Posts By: Andrew Kuhn

HomeOur Blog
Andrew Kuhn September 20, 2017

Warren Buffett’s Partnership Letters and My Investing Thought Process

“You can’t predict. You can Prepare.”
-Howard Marks

I have been reading all of Warren Buffett’s old partnership letters the past week or so. These letters are the letters he wrote to his Investors yearly (and then semi-annually) from 1957- 1970 before winding down his partnerships to eventually run Berkshire. I was inspired to do so because I have also been rereading The Snowball by Alice Schroeder’s for the past month, and it’s awesome how it takes you back to the beginning and goes year by year in Warren’s life as the snowball was building up and starting to roll downhill. There are a few books I re-read every year, and The Snowball is one of them. (Also on that list is Poor Charlies Almanack, another book I highly recommend.) The partnership letters are too long to embed in this post, but if you go to this link you should be able to pull them yourself:

http://csinvesting.org/wp-content/uploads/2012/05/complete_buffett_partnership_letters-1957-70_in-sections.pdf

Although Warren invests completely differently now, there are still a lot of takeaways you can pull for yourself from his writings. One thing I found interesting is on page 20 in his 1961 letter where Warren goes over his different types of Investment Categories. I’ll let him explain:

 

“The first section consists of generally undervalued securities (hereinafter called “generals”) where we have nothing to say about corporate policies and no timetable as to when the undervaluation may correct itself. Over the years, this has been our largest category of investment, and more money has been made here than in either of the other categories. We usually have fairly large positions (5% to 10% of our total assets) in each of five or six generals, with smaller positions in another ten or fifteen. Sometimes these work out very fast; many times they take years. It is difficult at the time of purchase to know any specific reason why they should appreciate in price. However, because of this lack of glamour or anything pending which might create immediate favorable market action, they are available at very cheap prices. A lot of value can be obtained for the price paid. This substantial excess of value creates a comfortable margin of safety in each transaction. This individual margin of safety, coupled with a diversity of commitments creates a most attractive package of safety and appreciation potential. Over the years our timing of purchases has been considerably better than our timing of sales. We do not go into these generals with the idea of getting the last nickel, but are usually quite content selling out at some intermediate level between our purchase price and what we regard as fair value to a private owner. The generals tend to behave market-wise very much in sympathy with the Dow. Just because something is cheap does not mean it is not going to go down. During abrupt downward movements in the market, this segment may very well go down percentage-wise just as much as the Dow. Over a period of …

Read more
Andrew Kuhn June 17, 2017

Stock Write-Ups

Comment below a stock symbol that you would like Geoff to research and do a write-up on. He will choose from this comment section 2-3 times a week.

… Read more
Andrew Kuhn June 17, 2017

Investing Questions

Comment below any sort of question(s) related to investing to get a direct answer from Geoff.

… Read more
Andrew Kuhn June 17, 2017

Sessions with Geoff

[ecwd id=”2135″ type=”full” page_items=”5″ event_search=”yes” display=”full” displays=”full,list,week,day” filters=””]

As a member, you can book a session with Geoff over skype to ask him anything about investing one-on-one. Comment below on what slot you’d like and Geoff will reach out to you. First-come, first-serve.

 

 …

Read more
Andrew Kuhn June 13, 2017

A Blast from the Past: Warren Buffett’s 1977 Shareholder Letter

Whenever someone comes to me asking for advice on how to get started in investing, the first place I direct them to is reading all Warren Buffett’s Berkshire shareholder letters. It is no secret that his letters have tons of golden investing-wisdom nuggets laid upon them. I have read them many times but interestingly enough, I always take something new away from them every time I reread them. In this series, we’re going to go all the way back and start from the beginning and review all of Berkshires’ Investor letters and all the significant passages, starting with 1977; a cool 19 years before I was born.

