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Introduction and Prologue *skimmed with some highlighting


I.Corporate Governance
II. finance and investing
III.
IV. common stock
II. finance and investing
-the key to successful investing is the purchase of shares in good businesses wh
en market prices are at a large discount from underlying business values
a. mr.market
-approach to purchasing common stocks: buying private business; look at economic
prospect of the business + managers + price. Do not have in mind time or price
for sale. Willing to hold indefinitely as long as intrinsic value increases at s
atisfactory rate. Mindset: business analyst, not market/macro/security analyst
-suspension of trading in securities you hold should not bother you because your
economic fate is determined by economic fate of business you own
-mr.market, your partner in a private business, appears daily and names a price.
Transactions are strictly at your option. The more manic-depressive mr.market,
the better for you.
-mr.market is there to serve you, not to guide you. it's his pocketbook, not his
wisdom, that you will find useful. if you can't understand and value your busin
ess better than mr.market, you don't belong in the game
-investment success will not be produced by arcane formulas, computer programs o
r signals flashed by the price behavior of stocks and markets. rather an investo
r will succeed by coupling good business judgment with an ability to insulate th
oughts & behavior from the contagious emotions that swirl about the marketplace
-operating results - price quotations - reflect equity performance
-market will eventually confirm business success
-in short term, market is voting machine; long run, weighing machine
-speed @w/ business success is recognized is irrelevant as long as intrinsic val
ue is growing @ satisfactory rate
-delayed recognition poses opportunities to buy more at bargain price
-sell only when market overvalues
-reason to sell fairly valued/undervalued holdings: require funds for a still mo
re undervalued investment or one you understand better
-do not sell just because they have appreciated or b/c held for a long time. be
content to hold any security indefinitely as long as i.prospective return on equ
ity capital is satisfactory, management is competent and honest, and market does
not overvalue the business
-prospective purchasers should prefer sinking prices; only sellers should be hap
py at seeing stocks rise
b. arbitrage
-engagement in arbitrage is alternative to holding short-term cash equivalents.
prefer to make major LT commitments, but when more cash than good ideas, arbitra
ge sometimes promises more return than treasury bills; another purpose: cools te
mptation to relax standard for LT investment
-once arbitrage = simultaneous purchase & sale of securities/ foreign xchange in
2 different markets
-has expanded to include pursuit of profit from announced corporate events such
as merger, recapitalization, reorganization, liquidation, self-tender, etc.; arb
itrageur expects profit regardless of behavior of market; major risk: announced
event does not happen
-in recent years, most arbitrage operations have involved takeovers, friendly an
d unfriendly
-to evaluate arbitrage situations, answer 4 questions
1. likelihood of occurence
2. how long will your money be tied up

3. chance that something still better will transpire


4. what happens if event does not take place
-berkshire's arbitrage activities: only participate in a few (most do ~50 - must
monitor progress of deals and market mvt. of related stocks)
-little diversification means larger impact than typical arbitrage
-participate only in publicly announced transactions. does not trade on rumors o
r try to guess takeover candidates. "just read the papers, think about a few of
the big propositions, and go by our own sense of probabilities"
c. debunking standard dogma
-efficient market theory: analyzing stock is useless b/c all information are ref
lected in prices
-63-yr arbitrage experience of graham-newman corp., buffet partnership, and berk
shire: EMT is foolish; market is reasonably efficient much of the time
-conditions required for fair test of portfolio performance: 1. hundreds of tran
sactions 2. results not skewed by few fortunate experiences 3. did not have to d
ig for obscure fact; simply acted on highly-publicized events 4. arbitrate posit
ions clearly identified universe - not hindsight
-superior profit from stocks can be generated only by carefully evaluating facts
and continuously exercising discipline; cannot be generated from simply committ
ing to a specific investment category/style
-"cutting the flowers and watering the weeds" -foolish act to book profits when
companies perform well and hang on to ones that do not
-investor should hold a small piece of a good business with sane tenacity of an
owner; foolish to part with an interest in a business that's understandable and
durably wonderful; parent company isn't likely to sell a subsidiary with superb
long-term economics
-Berkshire aims for one smart decision a year
-portfolio concentration should decrease risk: i. increased intensity of researc
h ii. increased comfort-level of economic characteristic
-risk: the possibility of loss or injury
-beta: relative volatility to market - beta implies a stock that dropped steeply
is riskier, but in reality it's a bargain; true investor welcome volatility bec
ause volatility -> more bargain opportunities
-investor is free to ignore the market or exploit its folly
-real risk: if aggregate after-tax receipts from investment will maintain purcha
sing power and give a modest rate of interest
-factors:
(1) The certainty with which the long-term economic characteristics of the busin
ess can be evaluated
(2) The certainty with which management can be evaluated, both as to its ability
to realize the full potential of the business and to wisely employ its cash flo
ws
(3) The certainty with which management can be counted on to channel the reward
from the business to the shareholders rather than to itself
(4) The purchase price of the business
(5) The levels of taxation and inflation that will be experienced and that will
determine the degree by which an investor s purchasing-power return is reduced fro
m his gross return.
-why search for a needle buried in a haysack when one is sitting in plain sight?
buffet cannot predict future of rapidly-evolving businesses
-some investment strategies do require wide diversification: arbitrage; themati
c investing due to lack of understanding of specific businesses
-conventional diversification makes no sense for an investor who is 1. able to u
nderstand business economics 2. able to find 5~10 sensibly priced companies with
important LT competitive advantages; hurts result and increase risk; why put mo
ney into 20th favorite stock rather than adding money to top choice? top choice
presents least risk with greatest potential
-"til-death-do-us-part policy lets Berkshire's managers and investees run their
businesses free of distraction

