The secret of Warren Buffett's success at Berkshire Hathaway

We've just had the 50th anniversary of Warren Buffett and Charlie Munger taking over Berkshire Hathaway and that means we've also just had their 50th letter to shareholders. And this is the point where we try to puzzle over just how two guys managed to make so many hundreds of billions (if we include their own holdings and those …

[Anonymous Coward]

Re: It's an interesting analysis

"But it doesn't really explain why Buffett is so successful at buying shares"

Read several of the letters to shareholders. Investing involves risk, but you can minimise that risk - there is a sauce, but Buffett has generously shared the recipe so it is not a secret sauce. The long and the short of this sauce is "don't buy businesses you don't understand, understand a balance sheet, only buy financially robust businesses, and employ competent people".

The reason why the opportunities still exist is because so may poor investors are active in the market, and because too many of them are gambling with other people's money. Arguably that's what Berkshire Hathaway are doing, but there's a difference - first that they are good at it in aggregate, and secondly (unlike most fund managers, pension manager, and insurers) there's one or two men with their names on the line, every time.

[Eddy Ito]

Re: It's an interesting analysis

Also don't forget how Buffett got where he is. He looked for companies that had been punished by market for one reason or another and were selling at a discount to their book value. He bought a company at a discount, sold off the capital shortly after and made a profit, all with minimal if not zero risk. Buffett himself compares it to picking up a cigar butt and taking the last puff.

Berkshire Hathaway was a textile company in New Bedford, Massachusetts which was going to be another "one last puff" but Buffett was angered by a buyout offer from Seabury Stanton, who was running the company, which led Buffett to buy the company so he could fire Stanton. While it later became the name of Buffett's money storehouse, Buffett maintains it was a mistake.

If anyone is interested, I found the book Snowball to be quite a good read. I even bought the audiobook for the car but then radio has gotten to the point where I don't mind going over it again.

[Zog_but_not_the_first]

Money, it's a crime...

"But, as Buffett notes, while that money doesn't “belong” to the insurance company, the profits to be made from investing it do"

So, like a bank then. Except that the bank has the added "benefit" of being able to create more dosh out of nothing by the fractional reserve mechanism.

There is an argument that the profits made out of "investing premiums" could be used to cut said premiums, and I guess that you're hinting at this in your section on competitiveness in the insurance industry.

I used to think that money was "broken" but I'm beginning to see it as being transmogrified (love that word!) into a device increasingly for exercising power in the interest of a minority.

T'was ever thus, I suppose.

[Ossi]

Re: Money, it's a crime...

Fractional reserve banking is a much misunderstood idea. It is, in a sense, a 'licence to print money', but it doesn't enrich banks, or anyone for that matter. Money, at the end of the day, is just tokens that you pass around. Briefly, the idea behind fractional reserve banking is that banks only hold back in their vaults a proportion of their deposits as they don't expect to pay out all their deposits at the same time (if they did, that would be a run on the bank and that would be the end of the bank). Imagine, for simplicity, an economy where there is only a bank and one person, and all money is held as bank deposits.

We start with person A, who has £100 - so there's £100 in the economy. She puts the money in the bank, the bank keeps, say 10% as a reserve, and it can now lend £90. It lends £90 to her and that's deposited in the bank, so there's now £190 in the economy. The bank lends £81 of that etc.

Now, one important thing to realise is that the bank has not created free money - it has to pay interest on all that money deposited. The other important thing to realise is that the bank itself has not made the money - the interaction between the bank and the economy has made the money. My model had to have 2 actors in to work. The depositors are playing an equal part to the bank. Note that net assets in the economy are still £100, and that belongs to the person, not the bank.

Finally, both the bank and the economy have not in any sense been enriched. The assets in the economy have remained the same. The output of bread, hammers or whatever in the economy is the same. To see this, imagine a prison where cigarettes are used as currency. If there was a sudden influx of cigarettes, the prices would all go up but there wouldn't be more stuff to buy and sell in the prison 'economy'. The economy wouldn't be 'better off'.

This is why governments need monetary policy to control prices - they don't have direct control of the money supply, but they do need to control it.

[Anonymous Coward]

Re: Money, it's a crime...

> Fractional reserve banking is a much misunderstood idea. It is, in a sense, a 'licence to print money', but it doesn't enrich banks, or anyone for that matter.

