Yes I know, I’m late to the party. Over the years I’ve read Buffett’s various letters at random. But I figured I’ll start reading them straight through. I’m starting at the beginning, with the 1957 partnership letter, long before Berkshire Hathaway became the vehicle of his investments and much before he teamed up with Charlie Munger.
This was a time when Buffett was investing in work-outs in addition to general issues. In the letter, Buffett explains the term work-out as follows:
A work-out is an investment which is dependent on a specific corporate action for its profit rather than a general advance in the price of the stock as in the case of undervalued situations. Work-outs come about through: sales, mergers, liquidations, tenders, etc. In each case, the risk is that something will upset the applecart and cause the abandonment of the planned action, not that the economic picture will deteriorate and stocks decline generally.
These sound like what you’d call special situations today. The interesting point he makes is that these investments are not very affected by general price levels in the markets. That would also imply that when markets are at ridiculous highs, that’s perhaps a good time to look for special situations rather than participating in the broader market. In Buffett’s case, he’d often buy enough to be able to affect the outcomes. He’d get a Board seat or at least a large enough voting share. Naturally, that’s not possible for individual investors today, so one carries more risk in that case.
Another interesting thing he talks about is his inability to beat the market during bull runs. He’s very clear that he thinks he can beat the market when it is flat or down, but only just keep up with it when it is up. That’s an important point. It is perhaps more important to make sure you don’t lose a lot of money when the markets are down, than it is to make a lot of it when the markets are up. When the market is rallying, investors can tend to feel left out and buy the latest fad, in the pursuit of returns. If even Warren Buffett didn’t attempt to beat the market during bull runs, perhaps we can take comfort in our own performance as well.
Finally, he says that when they are trying to build a position in some illiquid securities, they’re happier if the price remains flat or even declines. It might seem painful to watch it decline as you buy, but that’s good for long-term profits.
Read the original letter here.