-stock market serves as a relocation center at which money is moved from the act
ive to the patient.
-"searching for superstars"; Berkshire searches for large businesses with unders
tandable and good economics, able and shareholder-oriented management, sensible
price; considering large sum of Berkshire, it's hard to get great results by adr
oitly buying and selling portions of far-from-great businesses
-? If at first you do succeed, quit trying.
-John Maynard Keynes: ...I get convinced that the right method in investment is t
o put fairly large sums into enterprises which one thinks one knows something ab
out and in the management of which one thoroughly believes. It is a mistake to t
hink that one limits one s risk by spreading too much between enterprises about wh
ich one knows little and has no reason for special confidence. One s knowledge and
experience are definitely limited and there are seldom more than two or three e
nterprises at any given time in which I personally feel myself entitled to put f
ull confidence.
-?portfolio insurance and 1987 crash
-Wrong: retail investors have no chance in a market dominated by erratic behavio
r of the big boys; such markets are ideal for any investor with Buffet's style;
volatility offers more bargain opportunities
d. "value" investing: a redundancy
-buying control of business = buying small holdings; look for favorable long-ter
m economics
-outstanding business and sensible price > mediocre business and bargain price
-controlled company offers two advantages: 1. buffet gets to allocate capital 2.
tax advantage when owning >80% of a company?
-Berkshire selects marketable equity securities in much the same way as it evalu
ates a business for acquisition: 1. can understand 2. favorable LT prospects 3.
honest and competent management 4. attractive price
-growth is always a component in the calculation of value
-investing: the act of seeking value at least sufficient to justify the amount p
aid; "value investing" is redundant
-growth is good only when each dollar used to finance the growth creates more th
an a dollar of long term market value. in the case of a low-return business requ
iring incremental funds, growth hurts the investor
-John Burr Williams <<The Theory of Investment Value>> the value of any stock/bo
nd/business today is determined by the cash inflows and outflows - discounted at
an appropriate interest rate - that can be expected to occur during the remaini
ng life of the asset
-The investment shown by the discounted-flows-of-cash calculation to be the chea
pest is the one that the investor should purchase irrespective of whether the bus
iness grows or doesn t, displays volatility or smoothness in its earnings, or carr
ies a high price or low [price ] in relation to its current earnings and book va
lue.
-for equities one must estimate future coupons; bond has defined future CF (coup
on and maturity date); management dramatically affect equity "coupons", not bond
-best business to own: employ large amounts of incremental capital at very high
rates of return
-worst business: consistently employ ever-greater amounts of capital at low rate
of return
-owner of business that are high-return but need relatively little capital will
usually benefit from dividends and/or stock repurchases
-stick to businesses you can understand: simple and stable in character; if it's
complex or subject to constant change, you are not smart enough to predict futu
re CF
-what counts for most people in investing is not how much they know, but rather
how realistically they define what they do not know
-margin of safety is cornerstone of investment success
-avoid new-issue; on secondary market constantly setting "clearing price"; for t
he latter, price is ruled by controlling stockholders and corporations

