If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter. Predicting the long-term economics of companies that operate in fast-changing industries is simply far beyond our perimeter. If others claim predictive skill in those industries — and seem to have their claims validated by the behavior of the stock market — we neither envy nor emulate them. Instead, we just stick with what we understand. If we stray, we will have done so inadvertently, not because we got restless and substituted hope for rationality. Fortunately, it’s almost certain there will be opportunities from time to time for Berkshire to do well within the circle we’ve staked out.

Source:   Berkshire Hathaway Shareholder Letters

The declines make no difference to us, given that we expect all of our businesses to now and then have ups and downs. (Only in the sales presentations of investment banks do earnings move forever upward.) We don’t care about the bumps; what matters are the overall results. But the decisions of other people are sometimes affected by the near-term outlook, which can both spur sellers and temper the enthusiasm of purchasers who might otherwise compete with us.

Source:   Berkshire Hathaway Shareholder Letters

Leaving aside tax factors, the formula we use for evaluating stocks and businesses is identical. Indeed, the formula for valuing all assets that are purchased for financial gain has been unchanged since it was first laid out by a very smart man in about 600 B.C. (though he wasn’t smart enough to know it was 600 B.C.)...The oracle was Aesop and his enduring, though somewhat incomplete, investment insight was “a bird in the hand is worth two in the bush.” To flesh out this principle, you must answer only three questions. How certain are you that there are indeed birds in the bush? When will they emerge and how many will there be? What is the risk-free interest rate (which we consider to be the yield on long-term U.S. bonds)? If you can answer these three questions, you will know the maximum value of the bush, and the maximum number of the birds you now possess that should be offered for it. And, of course, don’t literally think birds. Think dollars.

Source:   Berkshire Hathaway Shareholder Letters

Usually, the range must be so wide that no useful conclusion can be reached. Occasionally, though, even very conservative estimates about the future emergence of birds reveal that the price quoted is startlingly low in relation to value. (Let’s call this phenomenon the IBT: Inefficient Bush Theory.) To be sure, an investor needs some general understanding of business economics as well as the ability to think independently to reach a well-founded positive conclusion. But the investor does not need brilliance nor blinding insights.

Source:   Berkshire Hathaway Shareholder Letters

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.

Source:   Berkshire Hathaway Shareholder Letters

But a pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons: First, many in Wall Street a community in which quality control is not prized will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest.

Source:   Berkshire Hathaway Shareholder Letters

A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the low-cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with “Roman Candles,” companies whose moats proved illusory and were soon crossed.

Source:   Berkshire Hathaway Shareholder Letters

Our criterion of “enduring” [moat] causes us to rule out companies in industries prone to rapid and continuous change. Though capitalism’s “creative destruction” is highly beneficial for society, it precludes investment certainty. A moat that must be continuously rebuilt will eventually be no moat at all.

Source:   Berkshire Hathaway Shareholder Letters

...this criterion [of an enduring moat] eliminates the business whose success depends on having a great manager. Of course, a terrific CEO is a huge asset for any enterprise, and at Berkshire we have an abundance of these managers. Their abilities have created billions of dollars of value that would never have materialized if typical CEOs had been running their businesses. But if a business requires a superstar to produce great results, the business itself cannot be deemed great. A medical partnership led by your area’s premier brain surgeon may enjoy outsized and growing earnings, but that tells little about its future. The partnership’s moat will go when the surgeon goes. You can count, though, on the moat of the Mayo Clinic to endure, even though you can’t name its CEO.

Source:   Berkshire Hathaway Shareholder Letters

Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can’t for any extended period reinvest a large portion of their earnings internally at high rates of return.

Source:   Berkshire Hathaway Shareholder Letters

The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers.

Source:   Berkshire Hathaway Shareholder Letters

To sum up [the discussion on Capex and Moat], think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

Source:   Berkshire Hathaway Shareholder Letters

When investing, pessimism is your friend, euphoria the enemy.

Source:   Berkshire Hathaway Shareholder Letters

...the market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market. This does not bother Charlie and me. Indeed, we enjoy such price declines if we have funds available to increase our positions. Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.

Source:   Berkshire Hathaway Shareholder Letters

Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy. At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable. Even then, we will make plenty of mistakes.

Source:   Berkshire Hathaway Shareholder Letters

Market price and intrinsic value often follow very different paths – sometimes for extended periods – but eventually they meet.

Source:   Berkshire Hathaway Shareholder Letters

Fund consultants like to require style boxes such as “long-short,” “macro,” “international equities.” At Berkshire our only style box is “smart.”

Source:   Berkshire Hathaway Shareholder Letters

Investing is forgoing consumption now in order to have the ability to consume more at a later date.

Source:   Berkshire Hathaway Shareholder Letters

The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.

Source:   Berkshire Hathaway Shareholder Letters

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. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”

Source:   Berkshire Hathaway Shareholder Letters

Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.

Source:   Berkshire Hathaway Shareholder Letters

If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.

Source:   Berkshire Hathaway Shareholder Letters

Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.

Source:   Berkshire Hathaway Shareholder Letters

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. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: “You don’t know how easy this game is until you get into that broadcasting booth.”)

Source:   Berkshire Hathaway Shareholder Letters

Owners of stocks, however, too often let the capricious and often irrational behavior of their fellow owners cause them to behave irrationally as well. Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits – and, worse yet, important to consider acting upon their comments.

Source:   Berkshire Hathaway Shareholder Letters

Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations and accompanying commentators delivering an implied message of “Don’t just sit there, do something.” For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.

Source:   Berkshire Hathaway Shareholder Letters

A “flash crash” or some other extreme market fluctuation can’t hurt an investor any more than an erratic and mouthy neighbor can hurt my farm investment. Indeed, tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.

Source:   Berkshire Hathaway Shareholder Letters

When Charlie and I buy stocks – which we think of as small portions of businesses – our analysis is very similar to that which we use in buying entire businesses. We first have to decide whether we can sensibly estimate an earnings range for five years out, or more. If the answer is yes, we will buy the stock (or business) if it sells at a reasonable price in relation to the bottom boundary of our estimate. If, however, we lack the ability to estimate future earnings – which is usually the case – we simply move on to other prospects. In the 54 years we have worked together, we have never foregone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions.

