WARREN BUFFETT’S INVESTMENT TENETS 2/MANAGEMENT TENETS

The Warren Buffett Way

WARREN BUFFETT’S INVESTMENT TENETS 2/MANAGEMENT TENETS DISCUSSES THE PRINCIPLES UNDER WHICH WARREN BUFFETT VIEWS THE QUALITY OF THE MANAGEMENT. THE MANAGEMENT OF THE COMPANIES HE INTENDS TO INVEST IN MUST HAVE CERTAIN ASPECTS TO CONVINCE BUFFETT. THESE ARE:

— IS THE MANAGEMENT RATIONAL?

— DOES THE MANAGEMENT HAVE A POSITIVE RELATION TO THE SHAREHOLDERS?

— CAN THE MANAGEMENT RESIST THE “INSTITUTIONAL IMPERATIVE”?

AS USUAL, YOU CAN DOWNLOAD “THE WARREN BUFFETT WAY” FROM THE BEGINNING OF THE ARTICLE. ENJOY READING!

FOR BUFFETT, MANAGERS MUST THINK AND HANDLE THE COMPANY AS IF THEY ERTR THE OWNERS. THIS MEANS PRIMARILY, THEY MUST ACT IN THE INTEREST OF THE SHAREHOLDERS WHO ARE THE OWNERS. CONSEQUENTLY, MANAGERS MUST FOCUS ON INCREASING SHAREHOLDER VALUE. FURTHERMORE, MANAGERS MUST REPORT TRUTHFULLY TO THE SHAREHOLDERS, AND THEY MUST BE OF HIGH CHARACTER. LET’S NOW HAVE A LOOK AT THE VARIOUS TENETS (PRINCIPLES).

1) IS THE MANAGER RATIONAL?

RATIONALITY OF MANAGEMENT FOR BUFFETT MAINLY MEANS HOW MANAGERS ALLOCATE THE CAPITAL OF THE ENTERPRISE. MANAGEMENT MUST DECIDE HOW TO USE THE MONEY THAT IS AVAILABLE TO THE FIRM – ESPECIALLY THE PROFIT. SHALL MANAGERS RE-INVEST THE PROFIT, OR SHALL THEY DISTRIBUTE IT TO SHAREHOLDERS AS DIVIDENDS?

THESE DECISIONS MANAGEMENT MUST MAKE ON A RATIONAL BASIS. FOR EXAMPLE, INVESTING IN A NEW PROJECT OR EXPANSION OF THE COMPANY IS A POSSIBILITY. THEN THE QUESTION ARISES WHETHER THIS NEW PROJECT IS BETTER THAN INVESTING IN A DIFFERENT OPPORTUNITY OR THAN A DIVIDEND DISTRIBUTION. IT IS FOR THE MOST PART A MATHEMATICAL PROBLEM, INVOLVING CALCULATION OF THE OPPORTUNITY COSTS. THIS MEANS, HOW DOES THE NEW PROJECT PERFORM IN COMPARISON WITH OTHER INVESTMENT OPPORTUNITIES? FURTHERMORE, IT IS IMPORTANT TO DECIDE WHETHER THE RETURN OF EQUITY IS HIGHER THAN THE COST OF CAPITAL. ALL THESE DECISIONS MANAGEMENT MUST BASE ON RATIONALITY.

2) IS MANAGEMENT CANDID WITH SHAREHOLDERS?

THIS PRINCIPLE IS CLOSELY CONNECTED WITH INCREASING SHAREHOLDER VALUE. BUT IT GOES FURTHER. HOW DOES MANAGEMENT TREAT THE SHAREHOLDERS? IS MANAGEMENT OPEN WITH SHAREHOLDERS, ESPECIALLY ON THE ANNUAL GENERAL MEETING, BUT NOT LIMITED TO THAT. MANAGEMENT THAT PAINTS A MORE BLOSSOMING PICTURE THAN REALITY, DOESN’T IMPRESS BUFFETT. ONLY A MANAGEMENT THAT KEEPS TO REALITY HAS THE CHANCE HAS THE CHANCE TO CHANGE FORTUNES.

ON THE OTHER HAND,  MANAGEMENT MIGHT PAINT THE PICTURE OF THE FIRM ROSIER THAN IT IS. AT THE LONG RUN, THIS MANAGEMENT MIGHT EVEN BELIEVE IN ITS PICTURE ITSELF. THIS MIGHT LEAD THEN TO THE IMPOSSIBILITY OF MANAGEMENT TO CORRECT ITS OWN MISTAKES.

FURTHERMORE,  MANAGEMENT  SHOULD PRESENT MORE FIGURES ABOUT THE FIRM’S PERFORMANCE. IT SHOULD NOT JUST KEEP TO THE FIGURES PRESENTED IN THE ANNUAL REPORT. THIS IS A SIGN OF APPRECIATION TOWARDS THE SHAREHOLDER.

3) THE INSTITUTIONAL IMPERATIVE

BUFFETT DEFINES THE “INSTITUTIONAL IMPERATIVE” AS

“THE TENDENCY OF EXECUTIVES TO MINDLESSLY IMITATE THE BEHAVIOR OF THEIR PEERS, NO MATTER HOW FOOLISH IT MAY BE TO DO SO.” (SEE: https://berkshirehathaway.com/letters/1990.html)

THIS BEHAVIOUR APPLIES TO CAPITAL ALLOCATION AS WELL AS TO THE GENERAL ATTITUDE OF MANY MANAGERS. ACCORDING TO BUFFETT, MANAGERS ARE BETTER ADVISED NOT TO FOLLOW THE TREND. THIS IS IN ACCORDANCE WITH HIS INVESTMENT PRINCIPLE, AS FOLLOWS.

BUY, WHEN OTHERS SELL, AND SELL, WHEN OTHERS BUY.

CONSEQUENTLY, MANAGERS MUST LOOK FOR INVESTMENT OPPORTUNITIES OTHERS RUN AWAY FROM. THEY MUST ANALYSE THE INVESTMENT OPPORTUNITY ITSELF THOROUGHLY. MANAGEMENT SHOULDN’T FOLLOW AN OPPORTUNITY ONLY BECAUSE OTHERS DO. THEY MUST FIND NICHES IN THE MARKET, AND INVESTMENT OPPORTUNITIES THAT ARE UNDERVALUED.

THAT’S IT FOR PART 2. WARREN BUFFETT’S INVESTMENT TENETS 2/MANAGEMENT TENETS DISCUSSED THE PRINCIPLES OF MANAGEMENT FOR INVESTMENT DECISIONS. NEXT WEEK WE WILL INVESTIGATE THE FINANCIAL TENETS.

STAY TUNED!

 

 

Leave a Reply

Your email address will not be published. Required fields are marked *