Lessons for Corporate America - Monitor …

1 The EssaysofWarrenBuffett: Lessons ,Arranged, ,Arranged, , 1997; .. "Value" .. ' .. ' .. ,BookValue, .. ' ,valuing businesses,andusingfinancialin-formation profitably,thewritingsarebroadinscope, , itistocorrectaninefficiencyinthemarketpl aceofideasbydisseminatingtheessaystoa 'slucidessaysisthattheprinciplesoffundam entalvaluationanalysis,firstformulatedby histeachersBenGrahamandDavidDodd, , ,accounting, 'slessonsdirectlycontradictwhathasbeenta ughtinbusinessandlawschoolsduringthepast thirtyyears.

2 Buffettistheirprodi-galpupil, ,toconvincingdemonstrationsofthedeleteri ouseffectsofusingstockoptionstocompensat emanagers, ,a companywithrootsina ,whenitsbookvaluepersharewas$ ,itsbookvaluepershareisaround$20, [ holdingcompanyengagedina varietyofbusinesses, 'smostimportantbusi-nessisinsurance,carr iedonprincipallythroughits100%ownedsubsi diary,GEICOC orporation, ,homefurnishings,andcleaningsys-tems,toc hocolatecandies,icecream,footwear,unifor ms, ,includingAmericanExpress,Coca-Cola,Walt Disney,FreddieMac,Gillette,McDonald's,Th eWashingtonPost, $ busi-nessata fairprice,theytakea "double-barreledapproach"ofbuy-ingontheo penmarketlessthan100%ofsuchbusinesseswhe ntheycandosoata pro-ratapricewellbelowwhatit wouldtaketobuy100%.]

3 'sportfolio,ona persharebasis,increasedfrom$4in1965toove r$22,000in1995, $4toover$258,a , , partnershipamonghim,Mungerandothershareh olders,andvirtuallyallhis$ 'spershareintrinsicvaluebyowningallorpar tofa , ]THEESSAYSOFWARRENBUFFETT7 Berkshireretainsandreinvestsearningswhen doingsodeliv-ersatleastproportionalincre asesinpersharemarketvalueovertime. It usesdebtsparinglyandsellsequityonlywheni t receivesasmuchinvalueasit , ,asBuffettcallsthem, ,theessaysconstituteanelegantandinstruct ivemanualonmanagement,investment,finance , 'sbasicprinciplesformtheframeworkfora It istruethatinvestorsshouldfocusonfundamen tals,bepatient, 'sessays, , ,butthinkingabouthowtomakesoundinvestmen tselectionsbasedonBerkshire' 'swritingsandlearnfromthem,ratherthantry toemulateBerkshire' '.

4 BuffettsaidthatIcouldbethepopularizerofG raham'sideasandBuffett' 'sintellectualgenerosityandbelievesitisa ppropriatethathepassthewisdomon, , , [ 'sforty-yearcareeranda likeitis, , ,a 'sdisclosurepracticeandtheowner-relatedb usinessprinciplessummarizedabove, ,mappinganabstractchainofcommandontoa particularbusinesssituation,accordingtoB uffett, ,honest, ,standardsformeasuringaCEO'sperformancea reinadequateoreasytomanipulate,soaCEO' ,nooneisseniortotheCEO,sonoseniorperson' ,a ; , ,however, ]THEESSAYSOFWARRENBUFFETT9 Thebestsolution,Buffettinstructs, , ,theirinterest, ,oneofthegreatestproblemsamongboardsinco rporateAmericaisthatmembersareselectedfo rotherrea-sons,suchasaddingdiversityorpr ominencetoa , ,directorpowerisweakestinthecasewherethe reisa ,thereislittlea directorcandootherthantoobjectand,inseri ouscircumstances, ,wherethereisa ,however,isa corporationwithouta ,Buffettsays.

5 It wouldbehelpfulif directorscouldsup-plynecessarydiscipline , , commoncharacteristic:theter-riblemanager isa ,Buffettemphasizes, If onlyshort-termresultsmattered,manymanage rialdecisionswouldbemucheasier, ,considerAlDunlap' [VoL19:1beam'sworkersandclosedorconsolid atedmorethanhalfitsfacili-ties, , , ,however,ifyourecognizethatsuperiorlong- termresultscanflowfromearningthetrustofs ocialcommunities,asBuffett' ' reversalofitsmisfortunes,notinghowimport antBerkshire'stextilebusinesswastoitsemp loyeesandlocalcommu-nitiesinNewEngland, ,buta , , , ,managementallocatesa , ,solongasaggre-gateannualdonationsarerea sonableinamount,usuallynotgreaterthan10% ,thisdemonstratesa costoftheshort-termmentalityofAmerica' ]