Source:   Berkshire Hathaway Shareholder Letters

I can’t remember what I paid for that first copy of The Intelligent Investor. Whatever the cost, it would underscore the truth of Ben’s adage: Price is what you pay, value is what you get. Of all the investments I ever made, buying Ben’s book was the best (except for my purchase of two marriage licenses).

Source:   Berkshire Hathaway Shareholder Letters

My experience in business helps me as an investor and that my investment experience has made me a better businessman.

Source:   Berkshire Hathaway Shareholder Letters

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.

Source:   Berkshire Hathaway Shareholder Letters

If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things.

Source:   Berkshire Hathaway Shareholder Letters

It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.

Source:   Poor Charlie's Almanack

When Warren lectures at business schools he says “I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches – representing all the investments that you get to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”

Source:   Poor Charlie's Almanack

To us investing is the equivalent of going out and betting against the pari-mutuel system. We look for a horse with one chance in two of winning and which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.

Source:   Poor Charlie's Almanack

Be a business analyst, not a market, macroeconomic, or security analyst.

Source:   Poor Charlie's Almanack

Opportunity meeting the prepared mind; that’s the game.

Source:   Poor Charlie's Almanack

We try more to profit from always remembering the obvious than from grasping the esoteric. It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be intelligent.

Source:   Poor Charlie's Almanack

One of the key elements to successful investing is having the right temperament – most people are too fretful; they worry too much. Success means being very patient, but aggressive when it’s time.

Source:   Poor Charlie's Almanack

Our investment style has been given a name – focus investing – which implies ten holdings, not one hundred, or four hundred…The idea that it is hard to find good investments, so concentrate in a few, seems to me to be an obviously good idea. But 98% of the investment world doesn’t think this way. It’s been good for us that we’ve done this…Focus investing is growing somewhat, but what’s really growing is the unlimited use of consultants to advise on asset allocation, to analyze other consultants, and so forth. Maybe 2% of the people will come into our corner of the tent, and the rest of the 98% will believe what they’ve been told [e.g. that markets are totally efficient].

Source:   Poor Charlie's Almanack

You must know the big ideas in the big disciplines and use them routinely – all of them, not just a few. Most people are trained in one model – economics, for example – and try to solve all problems in one way. You know the old saying: To the man with a hammer, the world looks like a nail. This is a dumb way of handling problems.

Source:   Poor Charlie's Almanack

Eighty or Ninety important models will carry about ninety percent of the freight in making you a worldly-wise person. And, of course, only a mere handful really carry very heavy freight.

Source:   Poor Charlie's Almanack

How many insights do you need? Well, I’d argue that you don’t need many in a lifetime. If you look at Berkshire Hathaway and all its accumulated billions, the top ten insights account for most of it. And that’s with a very brilliant man – Warren’s a lot more able than I am and very disciplined – devoting his lifetime to it. I don’t mean to say that he’s only had ten insights. I’m just saying that most of the money came from ten insights.

Source:   Poor Charlie's Almanack

If you don’t get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a one-legged man in an ass-kicking contest.

Source:   Poor Charlie's Almanack

To me it’s obvious that the winner has to be bet very selectively. It’s been obvious to me since very early in life. I don’t know why it’s not obvious to many other people. I think the reason why we got into such idiocy in the investment management business is best illustrated by a story that I tell about the guy who sold fishing tackle. I asked him, “My God, they’re purple and green. Do fish really take these lures?” And he said “Mister, I don’t sell to fish”.

Source:   Poor Charlie's Almanack

Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns.

Source:   Poor Charlie's Almanack

Graham, great though he was as a man, had a screw loose as he tried to predict outcomes for the stock market as a whole. In contrast, Warren and I are almost agnostic about the market.

Source:   Poor Charlie's Almanack

I believe in the discipline of mastering the best that other people have ever figured out. I don’t believe in just sitting down and trying to dream it all up yourself. Nobody’s that smart.

Source:   Poor Charlie's Almanack

What is elementary worldly wisdom? Well, the first rule is that you can't really know anything if you just remember isolated facts and try to bang 'em back. If the facts don't hang together on a latticework of theory, you don't have them in a usable form. You've got to have models in your head. And you've got to array your experience - both vicarious and direct - on this latticework of models.

Source:   Poor Charlie's Almanack

The great lesson in Microeconomics is to discriminate between when technology is going to help you and when it's going to kill you.

Source:   Poor Charlie's Almanack

…there's another model from microeconomics that I find very interesting. When technology moves as fast as it does in a civilization like ours, you get a phenomenon that I call competitive destruction. You know, you have the finest buggy whip factory, and, all of a sudden, in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or you're dead - you're destroyed. It happens again and again and again.

Source:   Poor Charlie's Almanack

You have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don't, you're going to lose.

Source:   Poor Charlie's Almanack

…it's rather interesting because one of the greatest economists in the world is a substantial shareholder in Berkshire Hathaway and has been from the very early days after Buffett was in control. His textbook always taught that the stock market was perfectly efficient and the nobody could beat it. But his own money went into Berkshire and made him wealthy. So, like Pascal in his famous wager, he hedged his bet.

Source:   Poor Charlie's Almanack

The one thing all those winning bettors in the whole history of people who’ve beaten the pari-mutuel system is quite simple: they bet very seldom.

Source:   Poor Charlie's Almanack

It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it - who look and sift the world for a mispriced bet - that they can occasionally find one. And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time they don't. It's just that simple.

Source:   Poor Charlie's Almanack

The way to win is to work, work, work, work, and hope for a few insights.

Source:   Poor Charlie's Almanack

If you invested Berkshire Hathaway-style, it would be hard to get paid as an investment manager as well as they're currently paid - because you'd be holding a block of Wal-Mart aand a block of Coca-Cola and a block of something else. You'd be sitting on your ass. And the client would be getting rich. And, after a while, the client would think, "why am I paying this guy half-a-percent a year on my wonderful passive holdings?" So what makes sense for the investor is different from what makes sense for the manager. And, as usual in human affairs, what determines the behavior are incentives for the decision maker.