Really? No-one gets enriched by lending? What's the purpose of lending then? Is it social altruism perhaps? Do banks not charge interest - always above inflation - in order to extract a profit from lending? What is the purpose of profit, if not enrichment? Do banks function as non-profit entities?

Fractional reserve lending contributed - in great part - to the credit derivatives bubble and subsequent crash of 2008. No-one got enriched from the credit bubble? Really? What about Bob Rubin - he, of Goldman Sachs and Clinton's Treasury Secretary? He made bank to the tune of several hundred million USD while at Citibank. What was Citibank doing at the time? Selling worthless CDO's and CMO's. Of course, Bob Rubin - being the paragon of ethics that he is known to be - returned all his bonuses back after the 2008 crash. Not.

But, you are absolutely right. Lending - of any kind - is not driven by greed and the irrational need for constant personal enrichment of a few. It's something else. Perhaps you can enlighten all of us as to what that "something else" might be.

Same for MF Global and Jon Corzine - also of Goldman Sachs. There was no greed at play there.

> This is why governments need monetary policy to control prices - they don't have direct control of the money supply, but they do need to control it.

Governments don't control the money supply, central banks do. Central banks are - at least in theory - independent of the government.

The last time the US government imposed price controls was in the early '70's during the Nixon administration. It had no effect on inflation. Inflation still skyrocketed - mainly because of the oil shocks. Neo-classical Austrians hate that one. During Bush 43's administration, there was no increase in money supply, yet there was significant inflation in basic consumer subsistence goods: food and energy. Conveniently enough, food and energy prices are excluded from the US inflation calculations. Neo-classical Austrians' explanation for food price increases in the US: "we can't explain it. It must have something to do with China and India eating more steak and frites and driving better cars". Seriously.

Having said that: All Hail Warren Buffett. We can all start our own Berkshire Hathaway, be miraculous investors and we'll all get rich. Right? In other words - and this is for the "self-help" section at the bookstore: "You Too Can Be The Next Warren Buffett - in twelve easy steps".

Stephen Colbert summarized it best: "I am America, and So Can You".

Is anyone still buying this bullshit? I realize that there are, apparently, those still trying to sell it.

[Gordon 10]

Re: Money, it's a crime...

I love hysterical posts like ST's. . They always follow the same pattern of taking an extreme example of something and conflating it with the whole of something.

Whilst that pattern has worked successfully for many extreme politicians and the Daily mail I'm not sure it's one I'd choose if I wanted to act all holier than thou.

Have a bag of fail good sir.

[Anonymous Coward]

Re: Money, it's a crime...

> extreme example of something and conflating it with the whole of something

I'd love to read your learned expansion and clarification of the above assertion. I also know there won't be one.

But, for the sake of argument: "Extreme example" of what?

On the other hand: when you don't like the message, attack the messenger. It works in some circles.

[Tim Worstal]

Re: Money, it's a crime...

"Really? No-one gets enriched by lending? What's the purpose of lending then? Is it social altruism perhaps? Do banks not charge interest - always above inflation - in order to extract a profit from lending?"

Bit of a leap there don't you think? He was talking about FRB. You are now talking about lending. You do know that full reserve banking, the opposite of FRB, would still have lending? Good, then we can't define lending as being unique to FRB then, can we?

And of course lending enriches. But we've already agreed that lending and FRB are not the same thing, haven't we? BTW, lending is not always done at rates above inflation. 70s Britian it most certainly wasn't for example.

"Fractional reserve lending contributed - in great part - to the credit derivatives bubble"

No, it didn't.

"subsequent crash of 2008"

Absolutely correct, it did. It's the great weakness of an FRB system, that a bank can be solvent but illiquid....and yet has millions of people all demanding their money back right now. It's also the source of the great value of FRB, which is that a system of FRB performs maturity transformation. It might be that your and my and 5 million other checking accounts have zero in them at the end of the month, but the average balance over the month is maybe £1,000 each and the bank is able to budle up those 5 million £1,000s and then lend them out as long term loans to industry and or mortgages.

As I say, both the point and the weakness of FRB.

"Same for MF Global and Jon Corzine - also of Goldman Sachs. There was no greed at play there."

I actually mention in the piece what happened at MF Global....

"The last time the US government imposed price controls was in the early '70's during the Nixon administration. It had no effect on inflation. Inflation still skyrocketed - mainly because of the oil shocks. Neo-classical Austrians hate that one."

