Explanation of Warren Buffet's two rules of investing

http://www.livemint.com/Money/DIyXPTM5KdaagdXJqkTbQJ/Why-downside-matters-and-some-basic-arithmetic.html

Baseball - The Best Sports Analogy to Investing

Baseball - The Best Sports Analogy to Investing

• Know your sweet spot, and only swing at pitches you can hit. - Ted Williams (in book The Science of Hitting)
• The biggest difference between baseball and investing is in investing there are no called stikes.
• “The stock market is a no-called-strike game. You don’t have to swing at every everything- you can wait four your pitch. The problem when you are a money manager is that your fans keep yelling, ‘Swing, you bum!’ ” - Warren Buffett

Warren Buffett on Great Business

“The ideal business is one that generates very high returns on capital and can invest that capital back into the business at equally high rates. Imagine a $100 million business that earns 20% in one year, reinvests the $20 million profit and in the next year earns 20% of $120 million and so forth. But there are very very few businesses like this. Coke has high returns on capital, but incremental capital doesn’t earn anything like its current returns. We love businesses that can earn high rates on even more capital than it earns. Most of our businesses generate lots of money, but can’t generate high returns on incremental capital — for example, See’s and Buffalo News. We look for them [areas to wisely reinvest capital], but they don’t exist.
So, what we do is take money and move it around into other businesses. The newspaper business earned great returns but not on incremental capital. But the people in the industry only knew how to reinvest it [so they squandered a lot of capital]. But our structure allows us to take excess capital and invest it elsewhere, wherever it makes the most sense. It’s an enormous advantage.” – Warren Buffett (at 2003 Berkshire Hathway meeting.)

“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result."- Charlie Munger

Berkshire Hathway's ACQUISITION CRITERIA

Source: http://www.berkshirehathaway.com/2000ar/acq.html

ACQUISITION CRITERIA

     We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:

1. Large purchases (at least $50 million of before-tax earnings),
2. Demonstrated consistent earning power (future projections are of no interest to us, nor are "turnaround" situations), 
3. Businesses earning good returns on equity while employing little or no debt, 
4. Management in place (we can't supply it),
5. Simple businesses (if there's lots of technology, we won't understand it),
6. An offering price (we don't want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).

Criteria 2,3,5 &5 can be used by retain investors when choosing their investments into secondary markets

Warren Buffett on importance of behavior

“Good profits simply are not inconsistent with good behavior.”- Warren Buffett

Warren Buffett on predictability of earnings

"If a company’s future cannot be predicted, it cannot be valued."- Warren Buffett 

• “The World always has issues … The best thing to do when you are investing is to focus on the micro and focus on a specific business. It is hard enough to just hone in on a particular business and try to extrapolate forward what happens to that business. It will hurt investors more than it will help investors if they overdose on macro. Most of the macro things are very hard to predict and the best thing is to just not bother about predicting them” - Mohnish Pabrai [in response to question asked by young student on Global economy given the crisis in Russia, Iran sanction etc.]
• “The world’s always uncertain. The world was uncertain on December 6th, 1941, we just didn’t know it. The world was uncertain on October 18th, 1987, you know, we just didn’t know it. The world was uncertain on September 10th, 2001, we just didn’t know it. The world – there’s always uncertainty. Now the question is, what do you do with your money? And if you – the one thing is if you leave it in your pocket, it’ll become worth less – not worthless – worth less over time. That’s certain – that’s almost certain. You can put it in bonds and then you can get a certain 2 percent for 10 years and that’s almost certain to be less than the decline and the purchasing power. You can put it in farms and the farms will probably keep growing corn and soybeans and they’ll grow it whether, you know, whether Italy has trouble tomorrow or not. It’s very interesting to me, if you own a farm and somebody said, you know, Italy’s got problems. Do you sell your farm tomorrow?” - Warren Buffett [Answers on how Warren processes Uncertainity.]
• If you own a good business locally in Omaha and somebody says Italy’s got problems tomorrow, do you sell your business? Do you sell your apartment house? No. But for some reason, people think if they own wonderful businesses indirectly through stocks, they’ve got to make a decision every five minutes. So I do not think if Ben Bernanke comes up and whispers to me that he’s going to do X, Y or Z tomorrow, I’m not going to change my view about what businesses I want to own. I want – I’m going to own those businesses for years just like I would own a farm or an apartment house and they’ll be all kinds of events and there’ll be all kinds of uncertainties and in the end, what will really count is how that business or farm or apartment house does over the years.” - Warren Buffett
• “I don’t think about the macro stuff. What you really want to do in investments is figure out what is important and knowable. If it is unimportant or unknowable, you forget about it. What you are talking about is important but is not knowable…. We don’t want to pass up the chance to do something intelligent because of some prediction about something that we are no good at anyway” - Waren Buffett
• “That factor so overrides anything else. If you’re right about the business, you’ll make a lot of money … the timing part of it is a very tricky thing. I don’t worry about any given event if I have a wonderful business … With a wonderful business, you can figure out what will happen, you cannot figure out when it will happen. You don’t want to focus too much on “when”, you want to focus on “what”. If you’re right about “what”, you don’t have to worry about “when” very much” - Warren Buffett