Source:   Poor Charlie's Almanack

Of course, the best part of [Benjamin Graham's approach] was his concept of "Mr. Market". Instead of thinking the market was efficient, Graham treated it as a manic-depressive who comes by every day. And some days "Mr. Market" says, "I'll sell you some of my interest for way less than you think is worth." And other days, he comes by and says "I'll buy your interest at a price that's way higher than what you think it's worth." And you get the option of deciding whether you want to buy more, sell part of what you already have, or do nothing at all. To Graham, it was a blessing to be in a business with a manic-depressive who gave you this series of options all the time. That was a very significant mental construct. And it's been very useful to Buffett, for instance, over his whole adult lifetime.

Source:   Poor Charlie's Almanack

…having started out as Grahamites - which, by the way, worked fine - we gradually got what I would call better insights. And we realized that some company that was selling at two or three times book value could still be hell or a bargain because of the momentums implicit in its position, sometimes combined with an unusual management skill plainly present in some individual or other, or some system or other.

Source:   Poor Charlie's Almanack

[Most Investment Managers are] in a game where the clients expect them to know a lot of things. We didn't have any clients who could fire us at Berkshire Hathaway. So we didn't have to be governed by any such construct. And we came to this notion of finding a mispriced bet and loading up when we were very confident that we were right. So we're way less diversified. And I think our system is miles better.

Source:   Poor Charlie's Almanack

…averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager.

Source:   Poor Charlie's Almanack

There are huge advantages for an individual to get into a position where you make a few great investments and just sit on your ass. You're paying less to brokers. You're listening to less nonsense. And if it works, the governmental tax system gives you an extra one, two, or three percentage points per annum compounded. And if you think that most of you are going to get that much advantage by hiring investment counselors and paying them one percent to run around, incurring a lot of taxes on you behalf, Lots of luck.

Source:   Poor Charlie's Almanack

…some of the worst dysfunctions in businesses [and professional investment managers] come from the fact that they balkanize reality into little individual departments with territoriality and turf protection and so forth. So if you want to be a good thinker, you must develop a mind that can jump the jurisdictional boundaries. You don't have to know it all. Just take in the best big ideas from all these disciplines. And it's not hard to do.

Source:   Poor Charlie's Almanack

The word “intelligent” in our title will be used throughout the book in its common and dictionary sense as meaning “endowed with the capacity for knowledge and understanding”. It will not be taken to mean “smart” or “shrewd” or gifted with unusual foresight or insight. Actually the intelligence here presupposed is a trait more the character than of the brain. This is particularly true of that major class of investors whom we shall call the defensive – or the conservative, in the sense of conserving capital. Such an investor – whom we envisage, typically as a widow who must live on the money left her – will place her chief emphasis on the avoidance of any serious mistakes or losses. Her second aim will be freedom from effort, annoyance, and the need for making frequent decisions.

Source:   The Intelligent Investor

The long term future of a company is at best “an educated guess”. Some of the best-educated guesses, derived from the most painstaking research, have turned out to be abysmally wrong.

Source:   The Intelligent Investor

You may take it as an axiom that you cannot profit in Wall Street by continuously doing the obvious or the popular thing.

Source:   The Intelligent Investor

Once a competent analysis has been made and the salient facts presented, the intelligent investor will have the material needed to satisfy his own mind that the commitment is sound and attractive. He will not have to subordinate his own judgement to that of his advisors – which is often required of him in other types of security operations.

Source:   The Intelligent Investor

As a matter of business practice, or perhaps of thorough-going conviction, the stock brokers and the investment services seem wedded to the principle that both investors and speculators in common stocks should devote careful attention to market forecasts. The farther one gets from Wall Street the more skepticism one will find, we believe, as to the pretensions of stock-market forecasting or timing. The investor can scarcely take seriously the innumerable predictions which appear almost daily and are his for the asking. Yet in many cases he pays attention to them and even acts upon them. Why? Because he has been persuaded that it is important for him to form some opinion of the future course of the stock market, and because he feels that the brokerage or service forecast is at least more dependable that his own. This attitude will bring the typical investor nothing but regrets.

Source:   The Intelligent Investor

This point is vital: The investor cannot enter the arena of the stock market with any real hope of success unless he is armed with mental weapons that distinguish him in KIND – not in a fancier superior degree – from the trading public. One possible weapon is indifference to market fluctuations; such an investor buys carefully when he has money to place and then lets prices take care of themselves.

Source:   The Intelligent Investor

…the prime test of the competent analyst is his power to distinguish between important and unimportant factors and figures in a given situation.

Source:   The Intelligent Investor

Thus we reach our conclusion, with its overtones of a spiritual paradox, that the investor can profit from market fluctuations only by paying them little heed. He must not fix his eye on what the market has been doing – or what it apparently is going to do – but only on the result of its action as expressed in the relationship between the price level and the level of underlying or central themes.

Source:   The Intelligent Investor

Our approach to the [Management Quality] problem may be concentrated and simplified by pointing out that there are just two basic questions to which stockholders should turn their attention: 1) Is the management reasonably efficient and 2) Are the interests of the average outside stockholder receiving proper recognition?

Source:   The Intelligent Investor

There are three clear-cut signs that a management has been unsuccessful and is presumably inefficient unless it can convince the proprietors otherwise. These are: 1) Its failure to earn a satisfactory return on the stockholders’ investment during a period of several years in which the industry as a whole is prosperous, 2) Its failure to maintain its approximate share of the total sales volume of the industry, 3) Its failure to show a profit margin on sales reasonably close to that of the industry as a whole.