Why would neo-classical Austrians (whoever they are, Austrians are not normally regarded as neo-classicals) hate that one? Both groups say that price controls don't work. Price controls didn't, as you note, work. Why would they hate what they think doesn't work not working?

"During Bush 43's administration, there was no increase in money supply,"

Eh? M2 (Money stock) went from 4,600 billion to 7,500 billion during Bush 43.

"yet there was significant inflation in basic consumer subsistence goods: food and energy."

Food and energy prices did rise, yes.

" Conveniently enough, food and energy prices are excluded from the US inflation calculations."

Not so. Food and energy, being more volatile in price than most other things, are excluded from "core inflation". The actual inflation rate, CPI or whatever, is core inflation plus food and energy.

" Neo-classical Austrians' explanation for food price increases in the US: "we can't explain it. It must have something to do with China and India eating more steak and frites and driving better cars". Seriously."

Not so much. The usual explanation is that some idiot decided to put corn into gas tanks as ethanol rather than into the food chain. Given that corn is the basic raw ingredient of a lot of food (pork as just one example) this raised food prices. Other food prices (wheat etc) also rose as people substituted away from corn.

And even if the China story was right, what's wrong with that? Higher demand for food means food prices rise. You do agree that demand affects prices, yes?

" We can all start our own Berkshire Hathaway, be miraculous investors and we'll all get rich. Right?"

At the end of the article I do sorta point out that no, we can't get rich the Warren Buffett way....

[Ossi]

Re: Money, it's a crime...

Thanks Tim for saving me the effort.

[Anonymous Coward]

Re: Money, it's a crime...

ST> "Fractional reserve lending contributed - in great part - to the credit derivatives bubble"

TW> No, it didn't.

Yes, it did. Fractional Reserve Lending allowed banks to be leveraged 25 or 30 to 1 in their mortgage lending. Because of so much slack, they issued mortgages to people who were never going to be able to repay their loans, and under a faulty assumption: that the price of the mortgaged house will always, and inevitably, go up. These bad-quality mortgages were then re-packaged into CMO's and CDO's, and their credit quality was 'creatively massaged' up. When the borrowers defaulted on their mortgage payments, the CMO or CDO constructions blew up.

Who's at fault here? The banks, not the borrowers. The bank has the right of first refusal: it can always say "no" to a loan or mortgage application with a credit score below 720 - an arbitrarily chosen credit score, used only as an example.

With Full Reserve Banking, the banks simply couldn't have issued so many mortgages. That would have eliminated the borrowers with no ability to repay, which, in turn, would have disabled the creation of the worthless CMO's and CDO's: there wouldn't be enough mortgages around, and the mortgages that did exit would have had good credit quality.

The underlying driver for the bad loans/mortgages was, again, greed: borrowers with poor credit were issued mortgages with high interest rates, or with periodically resetting rates, or with "negative amortization" - i.e. the loan that one can never repay back in full.

TW> Why would neo-classical Austrians (whoever they are, Austrians are not normally regarded as neo-classicals) hate that one?

Because there was no increase in the money supply during that period (1970 - 1975), and without an increase in the money supply, there should have been no inflation - in the neo-classical/Austrian theory:

http://goldsilverworldscom.c.presscdn.com/wp-content/uploads/2012/07/M1_money_supply_vs_gold_price_1970-2012.gif

Yet, there was inflation.

Also, on the same chart: I do not see an increase in the money supply between 2001 and 2008. If anything I see a decrease (same chart).

TW> Not so much. The usual explanation is that some idiot decided to put corn into gas tanks as ethanol rather than into the food chain. Given that corn is the basic raw ingredient of a lot of food (pork as just one example) this raised food prices.

OK, but: the US is a net exporter of corn and wheat. Diverting some of the production of corn and wheat to spiking gasoline with ethanol doesn't justify the sharp increase in food prices in the US.

I have a simpler explanation: food prices increased sharply from 2003 onwards because the sharp increases in the price of oil during the same period. At first it was Iraq War II, after that it was just greed - hey, if I can sell a barrel of oil for $120 instead of $40, why not. Cost of transportation in the US is correlated to the price of oil, because we do not have a railway infrastructure to speak of, and everything gets hauled by truck on highways.

Finally: If the premise of your article is that "successful" speculators such as Warren Buffett - or Bob Rubin or Jon Corzine - become rich not by being long-term, sound and thoughtful investors, but merely by a strike of luck - or lack of ethics, or outright fraud, which are alternative terms for "luck" on Wall Street - then I have no disagreements with it.

