Sunday, November 14, 2010

Buffett Partnership Letters: 1968

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.

The Index Matters

Buffett has repeatedly compared his performance against that of the Dow. As described earlier, one of the reasons the Dow was chosen as a measuring stick is because it is widely known. Unfortunately, as a price-weighted index, the Dow can be skewed by a few abnormal results. These abnormalities caused the Dow to underperform most actively managed funds during this period. Even investment management firms, who almost regularly underperform the market, were beating the Dow handily.

Beware Of Speculation

As terrific market returns became the norm, investors increased their willingness to risk their capital. The markets started to heat up. Buffett warns that chain-letter type stock-promotion practices are snow-balling, and he worries about the long-term effects these will have on the markets. In the short-term, however, they have caused stock prices to rise, which has allowed Buffett to sell many of his positions and sit on a pile of cash.

Stick To Your Strengths

While many funds were returning upwards of 100% during this speculative period, Buffett did not change his style. His standards remained the same, despite relative results (compared to new firms) that were unspectacular. He did not switch to this "new way" of investing, which was a form of speculation.

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