Source:   The Intelligent Investor

It is time now to say a word about the role of boards of directors in the determination of managerial ability. One reason why stockholders have largely ignored this question is their belief that the directors they elect are the ones who have both the duty and opportunity to pass critical judgement on the executive staff. Since the stockholders are much farther removed from the scene than are the directors, their traditional inertia is reinforced by a certain logic, which limits their expression of ownership to voting for the directors whose names appear on the official proxy statement. The rest is then up to the directors. The trouble with this idea is that the directions are rarely independent of management. They should be, of course, but it does not work out that way. Our observation is that the officers choose the directors more often than the directors choose the officers. In many cases, the executives actually constitute a majority of the board. Where this occurs, the notion that the directors serve as a check on management is patently incorrect. But in most of the other cases the situation is not really different, for even the non-officer directors are generally bound closely to the executives by ties of friendship and often of business dealings. When a president has outlived his usefulness, or fails to measure up to the growing requirements of his job, he is not going to be removed by his personal friends.

Source:   The Intelligent Investor

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings to “earning power” and assume that prosperity is synonymous with safety.

Source:   The Intelligent Investor

The danger in a growth-stock program lies precisely here. Fop such favored issues the market has a tendency to set prices which will not be adequately protected by a conservative projection of future earnings. (It is a basic rule of prudent investment that all estimates, when they differ from actual performance, must err at least slightly on the side of understatement.) The margin of safety is always dependent on the price paid.

Source:   The Intelligent Investor

The margin-of-safety idea becomes much more evident when we apply it to the field of undervalued or bargain securities. We have here, by definition, a favorable difference between price on the one hand and indicated or appraised value on the other. That difference is the safety margin. It is available for absorbing the effect of miscalculations or worse-than-average luck. The buyer of bargain issues places particular emphasis on the ability of the investment to withstand adverse developments. For in most cases he has no enthusiasm about the company’s prospects.

Source:   The Intelligent Investor

[Margin of Safety] guarantees only that he has a better chance for profit than loss – not that loss is impossible.

Source:   The Intelligent Investor

In his 'Treatise on Human Nature', the Scots philosopher David Hume posed the issue [of induction] in the following way: "No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute than conclusion".

Source:   Fooled By Randomness

The reason I feel that he [Karl Popper] is important to us traders is because to him the matter of knowledge and discovery is not so much in dealing with what we know, as in dealing with what we don't know…My extreme an obsessive Popperism is carried out as follows: I speculate in all of my activities on theories that represent some vision of the world, but with the following stipulation: No rare event should harm me. In fact, I would like all conceivable rare events to to help me.

Source:   Fooled By Randomness

Like [Pascal's Wager], I will therefore state the following argument: If the science of statistics can benefit me in anything, I will use it. If it poses a threat, then I will not. I want to take the best of what the past can give me without its dangers. Accordingly, I will use statistics and inductive methods to make aggressive bets, but I will not use them to manage my risks and exposure. Surprisingly, all the surviving traders I know seem to have done the same. They trade on ideas bases on some observation (that includes past history) but, like the Popperian scientists, they make sure that the costs of being wrong are limited (and their probability is not derived from past data).

Source:   Fooled By Randomness

"Satisificing" was [Herb Simon's] idea (the melding together of satisfy and suffice): You stop when you get a near-satisfactory solution. Otherwise it may take you an eternity to reach the smallest conclusion or perform the smallest act.

Source:   Fooled By Randomness

If prices in efficient markets already reflect the consensus, then sharing the consensus view will make you likely to earn just an average return. To beat the market you must hold and idiosyncratic, or nonconsensus, view.

Source:   The Most Important Thing

In the great debate over efficiency versus inefficiency, I have concluded that no market is completely one or the other. It’s just a matter of degree. I wholeheartedly appreciate the opportunities that inefficiency can provide, but I also respect the concept of market efficiency, and I believe strongly that mainstream securities markets can be so efficient that it’s largely a waste of time to work at finding winners there.

Source:   The Most Important Thing

Theory says high return is associated with high risk because the former exists to compensate for the latter. But pragmatic value investors feel just the opposite: They believe high return and low risk can be achieved simultaneously by buying things for less than they’re worth. In the same way, overpaying implies both low return and high risk.

Source:   The Most Important Thing

Ben Graham and David Dodd put it this way more than sixty years ago in the second edition of Security Analysis, the bible of value investors: “the relation between different kinds of investments and the risk of loss is entirely too indefinite, and too variable with changing conditions, to permit of sound mathematical formulation.”

Source:   The Most Important Thing

Understanding uncertainty: The possibility of a variety of outcomes means we musn't think of the future in terms of a single result but rather as a range of possibilities. The best we can do is fashion a probability distribution that summarizes the possibilities and describes their relative likelihood. We must think about the full range, not just the ones that are most likely to materialize. Some of the greatest losses arise when investors ignore the improbable possibilities.

Source:   The Most Important Thing

Whereas the theorist thinks return and risk are two separate things, albeit correlated, the value investor thinks of high risk and low prospective return as nothing but two sides of the same coin, both stemming primarily from high prices.

Source:   The Most Important Thing

The desire for more, the fear of missing out, the tendency to compare against others, the influence of the crowd and the dream of the sure thing—-these factors are near universal. Thus they have a profound collective impact on most investors and most markets. The result is mistakes, and those mistakes are frequent, widespread and recurring.

Source:   The Most Important Thing

Refusing to join in the errors of the herd—like so much else in investing—requires control over psyche and ego. It’s the hardest thing, but the payoff can be enormous. Mastery over the human side of investing isn’t sufficient for success, but combining it with analytical proficiency can lead to great results.

Source:   The Most Important Thing

You need the ability to detect instances in which prices have diverged significantly from intrinsic value. You have to have a strong-enough stomach to defy conventional wisdom (one of the greatest oxymorons) and resist the myth that the market’s always efficient and thus right. You need experience on which to base this resolute behavior. And you must have the support of understanding, patient constituencies. Without enough time to ride out the extremes while waiting for reason to prevail, you’ll become that most typical of market victims: the six-foot-tall man who drowned crossing the stream that was five feet deep on average.

Source:   The Most Important Thing

Active management strategies demand uninstitutional behavior from institutions, creating a paradox that few can unravel. Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom.

Source:   The Most Important Thing

Certain common threads run through the best investments I’ve witnessed. They’re usually contrarian, challenging and uncomfortable—although the experienced contrarian takes comfort from his or her position outside the herd.