-buffet values stability: management not distracted by "revolving-door capitalis


ts"; prefers to see managers aligned with shareholders in maximizing long-term v
alues
e. intelligent investing
-inactivity is intelligent behavior; treat an investment as if you own the busin
ess: managers would not dream of feverishly trading highly-profitable subsidiari
es b/c of small move in interest rate
-after investment is made, only have to monitor if qualities of a good investmen
t are preserved
-selling off portions of most successful invesement ~ trading Michael Jordan b/c
he has become so important to the team
-Berkshire favors businesses/industries unlikely to experience major change beca
use it looks for operations that we believe are virtually certain to possess eno
rmous competitive strength ten or twenty years from now; A fast-changing industr
y environment may offer the chance for huge wins, but it precludes the certainty
we seek
-the inevitables: will dominate their fields worldwide for an investment lifetim
e; coke and gillete
-rather be certain of a good result than hopeful of a great one; many companies
in high-tech businesses or embryonic industries will grow much faster in percent
age terms than the inevitables
-for every Inevitable, there are dozens of Impostors: companies now riding high
but vulnerable to competitive attacks; some industries have characteristics that
endow leaders with virtually insurmountable advantages -> survival of fittest;
most do not
-a few "highly probables" are inevitable in a portfolio
-in an overheated market, it might take extended period for value of an outstand
ing company to catch up with price you pay
-Buffet worries about loss of focus when contemplating investment in business wi
th general good outstanding: scenario: value stagnage in presence of hubris of b
oredom that cause management focus to wander - That s not going to happen again at
Coke and Gillette - given their current and prospective managements.
-goal as an investor: purchase, at a rational price,shares of an easily-understa
ndable business whose earnings are virtually certain to be materially higher fiv
e, ten and twenty years from now
-resist the temptation to stray from your guidelines: If you aren t willing to own
a stock for ten years, don t even think about owning it for ten minutes. Put toge
ther a portfolio of companies whose aggregate earnings march upward over the yea
rs, and so also will the portfolio s market value.
-excitement and expenses (trading expenses) are enemies; be fearful when others
are greedy and greedy only when others are fearful
-competitive advantages that will endure over time makes for good long-term inve
stment results
-do not invest in a company if you cannot identify its enduring competitive adva
ntage with conviction - buffet owns few tech companies for this reason
-buffet's strength: recognizing when Berkshire is operating well within its circ
le of competence and when it is approaching the perimeter; predicting the long t
erm economics of companies in fast-changing industries is outside his perimeter
-comfortable business @ questionable price >> questionable business @ comfortabl
e price
-buffet has never attempted to forecast what the stock-market is going to do in
the next month or the next year
f. cigar butts and the institutional imperative
-cigar butt investing: buy at sufficiently low price, there will usually be some
hiccup in the fortunes of the business that give you a chance to unload at dece
nt profit, despite terrible LT performance
-a cigar butt found on the street that has only one puff left in it may not offe
r much of a smoke, but the bargain purchase will make that puff all profit.