6 THEESSAYSOFWARRENBUFFETT11 Theplantoalignmanagementandshareholderin terestsbyawardingexecutivesstockoptionsn otonlywasoversold, ,ratherthanbysuperiordeploymentofcapitaL AsBuffettexplains,how-ever,simplybyretai ningandreinvestingearnings,managerscanre portannualearningsincreaseswithoutsomuch asliftinga ,oncegranted,stockoptionsareoftenirrevoc able,uncondi-tional, managerialculturethatencouragesowner-lik ethinking, ,butthissubjectshouldreallybeonthefront- burnerofshareholders, ,afterprofitsarereducedbya ,theyshouldberelatedtoindividualper-form ance,ratherthancorporateperformance, ,asatBerkshire,stockoptionsshouldsimplyn otbepartofanexecutive' ,ex-ceptionalmanagerswhoearncashbonusesb asedontheperform-anceoftheirownbusinessc ansimplybuystockif theywantto;iftheydo,they"trulywalkinthes hoesofowners," :itisa ,youwilldo12 CARDOZOLAWREVIEW[ :1betterbyrandomlyselectinga groupofstocksfora ' diversifiedportfolio-thatis,it formalizesthefolkslogan"don'tputallyoure ggsinonebasket.]

7 "Theriskthatisleftoveristheonlyriskforwh ichinvestorswillbecompensated, , , ,incolleges,universities,businessschools ,andlawschools,butbecame standarddogmathroughoutfinancialAmericai nthepastthirtyyears, ,thattheonlyriskthatmattersisthevolatili tyofprices,andthatthebestwaytomanagethat riskistoinvestina distinguishedlineofinvestorsstretchingba cktoGrahamandDoddwhichdebunksstandarddog ma bylogicandexperience,Buffettthinksmostma rketsarenotpurelyefficientandthatequatin gvolatilitywithriskisa ,Buffettworriedthata wholegenerationofMBAsandlDs,undertheinfl uenceofmodernfinancetheory, , silverlining.

8 It ,norcouldmountainousotherphenomenarelati ngtothebehaviorofsmallcapitalizationstoc ks,highdividend-yieldstocks, ]THEESSAYSOFWARRENBUFFETT13emergedtosayt hatbetadoesnotreallymeasuretheinvestment riskthatmatters, ,peoplestartednoticingBuffett' ,formorethanfortyyearsBuffetthasgenerate daverageannualreturnsof20%orbetter, ,BenGraham' ,thestunningper-formancesatGraham-Newman andatBerkshiredeserverespect:thesamplesi zesweresignificant;theywereconductedover anex-tensivetimeperiod,andwerenotskewedb ya fewfortunateexper-iences;nodata-miningwa sinvolved;andtheperformanceswerelongitud inal, 'sperformance, ,modernfinanceenthusiastsstillinsistthat aninvestor'sbeststrategyistodiversifybas edonbetasordartthrowing,andconstantlyrec onfigureone' quipandsomeadvice:thequipisthatdevoteeso fhisinvestmentphilosophyshouldprobablyen dowchairstoensuretheperpetualteachingofe fficientmarketdogma.

9 ' ,theriskthatmattersisnotbetaorvolatility , company'smanagement,products,competitors , business,thequalityandintegrityofitsmana gement, ,particularlycomparedwiththeseductive14 CARDOZOLAWREVIEW[ :1precisionofbeta,butthepointisthatjudgm entsaboutsuchmat-terscannotbeavoided,exc epttoaninvestor' " 'riskier'atthelowerpricethanitwasatthehi gherprice" ,betacannotdistinguishtheriskinherentin" asingle-producttoycom-panysellingpetrock sorhulahoopsfromanothertoycompanywhoseso leproductisMonopolyorBarbie."Butordinary inves-torscanmakethosedistinctionsbythin kingaboutconsumerbe-haviorandthewayconsu merproductscompaniescompete,andcanalsofi gureoutwhena hugestock-pricedropsignalsa , buffett ' ,ifnotofone'sportfolio,thenatleastofitso wner' ,BuffettremindsusthatKeynes,whowasnotonl ya brillianteconomistbutalsoa brilliantinvestor, , 'sthinkingabouta ,accordingtoBuffett,suffersfrominatten-t ionto"afundamentalprinciple:Itisbetterto beapproximatelyrightthanpreciselywrong.]

10 "Long-terminvestmentsuccessde-pendsnoton studyingbetasandmaintaininga diversifiedportfo-lio,butonrecognizingth atasaninvestor, "flittingfromflowertoflower"imposeshuget ransactioncostsintheformsofspreads,feesa ndcommis-sions, "is likecallingsomeonewhorepeatedlyengagesin one-nightstandsa romantic."Invest-mentknittingturnsmodern financetheory'sfolkwisdomonitshead:inste adof"don'tputallyoureggsinonebasket,"weg etMarkTwain'sadvicefromPudd'nheadWilson: "Putallyoureggsinonebasket-andwatchthatb asket."1997] numberofclassicworks,includingTheIntelli gent