Source:  

Not only should the lonely and uncomfortable position be tolerated, it should be celebrated. Usually—and certainly at the extremes of the pendulum’s swing—being part of the herd should be a reason for worry.

Source:   The Most Important Thing

One of the great things about investing is that the only real penalty is for making losing investments. There’s no penalty for omitting losing investments, of course, just rewards. And even for missing a few winners, the penalty is bearable.

Source:   The Most Important Thing

I’m firmly convinced that (a) it’s hard to know what the macro future holds and (b) few people possess superior knowledge of these matters that can regularly be turned into an investing advantage. There are two caveats, however: 1) The more we concentrate on smaller-picture things, the more it’s possible to gain a knowledge advantage. 2) With hard work and skill, we can consistently know more than the next person about individual companies and securities, but that’s much less likely with regard to markets and economies. Thus, I suggest people try to “know the knowable.”

Source:   The Most Important Thing

Investing in an unknowable future as an agnostic is a daunting prospect, but if foreknowledge is elusive, investing as if you know what’s coming is close to nuts. Maybe Mark Twain put it best: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

Source:   The Most Important Thing

It would be wonderful to be able to successfully predict the swings of the pendulum and always move in the appropriate direction, but this is certainly an unrealistic expectation. I consider it far more reasonable to try to (a) stay alert for occasions when a market has reached an extreme, (b) adjust our behavior in response and, (c) most important, refuse to fall into line with the herd behavior that renders so many investors dead wrong at tops and bottoms.

Source:   The Most Important Thing

When buyers compete to put large amounts of capital to work in a market, prices are bid up relative to value, prospective returns shrink, and risk rises. It’s only when buyers predominate relative to sellers that you can have highly overpriced assets. The warning signs shouldn’t be hard to spot.

Source:   The Most Important Thing

Of the two ways to perform as an investor—racking up exceptional gains and avoiding losses—I believe the latter is the more dependable.

Source:   The Most Important Thing

Worry about the possibility of loss. Worry that there’s something you don’t know. Worry that you can make high-quality decisions but still be hit by bad luck or surprise events. Investing scared will prevent hubris; will keep your guard up and your mental adrenaline flowing; will make you insist on adequate margin of safety; and will increase the chances that your portfolio is prepared for things going wrong. And if nothing does go wrong, surely the winners will take care of themselves.

Source:   The Most Important Thing

The markets are a classroom where lessons are taught every day. The keys to investment success lie in observing and learning.

Source:   The Most Important Thing

The psychology of the investing herd moves in a regular, pendulum-like pattern—from optimism to pessimism; from credulousness to skepticism; from fear of missing opportunity to fear of losing money; and thus from eagerness to buy to urgency to sell. The swing of the pendulum causes the herd to buy at high prices and sell at low prices. Thus, being part of the herd is a formula for disaster, whereas contrarianism at the extremes will help to avert losses and lead eventually to success.

Source:   The Most Important Thing

Risk control and margin for error should be present in your portfolio at all times. But you must remember that they’re “hidden assets.” Most years in the markets are good years, but it’s only in the bad years—when the tide goes out—that the value of defense becomes evident. Thus, in the good years, defensive investors have to be content with the knowledge that their gains, although perhaps less than maximal, were achieved with risk protection in place … even though it turned out not to be needed.

Source:   The Most Important Thing

The most successful investors get things “about right” most of the time, and that’s much better than the rest.

Source:   The Most Important Thing

I made a conscious effort to find investment theses that were at odds with the prevailing opinion because that's where the best profit opportunities are to be found. I defined my task as engaging in an arbitrage between my own judgement and the prevailing view.

Source:   The Alchemy of Finance

Fundamental Analysis is more interesting because it is an out-growth of the equilibrium theory. Stocks are supposed to have a true or fundamental value distinct from their current market price. The fundamental value of a stock may be defined either in relation to the earning power of the underlying assets or in relation to the fundamental value of other stocks. In either case, the market price of a stock is supposed to tend toward its fundamental value over a period of time so that the analysis of fundamental values provided a useful guide to investment decisions...[But] the possibility that stock market developments may affect the fortunes [earning power] of the companies is left out of account...Stock market valuations have a direct way of influencing underlying values: through the issue and repurchase of shares and options and through corporate transactions of all kinds...

Source:   The Alchemy of Finance

In any case, a "reflexive" model cannot take the place of fundamental analysis: all it can do is to provide an ingredient that is missing from it. In principle, the two approaches could be reconciled. Fundamental analysis seeks to establish how underlying values are reflected in stock prices, whereas the theory of reflexivity shows how stock prices can influence underlying values. One provides a static picture, the other a dynamic one.

Source:   The Alchemy of Finance

...the intelligent investor should not buy common stocks simply because they are cheap but only if they give promise of major gain to him.

Source:   Common Stocks and Uncommon Profits

The reason why the growth stocks do so much better is that they seem to show gains in value in the hundreds of per cent each decade. In contrast, it is an unusual bargain that it is as much as 50 per cent undervalued. The cumulative effect of this simple arithmetic should be obvious.

Source:   Common Stocks and Uncommon Profits

The successful investor is usually an individual who is inherently interested in business problems.

Source:   Common Stocks and Uncommon Profits

In contrast to guessing which way general business or the stock market may go, he should be able to judge with only a small probability of error what the company into which he wants to buy is going to do in relation to business in general. Therefore he starts off with two advantages. He is making his bet upon something which he knows to be the case, rather than upon something about which he is largely guessing.

Source:   Common Stocks and Uncommon Profits

Actually dividend considerations should be given the least, not the most, weight by those desiring to select outstanding stocks. Perhaps the most peculiar aspect of this much-discussed subject of dividends is that those giving them the least consideration usually end up getting the best dividend return. Worthy of repetition here is that over a span of five to ten years, the best dividend results will come not from the high-yield stocks but from those with the relatively low yield.

