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The Brilliance of Buffett

Warren Buffett's company, Berkshire Hathaway, published its annual report and shareholder letter early Saturday. Rarely will I read an annual report front to back, but this one is different.

Most reports have lots of pretty pictures but fail to teach me anything meaningful about business.

Buffett, on the other hand, has a knack for taking incredibly complex concepts and gracefully boiling them down to something a sixth-grader can understand. This year was no different with Buffett leading his readers through investment decisions made decades ago.

Although known for his stock market prowess, Buffett made his points this year recounting the thought process behind two real estate purchases made more than 20 years ago.

In both cases, Buffett bought in at a time when pessimism weighed upon the valuation of the assets. Instead of reacting in fear, Buffett knew this type of environment often offers great opportunities.

Lesson one: Do not allow the overly pessimistic or optimistic opinions of others to determine your investment strategy.

Recognize that there will be good years and bad years. What matters most is the ability to produce over long time frames (10 or more years). This requires one to think logically and independently. If you are going to try to get rich quickly, you will most likely succeed in being frustrated and broke.

Despite the pessimism that existed at the time, Buffett was easily able to assess that he should earn a 10 percent rate of return based upon what the real estate produced in terms of current yield - crops or rents. It was all very simple math.

Buffett was not gambling on someone offering him more for the property, as the "greater fool theory" often fails to pan out. Instead, Buffett was getting a very fair return based upon today's production. Any additional increase in yields or rents would just enhance the return.

Lesson two: A 10 percent return is a great starting point.

Buffett has now owned these properties for decades.

Lesson three: The longer you can hold a good investment, the less you will be affected by taxes, commissions and other frictional costs. This boosts an investor's net rate of return.

The billionaire from Omaha does not care that there are not quotes offered up every second for his real estate. He also doesn't care about quotes on his stocks, either. Whether he is buying an entire farm or simply shares in a publicly traded company, he does so based upon the long-term productivity of that asset.

Lesson four: Turn off the news and the computer, as they generally serve as a distraction. If you are truly a long-term investor, then rapid-fire quotes serve to distract, not inform.

Future productivity in a passive interest in a stock means the ability to sell more and earn more with great consistency over decades.

Lesson five: Whether you buy one share of a stock or more, behave like you own an entire farm or business with the understanding that the true benefit comes from increased future production.

Berkshire Hathaway is the largest shareholder in Coca-Cola. However, a logical assessment of the earning power of Coca-Cola does not require an accurate assessment on the direction of interest rates, unemployment or the Federal Reserve chairman. Although macroeconomic discussions make for interesting water cooler discussions, they are not very meaningful when selecting good businesses to own.

Lesson six: Don't worry about the broad economy.

Berkshire Hathaway and its subsidiaries use debt very sparingly.

Lesson seven: Don't be in a position where debt can pull you under. This is true for people, corporations and governments.

Buffett continues to show that intelligent investing is not hard, but it does require patience and discipline. Additionally, it is better to be approximately right than precisely wrong. In doing so, make sure your investment decisions offer you a broad enough margin of safety, such that being approximately right leads to a good outcome.

Dave Sather is a Victoria certified financial planner and owner of Sather Financial Group. His column, Money Matters, publishes every other week.


Originally published March 4, 2014 Victoria Advocate