But there is something very difficult to understand or explain in Buffett's miracle: his success at outperforming the stock market by such a high factor. Buffett is exclusively a stock investor. Long-term, and in terms of ROI, fixed income markets outperorm equities markets. Buffett's miracle in the equities markets is very difficult to explain by conventional due diligence means.

[Tim Worstal]

Re: Money, it's a crime...

"Yes, it did. Fractional Reserve Lending allowed banks to be leveraged 25 or 30 to 1 in their mortgage lending."

No, leverage and FRB are not the same thing at all. FRB refers to what poetion of your deposits you can lend out (ie, what is the fractional reserve). Leverage is about how many multiples of your capital can you borrow to then lend out. The two just aren't the same thing.

"With Full Reserve Banking, the banks simply couldn't have issued so many mortgages."

That's true, with full reserve a bank couldn't make a single mortgage at all. Because it would only be able to lend out money on the terms that money was lent to it. Given that no one at all makes 30 year deposits in banks then a bank would never be able to offer a 30 year mortgage.

http://goldsilverworldscom.c.presscdn.com/wp-content/uploads/2012/07/M1_money_supply_vs_gold_price_1970-2012.gif

Yes, that's M1, base money. Notes and coins plus reserves at the central bank. Which is not "the money supply". M2, which I quoted, is closer to "the money supply". And standard monetarism (what I assume you mean by Austrian) regards M3 or possibly even M4 as the important variable (ie, M1 plus M2 plus bank accounts, deposits and near cash equivalents like credit card balances and so on and on). there were vast increases in M2-M4 in the 70s....and there was, as you note, inflation.

"OK, but: the US is a net exporter of corn and wheat. Diverting some of the production of corn and wheat to spiking gasoline with ethanol doesn't justify the sharp increase in food prices in the US."

What? We have a global price for grains. The wheat price in England is linked to that in France, the US, China, Ukraine. As Ricardo pointed out they'll be about the same price minus transport costs. So, if american start putting corn into cars then the global price of corn will rise. Including the American price of it.

"Cost of transportation in the US is correlated to the price of oil, because we do not have a railway infrastructure to speak of, and everything gets hauled by truck on highways."

My apologies, but are you dialing in from some alternate reality? The US has an absolutely superb railway infrastructure for hauling goods. Vastly more of US internal trade moves on the railways in the US than does anywhere in Europe for example (US, 2,500 billion tonne km as opposed to only 300 billion tonne km for the EU as a whole). It's passenger rail in the US which is pretty shitty. Which, given the distances, isn't all that surprising.

"Long-term, and in terms of ROI, fixed income markets outperorm equities markets."

Yep, you're definitely dialing in from some alternative reality. Over long periods stock beat bonds. Because inflation.

[Anonymous Coward]

Re: Money, it's a crime...

> Leverage is about how many multiples of your capital can you borrow to then lend out.

No. There is no borrowing from anywhere. It's simply lending in multiples of an existing capital base.

A bank issuing a mortgage loan does not borrow the amount it lends out from someplace else. It lends this money as a multiple of an existing capital base. Hence the term "bank capitalization". A bank's capitalization determines how much - in Fractional Reserve Lending - a bank can lend. At least in the US, all banks have limits on the amount of money they can lend. If the bank has reached its leverage ratio limit, it can sell some of its outstanding loans to a different bank, or to a government-sponsored entity (GNMA, FNMA, FMCC), or it can raise more capital, or it has to stop lending. If the bank is unable to reduce its leverage ratio exposure, or is unable to raise more capital, regulators might compel the bank to reduce its exposure.

What the bank cannot do is borrow money from someplace else - a liability - and use this loan as a capital reserve.

[Tim Worstal]

Re: Money, it's a crime...

Sure, you can't use a loan as a capital reserve (with limits. Perpetual floating rate notes were issued by a few banks and were regulatory capital). But all banks do go and borrow what they lend.

They really do not just "create the money" in the basement. If a bank gives me a loan today then by 4 pm today (well, OK, it's a Sunday, pretend it's Monday) it must balance its books. Either other people have deposited enough in the bank (which, to the bank, is just borrowing money from them) or they must go out into the interbank market to borrow it from another bank.

Banks really do go and borrow the money they lend out.