Source:   Common Stocks and Uncommon Profits

Don't overstress diversification...there is very little chance of the average investor being influenced to practice insufficient diversification. The horrors of what can happen to those who “put all their eggs in one basket” are too constantly being expounded. Too few people, however, give sufficient thought to the evils of the other extreme. This is the disadvantage of having eggs in so many baskets that a lot of the eggs do not end up in really attractive baskets, and it is impossible to keep watching all the baskets after the eggs get put into them. Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others about which they know nothing at all. It never seems to occur to them, much less to their advisors, that buying a company without having sufficient knowledge of it may be even more dangerous than having inadequate diversification.

Source:   Common Stocks and Uncommon Profits

...practical investors usually learn their problem is finding enough outstanding investments, rather than choosing among too many. The occasional investor who does find more such unusual companies than he really needs seldom has the time to keep in close enough touch with all additional corporations.

Source:   Common Stocks and Uncommon Profits

Usually a very long list of securities is not a sign of the brilliant investor, but of one who is unsure of himself.

Source:   Common Stocks and Uncommon Profits

The fact that a stock has or has not risen in the last several years is of no significance whatsoever in determining whether it should be bought now. What does matter is whether enough improvement has taken place or is likely to take place in the future to justify importantly higher prices than those now prevailing.

Source:   Common Stocks and Uncommon Profits

Don't follow the crowd.

Source:   Common Stocks and Uncommon Profits

...investment fads and misinterpretations of facts may run for several months or several years. In the long run, however, realities not only terminate them, but frequently, for a time, cause the affected stocks to go too far in the opposite direction. The ability to see through some majority opinions to find what facts are really there is a trait that can bring rich rewards in the field of common stocks. It is not easy to develop, however, for the composite opinion of those with whom we associate is a powerful influence upon the minds of us all.

Source:   Common Stocks and Uncommon Profits

I have found that “scuttlebutt” so many times furnishes an accurate forecast of how well a company will measure up to my fifteen points, that usually by the time I am ready to visit the management there will be at least a fair chance that I will want to buy into the company.

Source:   Common Stocks and Uncommon Profits

Unfortunately, often there is so much confusion between acting conservatively and acting conventionally.

Source:   Common Stocks and Uncommon Profits

...the importance of growth will present themselves. But fundamentally it should never be forgotten that, in a world where change is occurring at a faster and faster pace, nothing long remains the same. It is impossible to stand still. A company will either grow or shrink. A strong offense is the best defense. Only by growing better can a company be sure of not growing worse.

Source:   Common Stocks and Uncommon Profits

The true investment objective of [company] growth is not just to make gains but to avoid loss.

Source:   Common Stocks and Uncommon Profits

...reading the printed financial records about a company is never enough to justify an investment. One of the major steps in prudent investment must be to find out about a company's affairs from those who have some direct familiarity with them.

Source:   Common Stocks and Uncommon Profits

The largest profits in the investment field go to those who are capable of correctly zigging when the financial community is zagging...This matter of training oneself not to go with the crowd but to be able to zig when the crowd zags, in my opinion, is one of the most important fundamentals of investment success.

Source:   Common Stocks and Uncommon Profits

...an analyst must learn the limits of his or her competence and tend well the sheep at hand.

Source:   Common Stocks and Uncommon Profits

I have come to believe that the most that can be said on this subject of dividends is that it is an influence that should be downgraded very sharply by those who do not need the income. In general, more attractive opportunities will be found among stocks with a low dividend payout or none at all.

Source:   Common Stocks and Uncommon Profits

In the last few years, too much attention has been paid to a concept that I believe is quite fallacious. I refer to the notion that the market is perfectly efficient. Like other false beliefs in other periods, a contrary view may open up opportunities for the discerning.

Source:   Common Stocks and Uncommon Profits

“When investing,” [Buffett] says, “we view ourselves as business analysts, not as market analysts, not as macroeconomic analysts, and not even as security analysts.”

Source:   The Warren Buffett Way

Buffett is able to maintain this high level of knowledge about Berkshire’s businesses because he purposely limits his selection to companies that are within his area of financial and intellectual understanding. His logic is compelling. If you own a company (either outright or as a shareholder) in an industry you do not fully understand, you cannot possibly interpret developments accurately or make wise decisions.

Source:   The Warren Buffett Way

“Invest in your circle of competence,” Buffett counsels. “It’s not how big the circle is that counts; it’s how well you define the parameters.”

Source:   The Warren Buffett Way

“The key to investing,” [Buffett] explains, “is determining the competitive advantage of any given company and, above all, the durability of the advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors. The most important thing for me is figuring out how big a moat there is around the business. What I love, of course, is a big castle and a big moat with piranhas and crocodiles.”

Source:   The Warren Buffett Way

In particular, [Buffett] looks for three traits: 1. Is management rational? 2. Is management candid with shareholders? 3. Does management resist the institutional imperative?

Source:   The Warren Buffett Way

Buffett explains, “Within this gigantic auction arena, it is our job to select a business with economic characteristics allowing each dollar of retained earnings to be translated eventually into at least a dollar of market value.”

Source:   The Warren Buffett Way

Buffett thinks the whole idea that price volatility is a measure of risk is nonsense. In his mind, business risk is reduced, if not eliminated, by focusing on companies with consistent and predictable earnings. “I put a heavy weight on certainty,” he says. “If you do that, the whole idea of a risk factor doesn’t make sense to me. Risk comes from not knowing what you’re doing."

Source:   The Warren Buffett Way

All the shorthand methods—high or low price-to-earnings ratios, price-to-book ratios, and dividend yields, in any number of combinations—fall short. Buffett sums it up for us: Whether “an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value for his investment . . . irrespective of whether a business grows or doesn’t, displays volatility or smoothness in earnings, or carries a high price or low in relation to its current earnings and book value, the investment shown by the discounted-flows-of-cash calculation to be the cheapest is the one that the investor should purchase.”

Source:   The Warren Buffett Way

If we make mistakes, [Buffett] points out, it is either because of (1) the price we paid, (2) the management we joined, or (3) the future economics of the business. Miscalculations in the third instance are, he notes, the most common.

Source:   The Warren Buffett Way

[Buffett] refers to himself as a “focus investor”—“We just focus on a few outstanding companies.” This approach, called focus investing, greatly simplifies the task of portfolio management.

