Thursday, February 27, 2014

Blasphemy – I am calling “BS” on Warren Buffet (and I am not even talking politics here).

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  What if the US government stopped subsidizing soy beans or repealed the ethanol mandate, or charged the full cost for crop insurance?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? 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. 

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.”

It is always valuable to listen to Warren Buffet.  And most of the time it even makes sense to follow his advice. But when he came out in support of Barack Obama I knew that even he was fallible.  

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