Editor’s note: This article was first published in February 2014. “Now, 28 years later” refers to the letter published in 2014, and “next letter” means the 2013 letter released at the end of February 2014.
Fortune magazine has published an exclusive excerpt from his upcoming letter to shareholders, in which Warren Buffett looks back on a couple of real estate purchases and, true to form, offers some lessons for stock market investors.
Buffett begins his story back in 1973 in Nebraska, where a farm bubble burst and prices fell by more than 50%, devastating farmers and lenders. In 1986, Buffett bought a 400-hectare farm north of Omaha for 280,000 dollars, far less than it would have cost him a few years earlier. Buffett knew nothing about how a farm works, but he learned the basics about the costs of running it and what it could produce in bushels of corn and soybeans.
“From those estimates, I worked out the farm’s normalised return at around 10%. I also thought it very likely that productivity would improve over time and that crop prices would move higher. Both expectations were met.
I needed no unusual knowledge or intelligence to conclude that the investment had no downside and could potentially be profitable. Of course there would be years of poor harvests, and prices would sometimes disappoint me. But so what? There would be some unusually good years too.
Now, 28 years later, the farm has tripled its earnings and is worth five times what I paid. And I still know nothing about agriculture and farms.”
Building on this simple example of a real estate investment, Buffett returns to his investment fundamentals:
1. You don’t need to be an expert to achieve high investment returns, but you do need to recognise your limitations and try to keep things simple. Remember that Buffett has always said that if his worth as an investor had to be measured by his knowledge of algebra, he’d be better off doing something else.
2. Focus on the future productivity of the asset you are considering buying. Buffett points out that nobody can predict the future return on an investment, and there’s no need to try. You only need to understand what you are doing when you acquire the asset in question.
3. If you focus instead on the price change you expect from a purchase, you are speculating. Buffett has nothing against price speculation. But he insists on the importance of being able to tell the difference between investing for an asset’s productivity and investing in the hope that its price will move in your favour.
4. “With my small investment, I thought only about what the properties could produce and didn’t care at all about their daily valuations.” “Games are won by the players who focus on the playing field, not by those whose eyes are on the scoreboard.” You should be able to enjoy your Saturdays and Sundays without looking at share prices. In other words, you need to focus on the long term.
5. Constantly following macro opinions and listening to other people’s macro or market predictions is a waste of time. In fact, it’s dangerous, because it can cloud your view of the facts that really matter.
Further reading
- 10 Warren Buffett quotes for business
- Warren Buffett’s 10 keys to financial success
- Warren Buffett’s speech on investing and business (video)
Featured image: Richard Hurd, CC BY 2.0, via Flickr.