Source:   The Warren Buffett Way

What’s wrong with conventional diversification? For one thing, it greatly increases the chances that you will buy something you don’t know enough about. “Know-something” investors, applying the Buffett tenets, would do better to focus their attention on just a few companies—five to 10, Buffett suggests. For the average investor, a legitimate case can be made for investing in 10 to 20 companies.

Source:   The Warren Buffett Way

"It is a mistake to think one limits one’s risk by spreading too much between enterprises which one knows little and has no reason for special confidence. . . . One’s knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence." [said Keynes]

Source:   The Warren Buffett Way

Keynes prepared a full policy report for the Chest Fund, outlining his principles: 1. A careful selection of a few investments having regard to their cheapness in relation to their probable actual and potential intrinsic [emphasis his] value over a period of years ahead and in relation to alternative investments at the time; 2. A steadfast holding of these fairly large units through thick and thin, perhaps several years, until either they have fulfilled their promise or it is evident that they were purchased on a mistake; 3. A balanced [emphasis his] investment position, i.e., a variety of risks in spite of individual holdings being large, and if possible opposed risks.

Source:   The Warren Buffett Way

Buffett, Munger, Ruane, Simpson. It is clear the superinvestors of Buffettville have a common intellectual approach to investing. They are united in their belief that the way to reduce risk is to buy stocks only when the margin of safety (that is, the favorable discrepancy between the intrinsic value of the company and today’s market price) is high. They also believe that concentrating their portfolios around a limited number of these high-probability events not only reduces risk, but helps to generate returns far above the market rate of return.

Source:   The Warren Buffett Way

To eliminate any notion that the five superinvestors of Buffettville are nothing more than statistical aberrations, we need to examine a wider field. Unfortunately, the population of focus investors is very small. Among the thousands of portfolio managers who manage money, there are only a scant few who manage concentrated portfolios. Thus we are left with the same challenge.

Source:   The Warren Buffett Way

Warren Buffett once said he “wouldn’t care if the stock market closed for a year or two. After all, it closes on Saturday and Sunday and that hasn’t bothered me yet.” It is true that “an actively trading market is useful, since it periodically presents us with mouth-watering opportunities,” said Buffett. “But by no means is it essential.”

Source:   The Warren Buffett Way

“A prolonged suspension of trading in securities we hold would not bother us any more than does the lack of daily quotations for [Berkshire’s wholly owned subsidiaries]. Eventually our economic fate will be determined by the economic fate of the business we own, whether our ownership is partial [in the form of shares of stock] or total.” [says Buffett]

Source:   The Warren Buffett Way

...performance of a publicly traded company is no different. “Charlie and I let our marketable equities tell us by their operating results—not by their daily, or evenly yearly, price quotations—whether our investments are successful,” [Buffett] explains. “The market may ignore a business success for a while, but it eventually will confirm it.”

Source:   The Warren Buffett Way

Focus investing is necessarily a long-term approach to investing. If we were to ask Buffett what he considers an ideal holding period, he would answer, “Forever”—so long as the company continues to generate above-average economics and management allocates the earnings of the company in a rational manner. “Inactivity strikes us as an intelligent behavior,” he explains.

Source:   The Warren Buffett Way

“Neither we nor most business managers would dream of feverishly trading highly profitable subsidiaries because a small move in the Federal Reserve’s discount rate was predicted or because some Wall Street pundit has reversed his views on the market. Why, then, should we behave differently with our minority positions in wonderful businesses?” [says Buffett]

Source:   The Warren Buffett Way

What strategies lend themselves best to low turnover rates? One possible approach is a low-turnover index fund. Another is a focus portfolio. “It sounds like premarital counseling advice,” say Jeffrey and Arnott, “namely, to try to build a portfolio that you can live with for a long, long time.”

Source:   The Warren Buffett Way

Warren Buffett, [Graham's] most famous student, explains, “There are three important principles to Graham’s approach.” The first is simply looking at stocks as businesses, which “gives you an entirely different view than most people who are in the market.” The second is the margin-of-safety concept, which “gives you the competitive edge.” And the third is having a true investor’s attitude toward the stock market. “If you have that attitude,” says Buffett, “you start out ahead of 99 percent of all the people who are operating in the stock market—it is an enormous advantage.”

Source:   The Warren Buffett Way

Developing an investor’s attitude, Graham said, is a matter of being prepared, both financially and psychologically, for the market’s inevitable ups and downs—not merely knowing intellectually that a downturn will happen, but having the emotional ballast needed to react appropriately when it does. In Graham’s view, an investor’s appropriate reaction to a downturn is the same as a business owner’s response when offered an unattractive price: ignore it. “The true investor,” says Graham, “scarcely ever is forced to sell his shares and at all other times is free to disregard the current price quotation.”

Source:   The Warren Buffett Way

Is this constant fixation on stock prices healthy for investors? Richard Thaler has a crisp answer. He lectures frequently at the Behavioral Conference sponsored by the National Bureau of Economic Research and the John F. Kennedy School of Government at Harvard University, and he always includes this advice: “Invest in equities and then don’t open the mail.” To which we might add, “And don’t check your computer or your phone or any other device every minute.”

Source:   The Warren Buffett Way

...you can easily see how applying the Buffett approach will put you in conflict with its proponents. Not only are you intellectually at odds with modern portfolio theorists, but you are also vastly outnumbered, both in the classroom and the workspace. Embracing the Warren Buffett Way makes you a rebel looking out across the field at a much larger army of individuals who invest totally differently. As you will learn, being an outcast has its own emotional challenges.

Source:   The Warren Buffett Way

Intelligence alone is not enough to ensure investment success. The size of the investor’s brain is less important than the ability to detach the brain from the emotions. “Rationality is essential when others are making decisions based on short-term greed or fear,” says Buffett. “That is when the money is made.”

Source:   The Warren Buffett Way

When Buffett invests, he sees a business. Most investors see only a stock price. They spend far too much time and effort watching, predicting, and anticipating price changes and far too little time understanding the business they partly own. Elementary as this may be, it is the root of what distinguishes Buffett.