-cigar butt approach to buying business is foolish unless you are an liquidator
-1. bargain price may turn out to not be a steal; In a difficult business, no so
oner is one problem solved than another surfaces
-2. initial advantage will quickly be eroded by low return the business earns
-you buy a business for $ 8 million that can be sold or liquidated for $ 10 mill
ion and promptly take either course , you can realize a high return. But the inv
estment will disappoint if the business is sold for $ 10 million in ten years an
d in the interim has annually earned and distributed only a few percent on cost.
-time is the friend of the wonderful business, the enemy of the mediocre.
-when a management with a reputation for brilliance tackles a business with a re
putation for bad economics, it is the reputation of the business that remains in
tact.
-?institutional imperative - good management do not automatically make rational
business decisions; rationality frequently wilts when the institutional imperati
ve comes into play
(1) As if governed by Newton s First Law of Motion, an institution will resist any
change in its current direction
(2) Just as work expands to fill available time, corporate projects or acquisiti
ons will materialize to soak up available funds
(3) Any business craving of the leader, however foolish, will be quickly support
ed by detailed rate-of-return and strategic studies prepared by his troops
(4) The behavior of peer companies, whether they are expanding, acquiring , sett
ing executive compensation or whatever, will be mindlessly imitated.
-go into business only with people whom you like, trust, and admire; buffet wish
es not to join with managers who lack admirable qualities, no matter how attract
ive the prospects of their business
-1% chance of entering a bad situation when leveraged: We wouldn t have liked thos
e 99: 1 odds and never will. A small chance of distress or disgrace cannot , in o
ur view, be offset by a large chance of extra returns. If your actions are sensi
ble, you are certain to get good results; in most such cases, leverage just move
s things along faster. Charlie and I have never been in a big hurry: We enjoy th
e process far more than the proceeds though we have learned to live with those al
so.
g. life and debt
Except for token amounts , we shun debt, and use it for only three purposes:
1. part of certain short-term investing strategies that incorporate ownership of
U.S. government securities; purchases of this kind are highly opportunistic and
involve only the most liquid of securities
2. borrow money against portfolios of interest-bearing receivables whose risk ch
aracteristics we understand
3. [Subsidiaries , such as Mid-American, may incur debt that appears on Berkshir
e s consolidated balance sheet, but Berkshire does not guarantee the obligation.]
-From a risk standpoint , it is safer to have earnings from ten diverse and unco
rrelated utility operations that cover interest charges by, say, a 2: 1 ratio th
an it is to have far greater coverage provided by a single utility.
-Leverage can be lethal to businesses; companies with large debts often assume t
hat these obligations can be refinanced as they mature; assumption usually valid
except for when company-specific problems arise or there is a shortage of credi
t and maturities must be met by payment; for that, only cash will do the job;
-credit is like oxygen; when either is abundant, its presence goes unnoticed. Wh
en either is missing, that s all that is noticed .
-Even a short absence of credit can bring a company to its knees. In September 2
008, in fact, its overnight disappearance in many sectors of the economy came da
ngerously close to bringing our entire country to its knees.
-Berkshire holds at least $ 10 billion of cash, excluding that held at our regul
ated utility and railroad businesses; customarily keep at least $ 20 billion on
hand to 1. withstand unprecedented insurance losses ($3bn from Katrina) 2. quick
ly seize acquisition/investment opportunities even during times of financial tur

moil
-Berkshire keeps cash largely in treasury bills and avoids ST securities yieldin
g a few more basis points; a policy Berkshire has been adhering to long before t
he frailties of commercial paper and money market funds became apparent in Sept
2008
-Berkshire does not rely on bank lines, and does not enter into contracts that c
ould require postings of collateral except for amounts that are tiny in relation
to its liquid assets
-not a dime has left Berkshire for dividends or share repurchase; has retained a
ll earnings to strengthen its business
-extreme caution w.r.t. leverage penalizes return by a minor amount; having load
s of liquidity lets Buffet sleep well; during financial chaos, Berkshire is equi
pped financially and emotionally to play offense while others scramble for survi
val; Berkshire invested $ 15.6 billion in 25 days of panic following the Lehman
bankruptcy in 2008
IV. common stock
-timing, duration and degree of market aberrations are unpredictable; Berkshire
never try to anticipate arrival or departure of greed and fear
-Berkshire's goal: be fearful when others are greedy and greedy only when others
are fearful
-transaction and investment management costs -> stockholder over long term under
perform companies they own
a. the bane of trading: transaction costs
-the most that owners in aggregate can earn between now and Judgment dDay is wha
t their businesses in aggregate earn (exception: bankrupcies, some losses born b
y creditors)
-investor A, through clever buying and selling, may take more than his share of
the pie at expense of investor B. All investors feel richer when stocks soar, bu
t an owner can exit only by having someone take his place; for owners as a whole
, there is no magic - they will not extract wealth beyond that created by the co
mpanies themselves
-frictional cost of all sorts may well amount to 20% of earnings of American bus
iness; the burden of paying "helpers" may cause American equity investors to col
lectively earn only 80% of what they would earn if they just sat still and liste
ned to no one
-for investors as a whole, returns decrease as motion increases
-2 criteria for best market place for Berkshire stock
-1. consistently trade at a price rationally related to intrinsic value -> inves
tment result achieved by each shareholder approximate Berkshire's business resul
t
-swinging between undervaluation and overvaluation reward/penalize owners in a m
anner disconnected to how business has performed; Berkshire wants to avoid such
capricious results; Berkshire's goal is to have its shareholder-partners profit
from the achievements of the business rather than foolish behavior of co-owners
-in the long run, aggregate pre-tax reward to Berkshire's owners = business gain
s of company minus transaction cost imposed by marketplace (commissions by broke
rs + net realized spreads of market-makers)
b. attracting the right sort of investor
-Berkshire's goals:
-1. does not want to maximize share price; wish share price trades in a narrow r
ange centered at intrinsic value (which Berkshire hopes will increase at a reaso
nable rate)
-2. wish very little trading activity; analogy: private business with a few pass
ive partners who frequently want to leave partnership
-3. attract LT investor who have no timetable or price target for sale; hopes to
stay with BH indefinitely