[Ossi]

Re: Money, it's a crime...

"A bank issuing a mortgage loan does not borrow the amount it lends out from someplace else. It lends this money as a multiple of an existing capital base. Hence the term "bank capitalization". A bank's capitalization determines how much - in Fractional Reserve Lending - a bank can lend."

Sorry, but you've misunderstood. As I explained above, banks can only lend what they borrow - they're balance sheets have to - you won't be surprised to hear - balance. If they take a deposit of £100, and keep a reserve of 10%, then they can lend £90, and that's all:

asset (the loan and reserve) = liability (the deposit) = £100.

The creation of money, as I tried to explain above, comes about as a result of the interaction of the bank and the wider economy.

[Anonymous Coward]

Re: Money, it's a crime...

> As I explained above, banks can only lend what they borrow - they're balance sheets have to - you won't be surprised to hear - balance. If they take a deposit of £100, and keep a reserve of 10%, then they can lend £90, and that's all:

In the US, banks can lend against their capital base, which is:

- cash and cash-equivalent securities or holdings (i.e. US Treasury Bonds) not already posted as collateral at the Fed, (AAA-rated securities)

- a fraction of customer deposits - in the US, customer cash deposits are insured by the FDIC. The FDIC - the Federal Government - cannot be on the hook for a bank's overly extended loan leverage ratio. Although, to be fair, during the crash of 2008-2009, many small and medium-sized banks failed and the FDIC paid the bank depositors in full, although the bank itself was insolvent.

A bank's required capitalization level is assessed and determined periodically by the Fed.

A Fractional Reserve Lending (leverage) ratio of 10 would allow a bank to create USD $500 Billion of loans for a capital base of USD $50 Billion, because of the multiplier effect of money creation. During the credit market bubble of the 2000's' many banks had a leverage ratio of 25 or even 30.

[Ossi]

Re: Money, it's a crime...

I feel that we're going round in circles. What you've explained is their reserve - the 10% in my example. This is the proportion of their deposits kept aside, but it doesn't represent all their deposits. They would match their lending.

Please read Tim's explanation of the difference between leverage and FRB.

[Anonymous Coward]

Re: Money, it's a crime...

> Please read Tim's explanation of the difference between leverage and FRB.

Please stop using terms and concepts you do not understand.

If you do not understand how a bank capital base of USD $50 Billion can create USD $500 Billion in outstanding loans, that means you do not understand how commercial banking works, and there is no point in having this discussion in the first place.

[Tom 13]

Re: Please stop using terms and concepts you do not understand.

You first.

[Anonymous Coward]

Re: Money, it's a crime...

This - "Please stop using terms and concepts you do not understand." has to be the funniest line of the whole thread.

ST, please stop, you are, to put it politely, clueless about banking. You are simply regurgitating conspiracy banking theory, the theory of banking of how the evil bastards just create money; which rather begs the question of how the hell could any bank ever go broke.

[Ossi]

Re: Money, it's a crime...

"That's true, with full reserve a bank couldn't make a single mortgage at all. Because it would only be able to lend out money on the terms that money was lent to it. Given that no one at all makes 30 year deposits in banks then a bank would never be able to offer a 30 year mortgage."

@ST - This is a very important point, and one that should interest you. In 'the bubble' banks were offloading assets (and liabilities) into the securities market so they were, in effect, acting as intermediaries rather than as traditional banks - they effectively were just passing the money from the securities market to the mortgage borrower. A full reserve banking system, which you're a proponent of, would almost enforce that role on the banks - or some other intermediary - as banks' ability to originate loans would be severely curtailed. Are you sure that's what you want?

Really, if you want to take aim anywhere take aim at the securities market, not the banks. I think you'll find that the problems were largely there.

[Anonymous Coward]

@ST

I didn't particularly disagree with you until that whopper at the very end. Where in the world do you get this idea that fixed income markets outperform equity markets? That's absolutely not the case, and can be shown if you look at the Dow (with reinvested dividends) vs. bond market (with reinvested interest) for as far back as you'd like you go. There are short periods where that is not true - i.e. if you choose a period short enough that straddles a stock market crash, but even that effect disappears if you look at long enough timeframes. For instance, from 1928 to 2009, getting a crash after the first year and another before the last, the Dow still beats bonds over that period, and by quite a bit!