[Source: http://rakesh-jhunjhunwala.in/i-never-worry-about-macro-factors-when-buying-stocks-mohnish-pabrai/]

BUFFETT WISDOM THAT YOU MAY NOT HAVE HEARD BEFORE

• "Only way to stop a panic in today's times is to have someone say with absolute authority, "I will do whatever it takes to make this right."
• "The next panic will most likely come from a cyber/nuclear/biological or chemical attack on the US. The ability of psychotics, religious fanatics etc. to impact people has tremendously increased since 1945 (atomic bombing of Hiroshima and Nagasaki)"
• "The US will always bounce back. Our system really works, if you have cash during a time of panic, BUY"
• The auto industry has been the one of the most important industries during Buffett's investing career. He has extensive knowledge of auto. Despite that he doesn't feel comfortable buying auto stocks. Instead he chose to buy an auto dealer with 78,000 dealerships across the US. Simply because five years from now, he doesn't know which model will sell but he does know that the auto dealer will sell it. This is the same story in tech, Buffett does not know who the leader will be.
• 
  

Warren Buffett logic on buying IBM

It is always better to know reasons why great investors are buying particular investment. It is much important to know than what they are buying. Former is like learning to fish while latter is getting fish for a day.


Below is explanation from Warren Buffet on IBM shares buying. It was interview to CNBC.

BUFFETT TO CNBC: “I look at everything but most things I decide I can't figure out their future. IBM helps IT departments do their job better. We've got dozens and dozens of IT departments at Berkshire. I don't know how they run. I mean, but we went around and asked them and you find out that they very much get working hand in glove with suppliers. And that doesn't mean things won't change but it does mean that there's a lot of continuity to it. And then I think as you go around the world, IBM, in the most recent quarter, reported double-digit gains in 40 countries. Now, I would imagine if you're in some country around the world and you're developing your IT department, you're probably going to feel more comfortable with IBM than with many companies. - Warrent Buffett to CNBS (on IBM)

I said I competed with IBM 50 years ago. I was chairman of the board, believe it or not, of a tech company one time, and computers used to use zillions of tab cards and IBM in 1956 or '7 signed a consent decree and they had to get rid of half the capacity. So two friends of mine, one was a lawyer and one was an insurance agent, read the newspaper and they went into the tab card business and I went in with them. And we did a terrific job and built a nice little company. But every time we went into a place to sell them our tab cards at a lower price and with better delivery than IBM, the purchasing agent would say, nobody's ever gotten fired from buying—by buying from IBM. I mean, we probably heard that about a thousand times. That's not as strong now, but I imagine as you go around the world that there are—there's a fair amount of presumption in many places that if you're with IBM, that you stick with them, and that if you haven't been with anybody, you're developing things, that you certainly give them a fair shot at the business. And I think they've done a terrific job of developing that. And if you read their reports—if you read what they wrote five years ago they were going to do and the next five years, they've done it, you know, and now they tell you what they're going to do in the next five years, and as I say, they have this terrific reverence for the shareholder, which I think is very, very important. And I want to give full credit to Lou Gerstner because when he came in, I was a friend of Tom Murphy's and Jim Burke's, and they were on the search committee to find a solution when IBM was almost broke in 1992, and everybody thought they were going pretty far afield when they went to Lou Gerstner. - Warrent Buffett to CNBS (on IBM)

Well, you don't have to think of another one, Joe. And if you read his book, you know, "Who Said Elephants Can't Dance?" it's a great management book. Like I said, I read it twice. There were lots of things in that annual report but the truth is, there were probably lots of things in the report a year earlier or two years earlier that you say, why didn't I spot it then? And I think it was Keynes or somebody that said that the problem is not the new ideas, it's escaping from old ones. And, you know, I've had that many times in my life and I plead guilty to it. I will tell you one very smart thing that Thomas Watson Sr. said. I knew Thomas Watson Jr. just a little bit. Tom Watson Sr., this applies to stocks. He said, "I'm no genius but I'm smart in spots and I stay around those spots." And that's terrific advice. "I don't know of any large company that really has been as specific on what they intend to do and how they intend to do it as IBM," Buffett told CNBC in an interview. Buffett said he was convinced by IBM's long-term roadmap and by IBM’s entrenched position with major businesses. This “entrenched position with major businesses” is a big part of the durable competitive advantage that he looks for when investing. - Warrent Buffett to CNBS (on IBM)

BUFFETT TO CNBC: “The other thing I would say about IBM, too, is that a few years back, they had 240 million options outstanding. Now they probably are down to about 30 million. They treat their stock with reverence which I find is unusual among big companies. Or they really are thinking about the shareholder.” - Warrent Buffett to CNBS (on IBM)

Recently, IBM’s 5Yr Gross Margin (5-Year Avg.) is approximately 44.0% and its 5Yr Net Profit Margin (5-Year Avg.) is approximately 12.3%, while the industry Net Profit Margin (5-Year Avg.) is 11.2%, and the S&P Net Profit Margin (5-Year Avg.) is 11.5%.