c. dividend policy and share repurchase


-allocation of capital is crucial to business and investment management
-all earnings are not created equal
-?in many businesses, inflation causes some or all of reported earnings to becom
e ersatz (not real/genuine), ?particularly those that have high asset/profit rat
ios
-these "restricted" earnings cannot be distributed as dividends if business is t
o retain its economic position
-if paid out as dividends, company loses ability to: maintain unit volume of sal
es/ LT competitive position/ financial strength
-a company that consistently distributes restricted earnings is destined for obl
ivion unless equity capital is otherwise infused
-?restricted earnings are seldom valueless to owners, but they must be discounte
d heavily. In effect, they are conscripted by the business, no matter how poor i
ts economic potential; ?stock sold for 1/4 of book value; every time a dollar of
earnings is retained for reinvestment, transformed into only 25 cents of market
value
-unrestricted earnings: retained or distributed with equal feasibility
-reasons to withhold: expand corporate empire, financial comfort
-*only one valid reason for retention: there is a reasonable prospect - backed p
referably by historical evidence or, when appropriate, by a thoughtful analysis
of the future - that for every dollar retained by corporation, at least one doll
ar of market value will be created for owners
-this happens iff capital retained produces incremental earnings > those availab
le to investors
-go beyond simply comparing total incremental earnings in recent years to total
incremental capital - this relationship can be distorted
-ex.) inflationary period, company use small amount of incremental capital in co
re business which has great economics at high return; sink most of money in othe
r businesses that earn low returns; overall return appears excellent but still m
isused
-many corporations that consistently show good returns both on equity and on ove
rall incremental capital have, indeed, employed a large portion of their RE on e
conomically unattractive basis
-in this case, shareholders better off if earnings retained only to expand highreturn business, other paid as dividend or used for stock buyback
-stock repurchase at times of discrepancy between price and value - rewarding
-1. repurchase at price below intrinsic value increases value (getting $2 of pre
sent value for $1)
-2. management demonstrate it has shareholders' interest in mind
-only situation that makes stock repurchase advisable:
-1. has available funds (cash + borrowing capacity) beyond near-term needs of bu
siness (1. expenditure to maintain competitive position 2. optional outlays aime
d at business growth with positive IRR)
-2. stock selling below intrinsic value
-*shareholders should have been supplied all the info needed to estimate that va
lue; otherwise, insiders could take advantage of their uninformed partners and b
uy out there interests at a fraction of true worth
-now, repurchases are all the rage, but all too often to pump stock price or to
show confidence; hurts immediate buyers but hurts continuing shareholders, who a
re penalized by repurchases above intrinsic value - buying dollar bills for $1.1
0 is not good business for those who stick around
-if you intend to hold a stock, you should hope the stock falls and trades in su
fficient volume for firm to buy back
-at BH, financial strength takes precedence over all else
-when BH invests in a company that repurchases shares, hopes for two events: 1.
hope earnings will increase at a good clip for a long time 2. hope that stock un
derperforms in the market for a long time
-a net buyer of stock is hurt when stocks rise; benefit when they swoon; taking

comfort in seeing prices rise is analogous to commuter who rejoices after price
of gase increases, simply b/c his tank contains a day's supply
d. stock splits and trading activity
-Buffet disagrees with assumption that stock split is pro-shareholder action
-one goal of BH is to have stock trade at rational level -> need rational shareh
olders, both current and prospective
-irrationality -> silly stock prices -> helps BH in buying and selling stocks of
other companies, but not in best interest for long term holders
-high quality ownership can be attracted and maintained if we consistently commu
nicate our business and ownership philosophy along with no other conflicting mess
ages and then let self selection follow its course.
-BH tries to attract investors who understand its operations, attitudes, and exp
ectations
-want those who think of themselves as business owners and buy with intention of
staying for a long time; focused on business results, not market prices
-