Focus on Return on Invested Capital, instead of EPS growth

“Most companies define “record” earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding. Except for special cases (for example, companies with unusual debt-equity ratios or those with important assets carried at unrealistic balance sheet values), we believe a more appropriate measure of managerial economic performance to be return on equity capital. In 1977 our operating earnings on beginning equity capital amounted to 19%, slightly better than last year and above both our own long-term average and that of American industry in aggregate. But, while our operating earnings per share were up 37% from the year before, our beginning capital was up 24%, making the gain in earnings per share considerably less impressive than it might appear at first glance. We expect difficulty in matching our 1977 rate of return during the forthcoming year. Beginning equity capital is up 23% from a year ago, and we expect the trend of insurance underwriting profit margins to turn down well before the end of the year. Nevertheless, we expect a reasonably good year and our present estimate, subject to the usual caveats regarding the frailties of forecasts, is that operating earnings will improve somewhat on a per share basis during 1978.”

Warren is talking about looking through the noise and thinking about how a business has gotten to present day. What does Warren mean by this? Well, let’s look at a disastrous investment example to illustrate.

Valeant was the darling of Wall Street for quite some time, and everyone reading this blog will be familiar with what happened to them. The most alarming thing for me when I did some due-diligence on Valeant when it was in the $200’s, was their exploding debt followed by declining operating/net earnings… A true recipe for disaster. Growing revenue is good, but you want to understand how they got to where they are. The whole Valeant saga was, and still is, a case study in action. Standing from the sidelines, I have …

Read more
Andrew Kuhn May 25, 2017

The Punch Card Mindset

“I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches–representing all the investments that you got to make in a lifetime.  And once you’d punched through the card, you couldn’t make any more investments at all.  Under those rules, you’d really think carefully about what you did and you’d be forced to load up on what you’d really thought about.  So you would do so much better.”- Warren Buffett

Many Buffett and Munger pupils preach following the “punch card mindset,” yet very few actually do. I really think applying this filter has made all the difference for me in my evolutionary process as an investor, and I’m quite confident it will dramatically improve your results as well; especially if you are striving to be a focused investor like Geoff and myself. What does following the punch card mindset mean to me? It means doing the due-diligence required to get to a level of certainty that you are willing to put 20%+ of your net worth in a single idea. It means not succumbing to the daily irrational swings of Mr. Market, and being able to stick to your original thesis if nothing fundamentally has materially changed within the business. It means not laying out capital unless you feel like the odds are so heavily in your favor that heads, you’ll make money, or tails, you can at least break even or not lose that much. It is easy to talk the talk, but actually putting it into practice can be much more challenging, as It should be. After all, why should It be easy to become rich?  You need to be okay with the fact that not every stock you look at will be a punch card worthy investment. Logically speaking there would be no such thing as the punch card mindset if so. Success in investing to me is saying no a lot more than you say yes. The best part about investing though is even if you say “no” to an idea, the amount of work you did to get to that decision can be extremely useful to you. Everything in investing is all cumulative. All knowledge stores up like compound interest. So even if you feel like you are not getting anywhere because you are not finding any actionable ideas, trust me, you are. Just keep your head down and keep chugging along.

“The most important three words in investing may be: “I don’t know.” Having strong viewpoints on a lot of securities, and acting on them, is a sure-fire way to poor returns in my opinion. In my view, it’s easier to adopt this “I don’t know” ethos by focusing on the business first and valuation second, as opposed to the other way around. I’ve found that when valuation is the overriding driver of interest, I’m prone to get involved in challenging businesses or complicated ideas and liable to confuse a …

Read more
Andrew Kuhn May 21, 2017

“Go Where There Are Network Effects”

“Go Where There Are Network Effects” – Zero to One book, Peter Thiel

A business that has a strong and enduring Network Effect can be a great business to invest in. It is one of my favorite tools in my mental-model toolbox, and is one that I look for and think about often. The best part about a business that has a strong network effect is just like compound interest, it only gets better as the numbers get bigger. The simplest way to describe a network effect is when a product or service becomes more valuable as more people use it. For example, companies like Airbnb, Facebook, Microsoft, PayPal, eBay, Match Group and Twitter all have strong network effects. If a business can profit on this effect the rewards can be quite enormous. It can be a great starting point for investors seeking to find a business that has a wide and deep moat and a long runway for many years ahead.

