupier is not good for the customer. A hyperactive stock market is the pickpocket of enterprise.”
We often hear phrases like "you get out what you put in" or "you get what you give," and we tend to apply this idea to every aspect of our lives (our jobs, the gym, etc.).
However, this philosophy doesn’t apply to investing. In fact, it’s the opposite.
There's a saying: "Investing is like a bar of soap. The more you handle it, the smaller it gets." In other words, simplicity often yields better results, and the more you tinker, the worse off you’ll be.
This idea challenges the conventional wisdom of getting out what you put in, but before making changes to your portfolio, it's essential to ask yourself why you're doing so. Is there a sound reason behind your actions, or are you just acting out of boredom?
If your actions have a legitimate reason behind them, that's acceptable. But if you’re honest with yourself, and can admit that you’re merely acting out of boredom, it's best to refrain.
There's no need to make changes solely for the sake of activity, even if your investments aren't performing as expected in the immediate. As Pascal said, "All of humanity's problems stem from man's inability to sit quietly in a room alone."
Embracing periods of inactivity or "boredom" can be beneficial in investing. In fact, seeking boredom and avoiding unnecessary changes will likely lead to a better outcome.
“Adam Smith felt that all noncollusive acts in a free market were guided by an invisible hand that led an economy to maximum progress; our view is that casino-type markets and hair-trigger investment management act as an invisible foot that trips up and slows down a forward-moving economy.”
Adam Smith introduced the concept of the "invisible hand" around the same time America gained its independence. He believed that in a free market, individual self-interest and competition would naturally guide resources and actions in a way that benefits society as a whole.
Essentially, Smith argued that individuals pursuing their own interests unintentionally contribute to the overall well-being of the economy. Ayn Rand believed this as well. This is actually a pretty standard idea shared by those who support Laissez-faire Capitalism.
Contrasting this, Warren believes that “casino-type markets and hair-trigger investment management”, which refers to frequent buying and selling of assets, act like an "invisible foot."
Instead of facilitating progress, these “invisible foot” practices disrupt and slow down economic growth, which is bad for society as a whole.