After a quick google to look for anything you could hang your hat on for your argument, the only thing I could find is this: http://www.bloomberg.com/news/articles/2011-10-31/bonds-beating-u-s-stocks-over-30-years-for-first-time-since-19th-century That's basically picking the best 30 years in history for bonds - starting at historical high rates and finishing at historical lows. If that's the only way bonds can win in a 30 year period since 1861, I think your statement is pretty well refuted.

[Anonymous Coward]

Re: @ST

> fixed income markets outperform equity markets

http://observationsandnotes.blogspot.com/2010/12/us-treasury-bond-real-return-history.html

http://observationsandnotes.blogspot.com/2011/03/stock-market-100-year-inflation-history.html

Using the DJIA and US Treasuries as benchmark:

The inflation-adjusted compound internal annual rate of growth of the DJIA between 1900 and 2011 was 1.6%, excluding taxes and fees.

The inflation-adjusted average nominal internal real rate of return for US Treasuries was 1.7% for for the same period, excluding taxes. US Treasury Bonds can be purchased directly and without paying a fee.

US Treasuries are much too stable of an instrument to expect better returns - plus they are taxable. Non-taxable fixed income investments do exist, and carry only slightly more risk than US Treasuries.

I am discounting the current stock market bubble, which is driven by the Fed's quantitative easing over the past seven years. This too will end, and then the stock markets will correct, and revert to the mean.

[Eddy Ito]

Re: @ST

Not much point in going too far with this but if you're comparing the world to a price weighted index like the Dow I don't know how anyone is going to take you seriously and when you exclude dividends from stocks in your calculation it becomes even more silly. What's 100 years worth of dividends reinvested? Why reinvested? Because it's free money that's why and if you don't want to reinvest it becomes income. What's the dividend / income on your 10 year treasury note? Oh that's right, I'm sorry. Thanks for playing.

[Anonymous Coward]

Re: @ST

I was going to point out his link excluded dividends but you beat me to it. That analysis in his link is utterly worthless since it excludes them, but at least it does clearly state that it excludes them. ST was hoping we wouldn't notice, or too clueless to understand the massive impact dividends have. Even today, where buybacks or holding cash overseas is more common, the Dow 30 still tend to pay out dividends fairly generously and its newest member, Apple, was already doing so for a couple years before being added. Hanging his hat on that link is worse than if he cherry picked the 1981 - 2011 period for bonds!

I agree that the Dow is not a very good proxy for the market as a whole, but the S&P 500 has only been around since the 1950s so the Dow is all you've got data on if you want to go back a long way. Obviously if you invested by buying the Dow stocks at the Dow's price weighting it would be a less than ideal stock investment plan, but despite that it still blows T-bills out of the water once you add dividends to the mix which ST conveniently ignores because it proves how utterly flawed the premise of his argument is.

[Anonymous Coward]

Re: @ST

DougS> ST was hoping we wouldn't notice, or too clueless to understand the massive impact dividends have.

Yep. You knew what I was thinking (about dividends).

Which stocks pay dividends today?

Also:

http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2014/02/04/7-myths-about-dividend-paying-stocks

Most people do not invest directly in stocks, but in mutual funds.

Why don't you take a close look at your 401(k). Chances are - 9 out of 10 - that it's some sort of S&P500 index fund. Do an inflation-adjusted calculation of its value - not the pretty numbers printed by the mutual fund manager, throw in a reversion to the mean over the next 5 years, and then let us know how your 401(k) is doing in inflation-adjusted terms.

I can't help but notice that you didn't tackle - as brilliantly as ever - the problem of fees and taxes on capital gains, of which many fixed-income instruments, or fixed-income mutual funds would be exempt. Care to share your thoughts on this?

[Anonymous Coward]

Re: @ST - ALL Dow 30 stocks pay dividends

http://indexarb.com/dividendYieldSorteddj.html

The average yield is 2.8%, so even in today's climate where dividends are seen as a thing of the past (i.e. like the drooling moron who wrote the article you linked) when you're talking Dow stocks ignoring that dividend yield ignores something pretty huge.