  • People use Airbnb because they know there is a variety of different options to choose from when it comes to renting a place to stay, and “Hosts” list their houses on Airbnb because they know there’s an endless amount of people who are looking to rent instead of staying in a hotel.
  • People sign up and use Facebook because their friends and peers are signed up and use the website as well.
  • People continue to play video games on Xbox live because they know other people are gaming and competing on Xbox live. 
  • PayPal is convenient because it is so popular, which encourages companies to accept payments from it.
  • Buyers use eBay because they know there will be a lot of sellers selling items, and sellers use eBay because they know there will be a lot of buyers buying items.
  • People swipe on Tinder because they know other people are swiping on Tinder.
  • People use Twitter because no one wants to miss Donald Trump’s tweets….  (I’m half-kidding here)

You get the point, right?  Network effects can become significant after a certain number of users have been reached: this is the “Critical Mass” point. When the critical mass point has been achieved, the value obtained from this network effect can be greater than or equal to the price paid for the effect. What does that mean? It’s the point at which a growing company becomes more efficient, and no longer needs additional investment to remain economically sustainable. Charlie Munger always talks about learning the “big ideas” across many different disciplines, and critical mass comes from Nuclear Physics; where critical mass is defined as the smallest mass that can sustain a nuclear reaction at a constant level. When bringing this phenomenon into the investing world, it is about when a business becomes self-sustaining. Aiming to hit this critical mass point is the challenging part of business. This is why most tech companies are so focused on user growth and are often valued by user-progression, as opposed to traditional valuation …

Read more
Andrew Kuhn May 10, 2017

It’s All About the Long Term: Amazon’s 1997 Shareholder Letter

“Jeff Bezos is the most remarkable business person of our age, I’ve never seen a guy succeed in two businesses almost simultaneously that are really quite divergent in terms of customers and all the operations.” – Warren Buffett

I really do agree with Warren in the statement above. Anyone who knows me, knows I am a complete Amazon advocate. Not only does my firm own Amazon stock, but I am a frequent user of the website and really have developed into some sort of fanboy. It is a company that, in my opinion, is virtually certain to be bigger 5-10 years from now than it is today. Every year it leaves me flabbergasted that Amazon continuously knocks it out of the park. Companies that are doing 100B+ in revenue annually should not be continuously growing sales by 25+% per year. To me it is extraordinary. And it is certainly a case study in action that we can all learn from and add to our investing-wisdom toolbox, whether you are a shareholder or not. But before we talk about the present, I think it can help all of us as investors to go back to the beginning and study the company. After all, investing is all about pattern recognition. The beauty of hindsight is that it’s always 20/20. Let’s use this hindsight to our advantage and learn from it.

In this series, we are going to go back and review every Annual Letter to Shareholders written by Jeff Bezos. I really encourage everyone to do this yourself here. I have printed off every Shareholder Letter and have read them multiple times and, like any good literature, I take away something new from it each time. When reading, I encourage everyone to continuously ask yourself this: “Is there any information in this writing that I can take with me to make myself a better investor?” One of the greatest things about investing is that we are constantly learning and all information in life is relative –meaning you can read books completely unrelated to business, read newspapers, watch movies, you name it, and still take away some sort of insight or wisdom that can relate to investing. That’s essentially what we are trying to do here at Focused Compounding; compounding both capital and wisdom. If you have not already, I deeply encourage everyone to read the book “The Everything Store” by Brad Stone. It is a great book that will help you get familiar with the beginnings of Amazon, and more specifically with Jeff Bezos as a CEO.

Let’s go back to 1997 when Jeff Bezos wrote his first letter to shareholders. Anyone who is familiar with the company will know this letter serves as the groundwork of principles that Amazon still embodies today. In fact, Jeff has posted the 1997 letter at the end of every Letter to Shareholders every year since writing it to keep the standards top of mind.

A manager who doesn’t just talk the talk but actually walks …

Read more
Skip to toolbar