​4 Amazing Insights I Gleaned From Warren Buffett's 1957 Partnership Letter

4 Amazing Insights I Gleaned From Warren Buffett's 1957 Partnership Letter

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4 Amazing Insights I Gleaned From Warren Buffett's 1957 Partnership Letter

One great resource for investing ideas, inspiration, and wisdom from fund managers is reading the letters they write once or twice a year to their investors. When I found value investing, I started with Buffett, found Benjamin Graham and all of Graham’ disciples.

It’s obvious to everyone that Buffett is the Mac Daddy investor. The investor to rule them all. In Berkshire Hathaway, Buffett has created a giant Pac Man company, and continues to gobble up bigger and bigger companies.

So, in a nutshell, I wanted to start learning from the best. Once I read about Buffett’s early days running the Buffett Partnerships, I set about locating and reading the investor letters that he would send at first annually, then bi-annually.

I wasn’t disappointed. The letters are chock full of wisdom and amazing insights into both investing and business in general.

So this episode is dedicated to ___ things I learned from the Buffett investment partnership letters.

The letters  I have in my possession are from 1957 to the last letter in 1969 before Buffett dissolved the partnerships after taking control of Berkshire Hathaway. He continued to write annual letters for Berkshire Hathaway which can be found on the BH website.

The partnership letters are more difficult to find online, but I would try searching for them on the website Valuewalk.com.

Here are some of the things I learned from reading the 1957 Buffett partnership letter:

1. Buffett views the entire market as one business

 In his 1957 letter, Buffett states: “My view of the general market is that it is priced above intrinsic value.” Clearly, Buffett does have a view of what levels markets are selling at compared to some form of intrinsic value. Today, we would call it and “over-valued” market, meaning the price the market wants us to pay is higher than the value of the underlying businesses.

By viewing the market as an entire business, you can develop a better sense of where valuations are at any given time.  This insight may have led to the Buffett Indicator as we know it today, which I discussed in Episode 64 of this podcast.

2. Buffett always had a mix of what he called work-outs and generally undervalued securities


Here’s a quick refresher on what a work-out is, today they are known as special situations and include merger arbitrages of various kinds, tender offers, squeeze-outs, liquidations and other investments that are typically pinned to one price and generally don’t fluctuate with the overall market.

Generally undervalued securities were usually common stock in undervalued companies.

In the 1957 letter he says, “If the general market were to return to an undervalued status our capital might be deployed exclusively in general issues and perhaps some borrowed money would be used in this operation at that time. Conversely, if the market should go considerably higher our policy will be to reduce our general issues as profits present themselves and increase the work-out portfolio.”

This incredible paragraph speaks volumes about how Buffett managed money in the early days. When markets were in corrections or bear markets, he would move solely into generals. When markets were high, he would move into more work-outs.

By managing money this way, Buffett could mostly avoid damage to his portfolio during bear markets, and have tremendous upside during rising markets.

If this sounds like market timing, it isn’t really because Buffett always kept his money working for him. His partner Charlie Munger would occasionally go to mostly cash and wait for years for a major downturn in the market, but Buffett would continue compounding using work-outs.

The same 1957 letter has this sentence as well,” At the end of 1956, we had a ratio of about 70/30 between general issues and work-outs. It is now about 85-15.” This amazing sentence gives us a specific ratio of his general issues versus work-outs.

 

3. Buffett was an early activist investor and often attempted to influence management 

In the 1957 letter, he writes:

“During the past year we have taken positions in two situations which have reached a size where we may expect to take some part in corporate decisions…Both of these will probably take in the neighborhood of three to five years of work but the presently appear to have potential for a high average annual rate of return with a minimum of risk.”

Buffett, through diligent and disciplined digging, was able uncover activism opportunities,  even with a relatively small amount of assets under management.

This level of sophistication at the age of just 27 is remarkable. Imagine yourself as a 27 year old taking a board position, for example.

4. Buffett would take positions over time, often a year or more


Sometimes investors feel like they have to take a position fast to ensure they achieve a full position before the price moves much. This is a rookie mistake (one that I’ve made too many times) and can easily be avoided by setting up a Buying Program such as the one I discuss in episode 80 of this podcast.