Your same site has this graph, which shows that dividend yield, while it may be shrinking due to buybacks and holding cash overseas, is pretty significant, especially in the past. Which makes me wonder why they ignore dividend yield in the other article when they know damn well it matters - obviously they do it because it ruins the lie they're trying to perpetrate!

http://1.bp.blogspot.com/-QIolLXRTQNY/URPmdW5IlnI/AAAAAAAABqI/bd36r-RV4D4/s1600/Dow+Dividend+Yield+History.jpg

In case you're wondering why dividends have decreased in importance, besides the 'hold cash overseas and hope for another repatriation holiday' it is because of how many execs are compensated via stock options. When you hold stock options, you don't want dividends because you don't collect them on options. You want a higher stock price. So, buybacks become preferable for senior management over dividends - it is in their self interest so no one should be surprised at this.

[Tom 13]

Re: CPI or whatever, is core inflation plus food and energy.

Maybe on paper, but it sure isn't reflecting the price changes I see when I buy things.

More importantly, I just went to check what it actually is, and it seems they have once again changed definitions and some technical details. While it is supposedly "new and improved" it loses the most critical part from a scientific standpoint: continuity of the measurement.

[LucreLout]

Re: Money, it's a crime...

Except that the bank has the added "benefit" of being able to create more dosh out of nothing by the fractional reserve mechanism.

Sorry to be the bearer of bad news, but you don't understand Fractional Reserve Banking.

[Doctor Syntax]

"but it's really not all about their being perfect stock-pickers at al"

OTOH how much did they invest in Greek bonds?

[Eddy Ito]

Actually right about now is a tad late but still a good time to start buying Greek stocks as they've been beaten down pretty well during the recent brouhaha.

[Anonymous Coward]

Reinsurance is about scale

There are barriers to entry in that market, because you need to have a lot of money to sell insurance to insurance companies who are already (by definition and legal requirement) fairly well capitalized. The higher the barriers to entry in a market, the less competition there is. Insurers tend to minimize risk by splitting up their reinsurance contracts, but you need a certain size to offer terms good enough to even get a piece of the action.

I'd be interested to see the cost of capital curve for BH over the years. How has the spread between its capital cost and market rates changed over the years? If it was easy to enter the reinsurance business and compete for the sort of business BH does, others would do and drive down that spread. Maybe the spread has been driven down somewhat as others have clued in to how Buffett did it, but it is still there, still healthy. That's because barriers to entry mean very few can compete with Buffett at BH's scale.

[Tom 13]

Re: There are barriers to entry in that market

This is the real secret to Buffett's success. He invests in markets where there are significant barriers to entry that he can easily cross. One of them Tim left out is the regulatory market where he gets to talk directly to regulators and Congress critters and they take his advice on how to tailor bills and regulations. One item I frequently see mentioned these days is his opposition to the Keystone Pipeline and the money he makes on the freight line that currently carries the Canadian oil into the US for processing.

[Tim99]

The Three Threes

My father was an accountant/senior local government officer, and one of the early people who invested local government money in OTC Spot Markets. He said that for much of his working life retail/high street banking was the "Three Threes" - Borrow at 3%, lend at 3% more than you borrow, and be on the golf course at 3:00pm.

Fortunately he had retired when we all started paying ourselves too much for too little, Then came deregulation and the Big Bang when merchant bankers started playing with the money that little old ladies had put into retail bank investments.

I remember when interest on my mortgage was 18% and everybody was in an inflating market (partly due to poor tax practices and high brokerage commissions). One of the upshots was that when inflation was high, mortgagees were encouraging people to trade-up based on their apparent increase in collateral on their homes.

Before that period mortgage lending was almost sensible, a mortgager would expect a 10% deposit and only lend a first-time buyer 3 times their salary (or if you were a couple 2-2.5 times their combined income) - But only if they had a secure job. How the hell did we get to people being lent 8 times their salary in times of apparently low inflation? This seems to drive relative house prices higher, and pushes all linked prices up. This might be a reason why many younger people will be unable to purchase their own house - Whether that is a bad thing, or not, I don't know, if we compare, say, the relatively high rental property share in Germany to that of the UK.

[Tom 13]

Re: How the hell did we get to people being lent 8 times their salary...

Application of the analysis of a niche market to the broad market, or what became known as NINJa loans. The legitimate niche market was in what was essentially high stakes sales jobs. On paper, the people in these jobs have no reliable income because they work on commission. In reality, they have real high 5 digit or better incomes. So if you know how to do the analysis, you can make lower interest loans to these people than a regular bank will. But that analysis got adopted outside of its niche area because all those niche players were outperforming the regular loan market. Throw in some government backing for said loans, and some government regulations forcing all banks to make those kinds of loans or face racial discrimination penalties and you have a toxic brew that can topple an economic system.