Source:   The Warren Buffett Way

“I have always found it easier to evaluate the weights dictated by fundamentals,” said Buffett, “than votes dictated by psychology.”

Source:   The Warren Buffett Way

When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we'll take the cash flows.

Source:   Amazon Shareholder Letters

In that 1997 letter, we wrote, “When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows.” Why focus on cash flows? Because a share of stock is a share of a company's future cash flows, and, as a result, cash flows more than any other single variable seem to do the best job of explaining a company's stock price over the long term.

Source:   Amazon Shareholder Letters

Long-term thinking is both a requirement and an outcome of true ownership. Owners are different from tenants. I know of a couple who rented out their house, and the family who moved in nailed their Christmas tree to the hardwood floors instead of using a tree stand. Expedient, I suppose, and admittedly these were particularly bad tenants, but no owner would be so short-sighted. Similarly, many investors are effectively short-term tenants, turning their portfolios so quickly they are really just renting the stocks that they temporarily “own.”

Source:   Amazon Shareholder Letters

Our pricing strategy does not attempt to maximize margin percentages, but instead seeks to drive maximum value for customers and thereby create a much larger bottom line—in the long term. For example, we’re targeting gross margins on our jewelry sales to be substantially lower than industry norms because we believe over time—customers figure these things out—this approach will produce more value for shareholders.

Source:   Amazon Shareholder Letters

Our ultimate financial measure, and the one we most want to drive over the long-term, is free cash flow per share. Why not focus first and foremost, as many do, on earnings, earnings per share or earnings growth? The simple answer is that earnings don’t directly translate into cash flows, and shares are worth only the present value of their future cash flows, not the present value of their future earnings. Future earnings are a component—but not the only important component—of future cash flow per share. Working capital and capital expenditures are also important, as is future share dilution.

Source:   Amazon Shareholder Letters

Cash flow statements often don’t receive as much attention as they deserve. Discerning investors don’t stop with the income statement.

Source:   Amazon Shareholder Letters

As I write this, our recent stock performance has been positive, but we constantly remind ourselves of an important point – as I frequently quote famed investor Benjamin Graham in our employee all-hands meetings – “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” We don’t celebrate a 10% increase in the stock price like we celebrate excellent customer experience. We aren’t 10% smarter when that happens and conversely aren’t 10% dumber when the stock goes the other way. We want to be weighed, and we’re always working to build a heavier company.

Source:   Amazon Shareholder Letters

Two sources in particular have inspired my thinking on diversity. The first is the mental-models approach to investing, tirelessly advocated by Berkshire Hathaway’s Charlie Munger. The second is the Santa Fe Institute (SFI), a New Mexico-based research community dedicated to multidisciplinary collaboration in pursuit of themes in the natural and social sciences.

Source:   More Than You Know

Charlie Munger’s long record of success is an extraordinary testament to the multidisciplinary approach. For Munger, a mental model is a tool—a framework that helps you understand the problem you face. He argues for constructing a latticework of models so you can effectively solve as many problems as possible. The idea is to fit a model to the problem and not, in his words, to “torture reality” to fit your model.

Source:   More Than You Know

A quality investment philosophy is like a good diet: it only works if it is sensible over the long haul and you stick with it.

Source:   More Than You Know

Investment philosophy is really about temperament, not raw intelligence. In fact, a proper temperament will beat a high IQ all day. Once you’ve established a solid philosophical foundation, the rest is learning, hard work, focus, patience, and experience.

Source:   More Than You Know

First, in any probabilistic field—investing, handicapping, or gambling—you’re better off focusing on the decision-making process than on the short-term outcome.

Source:   More Than You Know

That leads to the second theme, the importance of taking a long-term perspective. You simply cannot judge results in a probabilistic system over the short term because there is way too much randomness.

Source:   More Than You Know

...investors often make the critical mistake of assuming that good outcomes are the result of a good process and that bad outcomes imply a bad process. In contrast, the best long-term performers in any probabilistic field—such as investing, sports-team management, and pari-mutuel betting—all emphasize process over outcome.

Source:   More Than You Know

Perhaps the single greatest error in the investment business is a failure to distinguish between the knowledge of a company’s fundamentals and the expectations implied by the market price.

Source:   More Than You Know

Four attributes generally set this group apart from the majority of active equity mutual fund managers: 1) [Low] Portfolio turnover. 2) [High] Portfolio Concentration. 3) Investment Style - [intrinsic-value investment approach]. 4) Geographical Location - [being away from money-centers like New York or Boston].

Source:   More Than You Know

In the real world there is no “easy way” to assure a financial profit. At least, it is gratifying to rationalize that we would rather lose intelligently than win ignorantly. —Richard A. Epstein, The Theory of Gambling and Statistical Logic.

Source:   More Than You Know

The frequency of correctness does not matter; it is the magnitude of correctness that matters.

Source:   More Than You Know

Constantly thinking in expected-value terms requires discipline and is somewhat unnatural. But the leading thinkers and practitioners from somewhat varied fields have converged on the same formula: focus not on the frequency of correctness but on the magnitude of correctness.

Source:   More Than You Know

The most direct consequence of more rapid business evolution is that the time an average company can sustain a competitive advantage—that is, generate an economic return in excess of its cost of capital—is shorter than it was in the past. This trend has potentially important implications for investors in areas such as valuation, portfolio turnover, and diversification.

Source:   More Than You Know

In investing, our innate desire to connect cause and effect collides with the elusiveness of such links. So what do we do? Naturally, we make up stories to explain cause and effect. The stock market is not a good place to satiate the inborn human desire to understand cause and effect. Investors should take nonobvious explanations for market movements with a grain of salt. Read the morning paper explaining yesterday’s action for entertainment, not education.

Source:   More Than You Know

Practitioners spanning the centuries have documented the role of sentiment in investing and speculation. Perhaps the best way to think about sentiment is Ben Graham’s Mr. Market metaphor. Graham suggested imagining market quotes coming from an accommodating fellow named Mr. Market, who never fails to show up and offer you a price to either buy or sell your interest in a business.

Source:   More Than You Know