If legendary investor Warren Buffett was a citizen of India, he would now qualify for Pranab Mukherjee’s freshly minted ‘Very Senior Citizen’ tag. At 81, he would qualify for Rs5 lakh worth of basic exemption in India. Not that he needs it, as anyone reading his latest letter to shareholders in Berkshire Hathway’s annual report would know.
In the 46 years that this legendary value investor has been at the helm, the per share book value of the company has generated annual returns of 20.2 per cent, versus the 9.4 per cent of the S&P500 index. Today Berkshire finds itself in a strong position because of the way Buffett used the economic crisis of 2008-09. This holds a lesson for every investor, as well as a warning of sorts for the Indian equity markets.
Buffett has firmly demonstrated the value, for American investors, of staying firmly focussed on American equities. Four-five years ago, he had started fishing abroad, buying some stocks in China and elsewhere in Asia. Once the crisis began, he turned his attention back to the US and made his largest ever acquisition for USD 26.5 billion. This was BNSF, America’s largest railway network. He called it a bet on America, and it was. As his letter shows, Buffett’s attention is entirely on the American economy and on American stocks.
This trend doesn’t spell good news for Indian stocks. For much of last year, Indian and other emerging market equities held foreign investors’ attention because their home markets were not considered good prospects. As always, Buffett was ahead of the curve. But as far as we are concerned, foreign investors turning their attention away from India and other emerging markets is not great news. As we have seen, when FIIs pull out funds, our markets tank.
Buffett’s letter also describes how hands-off he is from the 160-odd businesses that Berkshire owns. He’s apparently hands-off not just in terms of not taking decisions but also in terms of asking for information. Apart from periodic financial statements, he actually discourages his CEOs from getting in touch with him. He says: “Our trust is in people rather than process.” This anti-process attitude would sound like heresy to a conventional business manager, but then, no conventional business manager comes close to matching what Buffett has achieved.
Buffett’s scepticism for the gyrations of the equities markets is always obvious. While comparing the performance of Berkshire with the S&P500, he does not use market price. Rather, he uses book value, which he calls ‘an understated proxy’ for the intrinsic value of a business. In this year’s letter he says: “Market price and intrinsic value often follow very different paths — sometimes for extended periods — but eventually they meet.”
Buffett is known to be viscerally opposed to all types of financial engineering, particularly derivatives. This letter, like many earlier ones, has its dose of criticism. This time, Buffett talks about how the Black-Scholes formula (which won Fischer Black and Myron Scholes an economics Nobel) for valuing options produces wildly inaccurate results when used for long-dated options. Buffett quotes John Kenneth Galbraith saying that economists are most economical with ideas: they make the ones learned in college last a lifetime. But don’t just go by my word for what great reading Buffett’s letters make — go to berkshirehathaway.com and read all of them.