Saturday, October 30, 2010

Buffett Partnership Letters: 1963

Berkshire Hathaway's letters to shareholders are oft-quoted and Berkshire's annual shareholder meeting is well-followed, as value investors try to glean the wisdom of the world's greatest investor. But before he ran Berkshire, Warren Buffett was far less followed and ran his partnership with a sum of money much smaller than he employs today. The issues he faced then are probably far more relevant to the individual investor today than are Berkshire's current challenges. The following series attempts to summarize the key takeaways from Buffett's partnership letters.

Judge Performance Over The Long Term

Buffett prefers to measure the performance of a fund over at least five years of returns relative to a benchmark specified in advance. At an absolute minimum, Buffett requires at least three years be considered before giving any credence to a fund's returns.

Manager And Investor Interests Should Be Aligned

Buffett makes clear to his investors that he, his wife and his children have, and will continue to have, substantially all of their net worth invested in this partnership.

Management Matters

Having invested enough money to acquire control of a company called Dempster Mill at a discount to net working capital, Buffett attempts conversations with management to get the company on the right track. Six months later, he notices that costs are still high, so he decides to hire his own manager, and compensates him based on his meeting specific cost-cutting goals. This manager was able to cut the company's break-even point in half. As a result, this company generated substantial returns for investors.

Don't Count On The Business Doing Well

In the business described in the previous paragraph, strong improvement in the business' operations resulted in considerable returns. But Buffett makes the point that the fact that the business did well was just a bonus. The price paid for that business was so low that even if business did not improve, Buffett would likely still have made money.

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