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.
In this letter, Buffett delves into some possible reasons for why the top investment management firms cannot beat the passive Dow Jones Industrial Average even as Buffett trounces it. Buffett doesn't believe it to be a lack of integrity or of intelligence at the top firms. He attributes their under-performance to, among other things, group decisions. His opinion is that "...it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions."
Relative Valuation Can Still Be Pricey
Buffett describes a growing portion of his portfolio where companies are not cheap by "private owner" standards, but rather on a relative basis compared to similar companies. For example, he may buy a company at a P/E of 12 while a similar company of lower quality sells for a P/E of 20. While he notes that this section of his portfolio is showing promise, he does worry about situations where the latter company gets revalued to a P/E of 10. Buffett does hint at this point that he is implementing a technique to reduce this risk.
Don't Let Taxes Stop You
Nobody likes taxes, but Buffett argues that more investment mistakes are committed in the name of tax considerations than from any other cause. Buffett quotes a friend who argues that a majority of life's errors are caused by forgetting what one is really trying to do. Paying the least amount of taxes is not the investor's goal; instead, the investor is trying to come away with the largest after-tax return. These are often not the same thing.