Articles on Warren Buffet(Part 1)

Taken from Intelligent Investor:

Taking an interest in the doings of Warren Buffett is one of those things that tends to start out as an act of intellectual curiosity and ends up dragging you deeper and deeper into the thought processes of this most remarkable of individuals. Over the years, many professional investors have made the journey, as I have done, from initial scepticism ("can this guy really be that good?") into outright awe and fascination at what this great investor and businessman has achieved.
This is not so much because of the track record that Buffett has put together as an investor over a period of more than 40 years, formidable though that is - a compound annual return of more than 20% per annum since the late 1950s. It is more, I think, because of his unrivalled ability to talk the most profound (and entertaining) common sense about the way that the business and financial world operates.
Professional investors are by and large a competitive and sceptical bunch, whose daily task is to filter hope (of which there is an unending supply in all financial markets) from reality, a somewhat rarer commodity. I have never found one who disputes that Buffett has an extraordinary capacity for telling things the way that they really are, and doing so in a way that is wonderfully succinct and to the point.
There are plenty of examples, many familiar, some less so, in a new book on Buffett that has just appeared. The author is a British fund manager James O'Loughlin, who is head of global equity strategy at the Co-Operative Insurance Society. He quotes extensively from the vast archive of Buffett quotes and folklore, but also adds some interesting new details on aspects of Buffett's career that have not been often aired elsewhere.
The sheer scale and scope of the business Buffett controls now does is frequently misunderstood. While he spent the first twenty years of his working life as a stock market investor, buying and trading shares for a group of wealthy clients in his home state of Nebraska , for the last thirty years he has been running something much more ambitious. His holding company Berkshire Hathaway is built around a core of cash-generative insurance companies; the cash they generate provides the capital that Buffett and his partner Charlie Munger then invest on their shareholders' behalf. Capital allocation is what Buffett and Munger see as being their "core competence".
Buffett is well-known for his large "semi-permanent" minority holdings in a handful of America 's largest companies, the likes of American Express, Coca-Cola and Gillette. Yet these represent only one part (and a declining one) of the company's overall investment activities. In addition to his insurance operations, Berkshire Hathaway now owns outright a string of industrial and retail companies, many in deeply boring but lucrative fields of business. While many of these were originally family-owned companies, an increasing number are now former quoted companies that Buffett has acquired outright on the stock market.
In fact, he has been stepping up the pace and range of his acquisitions over the last two years, taking advantage of the attractive valuations that the bear market has thrown up in some (though not all) sectors. Yet four years ago, as Mr O'Loughlin correctly points out, Buffett made what for him was a huge switch in his overall asset allocation in the opposite direction. This he did by buying General Re, one of the largest quoted reinsurance companies in the States.
Viewed in isolation, and from a strictly insurance business perspective, it is clear that Buffett made one of his rare mistakes in paying so much for General Re. The business turned out to have had laxer underwriting disciplines than Buffett expects or tolerates in his own insurance operations. This, combined with a string of high profile insurance disasters (including September 11), has produced some very large losses at the company.
But the much bigger purpose behind the merger, which was missed by many observeers at the time, was to reduce substantially Buffett's exposure to the overvalued stock market, and increase commensurately his holdings of bonds and fixed interest securities. Insurance companies generally hold a much greater proportion of their assets in fixed interest than other types of institutional investor.
By doing what he rarely does, and paying for the merger in Berkshire Hathaway's own shares, Buffett in effect bought himself a vast bond portfolio at below the market price - a piece of wholesale market timing that in scale and dexterity has few parallels in recent years. He also laid his hands on the prodigious cash flow of General Re, boosting still further the funds he has available to invest elsewhere.
In the event, it turned out that the management of General Re were not the type of owner-oriented, business-focussed management that Buffett normally relies on to ensure that his acquisitions work. One of the best sections in this new book details Buffett's uncannily accurate predictions of how Corporate America's love affair with one-way stock options and quarterly earnings management would end in tears for investors, as it eventually did so spectacularly in 2000 and since.
"Many businesses" says Buffett "would be better understood by their shareholder owners, as well as the general public, if managements and financial analysts modified the primary emphasis they place upon earnings per share and upon yearly changes in the figure. In the long run, managements stressing accounting appearance over economic substance usually achieve little of either".
As for stock market investors are concerned, Buffett explains his success quite simply: "Plenty of people have higher IQs and plenty of people work more hours, but I am rational about things. You have to be able to control yourself; you can't let your emotions get in the way of your mind". Everyone who has immersed themselves in the Buffett phenomenon naturally has their own explanations for his success. My own view on this is that his real genius lies not just in the quality of his analysis, or in the quality of his contacts, impressive though both are.
It was his decision to fashion out of Berkshire Hathaway, his holding company, a corporate vehicle that frees him to invest in a completely rational and unfettered way, free of the conflicts of interest and bureaucratic imperatives that bedevil most fund management operations. This is a luxury that is simply not available to most professional investors who act on your behalf, for reasons that anyone who has worked in a large organisation will readily understand.
Although Buffett has always refused to make specific predictions about the market, I have always found his throwaway lines a useful guide to what will happen next. His comment a couple of months ago that the bear market "could be over, but may not be" is potentially more significant than it sounds at first. It is his certainly his first even vaguely positive statement about the stock market I have seen since 1999. Although Wall Street's rally since mid-October has been a powerful one, it is not certain that the market cannot go higher still in the next 12 months, even if the UK market continues to lag for a while.