[johnwerneken]

Hoorah for Buffet!

THAT is replicable: look for something wildly profitable, not currently being done on a wide scale, and capable of being taken to the big time league. Do it first do it fast do it with all you've got. The world will beat a path to your door, carrying money to give to you!

[Eugene Crosser]

What about other insurance companies?

Insurance market in not competitive, and as a result, those who own an insurance company have "free money" to invest. OK, I got it.

But Buffett's not the only insurance company in existence. Why aren't the owners of other insurance companies making the same crazy profit as Buffett?

[Hollerith 1]

Re: What about other insurance companies?

They are> Insurance is a great way to make money. Some firms get too stuck in on insurance that is hard to make profitable -- car insurance was mentioned in the article - but B2B insurance is a great way to make the dosh.

Having worked for a huge insurance company, I can say that they get terribly complacent and waste mountansn of money on internal 'projects' and practices, because it's so easy to come buy and so easy to spend. I watched a few million $ walk out the door on mere changing of reporting lines within divisions. Also, teams not helping the bottom line (HR, Comms, etc) tend to blossom into toxic blooms, because money is practically lying on the ground waiting to be picked up, and there's a certain sort of leech who can sniff it out.

[Tom 13]

Re: What about other insurance companies?

Whenever you encounter the phrase market in not competitive there is always one root cause of the problem: government regulation. Buffett gets rich because he has access to all the people who make those regulations, the other insurance companies, not so much.

[cray74]

Re: What about other insurance companies?

"Whenever you encounter the phrase market in not competitive there is always one root cause of the problem: government regulation."

No, the market is quite capable of making itself non-competitive, too. See: abuses by monopolies.

[jzlondon]

If everyone was Warren Buffett, then Warren Buffett wouldn't be successful.

[Anonymous Coward]

The efficient market theory does make sense to me...

...but it assumes the investor is a passive holder of the shares. Another way you can beat the market is to interfere in how the business is run. Doesn't Buffett do this to some degree? Getting rid of duff management increases the gains from investing in a particular firm.

[LucreLout]

When Buffett calls....

... everyone, literally everyone in any industry, stops whatever they were doing and takes the call. His access to senior management is unrivaled anywhere in the world. Joe Schmo calls a CEO, and he won't even have his call put through: he'll be sent to investor relations or customer services.

With that access to management, it becomes much easier to determine who is a competent leader of enterprise, and who is a hollow suit with networking skills. The latter vastly outnumber the former, but it is only with the former that Buffett invests.

Buffett & Munger are two of the industry's greates rock stars. All time hall of famers. And yet, by all accounts, thoroughly decent people. I for one wish them continued success.

[Anonymous Coward]

" employ competent people"

Yes I think that is one huge element; too many CEOs are on an ego-trip. Cull those and you can make serious long-term gains.

[kmac499]

Translated into English

Leverage = Borrow

Invest = Lend

Interest = Rent

If you want to make a lot of money

Borrow money from people who don't want it back next week\month etc...

Pay them for this money by paying them a lower than average rent

Lend this money to others or use it to buy existing existing reliable businesses.

Get the people you lend to, pay you a rent that is slightly more than the rent you pay.

The businesses you own should be run so as to make a profit equivalent to the rent due..

Don't go Nuts or be greedy and always make sure you have enough money on hand to return back to any owner that want's it back now.

[Identity]

A little knowlege is a dangerous thing.

TW's article is clear — and just a tad obvious, to anyone who follows these things. However, I must niggle at his characterization of the US insurance market as non-competitive. As a Brit, he can be forgiven and does indeed know there are various state regulators. However, there are extreme differences from state to state. For instance, Massachusetts actually sets the rates, so everyone pays the same if fall into the same group, and the state requires (again for instance) every driver to carry insurance. No real competition there — insurers must compete on things like service (gasp!). In neighboring New Hampshire, the state does not set rates and the premiums for any given policy will vary from company to company. There is a small market in Massachusetts residents trying to figure out how to register their cars in New Hampshire, even though Massachusetts is a 'No Fault' state...

Similar variances abound.

[Tim Worstal]

Re: A little knowlege is a dangerous thing.

"and just a tad obvious, to anyone who follows these things. "

Well, yes. But if I was writing for people whjo already knew all these things then I'd be writing in "Warren Buffett Analysis Weekly" rather than El Reg.........