Here’s another insight from the 1957 letter:

“…This is due to both generally lower prices, and the fact that we have had more time to acquire more substantially undervalued securities that can only be acquired with patience.”

This paragraph alludes to two concepts. The first is that Buffett would often invest heavily in very illiquid securities. This tactic reduced competition for the stock, and allowed him to acquire much larger positions over time. Most investors shun illiquid securities. Buffett embraced them whole-heartedly.

The second concept is patient acquisition. Buffett adds to this concept by stating, “Obviously, during any acquisition period, our primary interest is to have the stock do nothing or decline rather than advance.” The questions is, what is the acquisition period? In future letters, Buffett says that the acquisition period is a year or more.

When was the last time you took an entire year to build a position? I would bet that most listeners haven’t taken more than a month or two to build a position. Buffett, even at 27, had tremendous patience in acquiring investments.

Conclusion:

I recommend that you get your hands on these letters and study them. All of these insights came out of just one letter. Imagine the wisdom contained in all twelve years of letters.

​Ask JB: ETF Stacked Fees and Tax Gain Harvesting

question on management fees (self.investing)

submitted an hour ago by letskill

If I buy an ETF (ETF1) with a management fee of 0.2%, and that ETF owns shares in a second ETF (ETF2) with a management fee of 0.3%, the total I would lose on fees would be 0.5%, correct?

So aren't ETFs that buy other ETFs just a way for the investment company to double dip on fees while only declaring a fraction of it in the ETF description?

This is mostly coming from me looking at XAW.TO, which is 44% in IVV, 35% in XEF, and 12% IEMG, all ETFs owned by ishare.

JB Says: This is the major problem I have with ETF’s of ETFs. The fees. Good luck understanding all that you are getting charged. You will have to spend significant time going through the prospectus for these ETF’s to find out how they charge stacked fees. Some may be waived, others may be paid.

Ask JB: Should I "Tax Gain harvest"? Any downsides? (self.investing)

submitted 8 hours ago by skilliard7

I'm only working PT so my income is somewhat low this year. Parents can't claim me as a dependant as my income is between $10k-15k, and I'm only PT in college.

Noticed I can take the "savers tax credit" since I deposited to a ROTH IRA, so I'll be getting $1,000(not refundable) off my taxes, so basically no federal income taxes owed this year.

While my income is low now since I'm only PT, I expect it to be higher in the future once I start working FT, thus eventually putting me in the 15% bracket for long term capital gains and 25% for ordinary income.

I have a bunch of stocks bought earlier in the year, and I have a "buy and hold" mentality in which I just hold and collect dividends. Some have gone up, some have gown down. Should I sell and rebuy the winners, while holding onto the losers, to establish a higher basis point for future capital gains to offset future taxation? Or is this a bad idea?

JB Says:

The first thing is that if the position was held less than a year, you will still be taxed on it as short term capital gains are taxed as income. To get the benefit of zero capital gains tax, it would need to be held for a year to become long-term capital gains.

If you fall into the tax bracket where you pay zero on taxable capital gains, watch out for when the gain moves you into a higher tax bracket which may eliminate the savers credit.

The gain increases your Adjusted Gross Income. Add your expected income for the year plus the capital gain and check to make sure you would still fall into the zero capital gain tax category. If so, there is no harm in selling, taking the gain and buying it back 31 days later.

If you would end up in a higher tax bracket, you can still sell some portion of the holding so your income plus capital gain is just below the new tax bracket to ensure you will still get the savers credit.

Do you have a burning question on investing you would like answered? Click the button below to send it to me and I will answer it on the podcast!

​News: Economic data looks promising

https://www.cnbc.com/2017/11/01/october-ism-nonmanufacturing-index-september-construction-spending.html
https://www.cnbc.com/2017/10/30/us-personal-income-sept-2017.html

Thoughts on this podcast? Disagree with me on some point? Something I missed? Leave a comment!

About the Author

Jeremy Scott Bailey is an investor, author, entrepreneur and host of the “What Works In Investing?” podcast now available on iTunes. He is founder and Chief Investment Officer of Burgeón Group, Inc. an investment advisory firm that provides portfolio management services to families and individuals.

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