Who
am I to criticize Warren Buffett who is generally considered the greatest
investor of all time? He is worth slightly more than I am and has been at it far longer.
His annual letters to the Berkshire shareholders are usually a treasure trove
of great advice. Just not this year!
Even
the Oracle of Omaha sometimes gets it flat wrong (investment in World Book Encyclopedia,1962
investment in the textile industry, 2008 investment in the Conoco Phillips). His
latest annual letter is featured in the March 17,
2014 Fortune (can I tell the future or what?)
includes some
horrible advice.
In 1986 Buffett purchased a 400-acre farm north of Omaha for $280,000. Warren
says: “I knew nothing about operating a farm. But I have a son who loves
farming, and I learned from him both how many bushels of corn and soybeans the
farm would produce and what the operating expenses would be. From these
estimates, I calculated the normalized return from the farm to then be about
10%. I also thought it was likely that productivity would improve over time and
that crop prices would move higher as well. Both expectations proved out.” But Warren, these are conflicting trends. Improved
efficiency tends to increased supply and reduced prices. (Remember the good old Law
of Supply and Demand?) Why would greater
productivity and supply lead to higher crop prices?
“I needed no unusual knowledge or intelligence to conclude that the
investment had no downside and potentially had substantial upside.” Warren – this falls in the “stupefying” or “huckster”
category. No downside? Remember the dust bowl? What if your
water supply dried up? What if there was
a colossal insect infestation? What if new technologies in farming increased foreign
production by 50% and the world-wide demand coincidentally dropped by 20% - would
that lead to higher prices? What if
fertilizer or insecticide prices doubled or the cost of tractor diesel fuel quadrupled? What if the US government stopped subsidizing
soy beans or repealed the ethanol mandate, or charged the full cost for crop
insurance? What if property tax rates
were increased dramatically? Your favorite president keeps warning us about the
ravages of global climate change. What
if this had an adverse impact on your ability to grow the most valuable crops on
your farm?
Warren continues: “Now, 28 years later, the farm has tripled its
earnings and is worth five times or more what I paid. I still know nothing
about farming and recently made just my second visit to the farm?” But Warren,
what if your managers had cheated you? (Even you are not immune to this risk.) What
if one of your workers had a terrible work accident and your worker’s
compensation insurance rates doubled? What if your work force had unionized? What
if one of your managers created a nice little cash business where he accepted
hazardous waste and buried it on your property? Were you going to notice this “detail”
in your visits twice every 28 years? Your ensuing liability would extend beyond
the money you had invested in the farm because of current hazardous waste
law.
Buffett then states: “You don’t need to be an expert in order to achieve
satisfactory investment returns. But if you aren't, you must recognize your limitations
and follow a course certain to work reasonably well.” Nice sounding “strategy” Warren but what do
you mean? What “course” would you follow
if you were to invest in a semi-conductor company, walnut orchard, or grocery
chain in which you knew nothing about the market, the trends, or the general business
landscape? How in the heck would you
determine a “course certain to work reasonably well”? How many times have you said that you don’t
invest in technology because you simply don’t understand the business? You made sense the first fifty times I heard
you say that you won’t invest in technology because you don’t have an edge? But
now, in hindsight, you try and feed us this cock and bull story that despite
knowing nothing about farming that you had an edge? Is there a chance that you
simply got lucky this time?
Buffett says: “I am unable to speculate successfully, and I am
skeptical of those who claim sustained success at doing so.” So Warren, how do you differentiate “speculation”
from other business bets that you make all the time? Dictionary.com defines
speculation as “engagement in business transactions involving considerable risk but offering the chance of
large gains, especially trading in commodities, stocks, etc., in the hope of profit from changes
in the market price.”
Warren, you were betting that your revenues would grow based on improved production and an increase in crop prices (you were going “long” these factors.) You were simultaneously betting that your expenses would hold steady or decrease (wages, insurance, seeds, fertilizer, water, diesel, electricity). You were “short” these expenses. So tell me why you weren't “speculating”? Please explain to me again how you had no downside – especially since you knew nothing about farming.
Warren, you were betting that your revenues would grow based on improved production and an increase in crop prices (you were going “long” these factors.) You were simultaneously betting that your expenses would hold steady or decrease (wages, insurance, seeds, fertilizer, water, diesel, electricity). You were “short” these expenses. So tell me why you weren't “speculating”? Please explain to me again how you had no downside – especially since you knew nothing about farming.
Buffett goes on to say: “Forming macro opinions or listening to
the macro or market predictions of others is a waste of time. Indeed, it is
dangerous because it may blur your vision of the facts that are truly important.”
Warren, are you saying that you were not subject to macro trends when you
bought the farm (by the way the Phrase Finder indicates that the meaning of the
phrase “bought the farm” is “to die, particularly in an accident or military action” - that is not my intended meaning here)? If you had bought the farm in 1929, your
investment would have performed poorly for the next decade as farm prices
collapsed (In this case the phrase would have had the Phrase Finder meaning as well.) Macro trends matter more than
micro trends (that’s what qualifies them as macro.) If you don’t know enough about a market, to
have an informed and usually correct perspective then you really are just counting
on dumb luck.
Buffett
then states: “During the extraordinary financial panic that occurred late in
2008, I never gave a thought to selling my farm or New York real estate, even
though a severe recession was clearly brewing. And if I had owned 100% of a solid
business with good long-term prospects, it would have been foolish for me to
even consider dumping it.” But Warren,
you already told us you knew and continue to know nothing about farming. So how can you or I count on you to
intelligently evaluate if the farm is a “solid business with good long-term
prospects”?
I prefer
Buffett’s earlier and wiser advice: “Risk comes from not knowing what you’re
doing.” Warren, you didn't know what you
were doing when you bought the farm. You got lucky (or alternatively weren't as
dumb as you suggest). I challenge your notion that one shouldn't look to
understand an investment or business extraordinarily well before putting your
money on the line.
I am a huge fan of Warren Buffett. But I take everything he says with a
grain of salt (especially in politics). I remain skeptical and try to understand
the logic of any advice before I apply it. Don’t believe everything you hear or
read - even from me!
I suggest you dig deep, find a competitive information advantage
(yourself) and then accept that there are no sure-things. And Rule #1 is: Don’t
buy a farm if you don’t understand farming.
Just to balance things out, here is advice from Buffet that you should
follow:
1)
“If you get into a lousy business, get out of it.”
2)
“If you want to be known as a good manager, buy a good business.” (Of
course this requires a deep understanding of the business to really know if it
is “good”.)
3)
“Price is what you pay. Value is what you get.”
4)
“Should you find yourself in a chronically leaking boat, energy devoted
to changing vessels is likely to be more productive than energy devoted to
patching leaks.”
