QUALIPORT
Buffett's Words of Wisdom

By Maynard Paton (TMFMayn)
March 11, 2002

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Carburton Street, London -- On Saturday, Warren Buffett published his latest Shareholders' Letter. As usual, it's a very informative and educational read. Today's Qualiport picks out the important parts of Buffett's missive for the ordinary UK investor.

(For those wanting a deeper analysis of Buffett and the performance of his Berkshire Hathaway (NYSE: BRK.A) business, the Berkshire Hathaway message board over at the US Fool is awash with in-depth comment and insight.)

Common stocks

Here's how Berkshire Hathaway's common stock portfolio stood at the end of last year:

Company                      Value ($m)

American Express               5,410
Coca Cola                      9,430
Gillette                       3,206
H&R Block                        715
Moody's Corporation              957
Washington Post                  916
Wells Fargo                    2,315
Others                         5,726
Total                         28,675

There are four points to note from the portfolio:

* Big bold bets are best: Representing some 80% of its value, Buffett has only seven major constituents in the common stock portfolio. The largest holding represents 33%. This concentration is quite consistent with the weightings of years gone by.

* Great long-term businesses are rarely attractively valued: It's now been six years since Buffett topped up on one of his 'core' common stock investments. At the moment, Buffett does not believe his equity holdings, as a group, are "undervalued".

*  Bring on the side bets: Buffett's success is still founded on the long-term buy and hold philosophy. Five of his main holdings (American Express (NYSE: AXP), Coca Cola (NYSE: KO.), Gillette (NYSE: G), Washington Post (NYSE: WPO) and Wells Fargo (NYSE: WFC)) have all been regular fixtures in the portfolio for at least eight years.

That said, following on from the calculations presented in this feature, Buffett's average holding period (since 1977) for his common stock investments now stands at just 4.76 years. He continues to invest in 'small' side bets that don't measure up to the more familiar 'business franchises'. Last year, purchases included bankrupt underwear firm Fruit Of The Loom and FINOVA (NYSE: FNVG) junk bonds.

* More fortune telling?: Buffett admits to having "decidedly lukewarm feelings" over the general prospects for US stocks during the next decade or so. But should investors worry? Not really.

While the prospect of lower stock market growth may be on the cards, you have to put that prospective performance into context. Over the long-term, the stock market has traditionally beaten cash and gilts during a variety of economic environments.

Insurance

When reviewing Buffett's 2000 Shareholders' Letter a year ago, I wrote:

"While Independent [Insurance] may become some sort of crisis play in the future, there remain far too many corporate uncertainties for the discerning private investor. A definite investment minefield. Buffett may wax lyrical about how he has generated fantastic returns from the insurance industry. But in my opinion, and with the ordinary UK investor in mind, the sector should be left to short-term players only."

One year on, and the insurance industry still remains a definite investment minefield. Independent Insurance eventually went bust, while Berkshire Hathaway's insurance businesses lost over $2b in 2001. On Berkshire's performance, Buffett et al just didn't evaluate properly the risk of a major terrorist attack in the US.

Needless to say, my opinion on the insurance sector hasn't changed. The investment difficulty all stems from the fact that an insurance company's accounts are largely based on the assumptions of tomorrow (via estimates of future claims), rather than the facts from the past. That being the case, the odds of making an investment mistake with an insurer are considerably greater than average. As Buffett intimates, investors "produce outstanding long-term results primarily by avoiding dumb decisions, rather than making brilliant ones."

Relative performance

Finally, when reviewing his investment achievements, Buffett outlined his preference for using relative measures set against the "general experience in securities".

He added: "Some people disagree with our focus on relative figures, arguing that "you can't eat relative performance." But if you expect, as... I do, that owning the S&P 500 will produce reasonably satisfactory results over time, it follows that, for long-term investors, gaining small advantages over that index must prove rewarding."

Although criticised once or twice for using relative performance figures in a falling market, I'm happy to continue benchmarking the Qualiport's progress against the major UK stock market indices. However, such performance comparisons should only be judged over a medium-term timescale. For those who attempt to beat the stock market and the building society every year, disappointment surely waits.

More: Berkshire Hathaway discussion board | Buffett 2000 | Buffett Video