Buffett's Owner's Manual - Part 1

In 1983 Warren Buffett set down 13 owner related business principles that he believed would help shareholders understand their managerial approach.  Since our approach to investing money is very similar to Buffett's I thought it would be helpful to also share those principles with our clients and friends. These principles are as applicable as they were in 1983.  

Some of them will directly apply to our clients. Some of them will be adapted to our relationship with our clients, which is obviously different than the manager/shareholder relationship that Buffett has with the shareholders of Berkshire Hathaway.  As we go through the principles, I'll try to relate the principle back to our team so that you can see the parallel.

Since this was too much to include in just one post, this will be a 3 part post, with a discussion of Intrinsic Value as defined by Buffett being the topic of the third post.

Principle 1

Although our form is corporate, our attitude is partnership – Buffett and Munger view the shareholders as their partners.  They view the corporation as a conduit through which the shareholders own the assets of the corporation.  They want shareholders to understand that when you buy a stock, you don't just own a piece of paper, but an interest in real assets.  They want shareholders to think of themselves as the owner of a business, just like they would if they owned a small business or a farm or a rental property.

It appears that Berkshire shareholders as a whole have embraced this philosophy as the turnover of Berkshire shares is much lower than that of other major American corporations. While the legal form of our relationship with our clients is different than a partnership, we still follow the same spirit of this principle.  

Every decision we make with respect to a client is with the client's best interests in mind and as such we treat them just like we treat our partners. We also encourage our clients to treat their investments as shares in a business.  By doing so we believe they will improve their returns as well as afford them the opportunity to own some fantastic businesses. Buffett has said that they "measure our success by long term progress of the companies rather than the month to month movements of the stock prices."  

This is also similar to how we urge our clients to look at their investments (as well as their own financial planning).  Short term movements are far less important than long term progress.

Principle 2

Directors have a major portion of their net worth invested in the Company.  We eat our own cooking. Just like Buffett and Munger have said, I cannot promise you results, but I can guarantee that your financial fortunes move in lockstep with ours for as long as you are a client of ours.  While all of our clients have individual portfolios that are customized to them, there is always common threads through all of our portfolios, mostly because good investment ideas are hard to come by and we definitely want to re-use them when we find them.

All of our clients' money is invested in a style identical to our own.  In addition, our family's money is also invested in exactly the same way.  In effect we also 'eat our own cooking'.

Principle 3

Our long term economic goal (subject to qualifications) is to maximize Berkshire's average annual rate of gain in intrinsic business value on a per share basis. This is somewhat hard to relate to our clients because clients don't have an intrinsic value.  But I think the intrinsic value of a business is very analogous to the progress towards a client's financial plan and their individual goals.  

Our long term goal is to maximize our client's progress towards their financial goals. In addition, we do measure our investment progress similarly to how Berkshire measures theirs.  We would be disappointed if we do not achieve greater returns after fees than a comparable benchmark such as the S&P 500 (US), TSX Composite (Canada), MSCI EAFE (International), and FTSE TM Bond Universe (Fixed Income).

Principle 4

Our preference would be to reach our goal by directly owning a diversified group of businesses that generate cash consistently earn above average returns on capital.  Our second choice is to own parts of similar businesses, attained primarily through the purchases of marketable common stocks by our insurance subsidiaries.  The price and availability of businesses and the need for insurance capital determine any given year's capital allocation.

Many of our clients similarly own their own business or at the very least have careers which pay them well.  In almost all cases, this is going to be the primary source of wealth creation for them.  So their situation would be similar to Berkshire's where some businesses are owned outright. What's interesting though is that there is still great opportunities to own partial shares of wonderful businesses.  In many cases these partial shares are much more easily obtained and can be much more affordable.  

That's where we provide a lot of value to our clients. At times opportunities to obtain even partial shares of businesses can be tough to find, such as the current market.  We actually benefit more from a depressed stock market than from a very expensive one, like the one we currently have.  Market corrections will present us and our clients with a very distinct advantage.

Principle 5

Consolidated reported earnings may reveal very little about our true economic performance.  Charlie and I, both as owners and managers, virtually ignore such consolidated numbers.  However we will also report to you the earnings of each major business we control, numbers we consider of great importance.  These figures, along with other information we will supply about the businesses, should generally aid you in making judgements about them.

Reporting accurate and meaningful information to shareholders is very important to Buffett. He wants shareholders to be well informed so that they can make the right decision for them when it comes to their investment in Berkshire Hathaway.  Transparency is a very key principle for Buffett. Similarly we also try to be very transparent with our clients and prospects so that they can make the right decision for themselves and their families.  

Similarly to Buffett we emphasize information which may not show up on a client's monthly statement.  This includes, progress towards their financial goals, financial planning objectives achieved, in addition to the actual rate of return they achieved on their investments.  We think these metrics are the important information on which to make a decision to work with us or not.

Principle 6

Accounting consequences do not influence our capital allocation decisions.  When acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable than to purchase $1 of earnings that is reportable. In aggregate and over time, we expect the unreported earnings to be fully reflected in our intrinsic value through capital gains.

Buffett always makes the most rational decision when it comes to investing and they will not make decisions based on how it will make themselves or Berkshire look. Over time, these hidden increases to intrinsic value eventually show up in the stock price, even if they don't show up on the accounting earnings.

Similarly, we try to do what's right for the client in all circumstances and we won't ever make a decision based on how it will look.  A common practice in the investment industry is to engage in 'tax-loss selling' towards the end of the year to sell off some of the stocks that have lost market value.  While this is a perfectly legitimate practice with real tax benefits, many advisors take advantage of this to do some 'window dressing' on their clients' portfolios to remove their worst mistakes from the client statements.  

We have never engaged in this.  The only reason we sell a stock is if we think the client will benefit more from selling it then they would from owning it.

Principle 7

We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long term fixed rate basis.  We will reject interesting opportunities rather than over-leverage our balance sheet.  This conservatism has penalized our results but it is the only behaviour that leaves us comfortable.  (As one of the Indianapolis 500 winners has said: "to finish first, you must first finish") Buffett never wants to "trade a good night's sleep for a few extra percentage points of return.  I've never believed in risking what my family and friends have and need in order to pursue what they don't have and don't need."

My thoughts are very similar to Buffett's.  We advise our clients to borrow money only when appropriate and very sparingly.  We also take the minimum amount of risk we can in order to achieve our client's goals, because we also don't want to trade a good night's sleep for a few extra dollars. To us this is just second nature. Unfortunately our experience has been that many clients and advisor's push the limits of leverage and take many unnecessary and dangerous risks.

- Craig White, BA, LL.B., CIM

Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

Industrial Alliance Securities Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Securities is a trademark and business name under which Industrial Alliance Securities Inc. operates.

This information has been prepared by Craig White who is an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.