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Wit, Wisdom, Warren (Issue #1): Key Investing Principles

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We start this series of review of Warren Buffett’s letters with his second letter to partners of Buffett Partnerships that he wrote in 1957 (the first letter isn’t available).

Buffett was just 27 years of age when he wrote this letter to his partners. So you can imagine his level of understanding at an age when most people are clueless about the future and are instead lost in the world of revelry and merriment.

But Buffett had his priorities well set. By this time, he had already:

  • Started and closed several small businesses (like selling chewing gum, Coca-Cola, weekly magazines, golf balls and stamps) that could earn him enough money to save and invest.
  • Bought a farm using his investments.
  • Accumulated more than US$ 90,000 in savings (measured in 2009 dollars).
  • Filed his first income tax return…at the age of 14!
  • Graduated with a Bachelor of Science in Business Administration (1949).
  • Earned a Master of Science in Economics from Columbia (1951).
  • Studied “Security Analysis” under Benjamin Graham and David Dodd (and earned the only A-Grade that Graham ever gave to any of his students).
  • Read Graham’s The Intelligent Investor several times
  • Worked as a securities analyst under Graham at Graham-Newman Corp. (1954-56).

He started Buffett Partnership Ltd. in 1956 after Graham retired and closed his partnership.

At this time, Buffett’s personal savings were over US$ 174,000 (or US$ 1.2 million inflation adjusted to 2009 dollars).

Buffett Partnership Ltd. was an investment partnership – actually a set of investment partnerships – that Buffett started to manage money of his friend and relatives, using the principles he had learned from first studying under Graham, and then working with him.

In 1957, Buffett had three partnerships operating the entire year.

The letter he wrote to his partners during that year contains a lot of simple, yet profound ideas that are relevant till today.

Intrinsic value as the bedrock
Buffett started his letter talking about the general stock market level, which he thought was priced above the intrinsic value.

This – importance of intrinsic value and its comparison with market prices – is one of the many great concepts that Buffett had learned from Graham (the other being margin of safety and Mr. Market).

Anyways, since Buffett thought that the US markets were priced higher than intrinsic value then, he also thought that there was a possibility of stock prices declining substantially in the future.

Compare this with the view most investors, analysts, fund managers, and other experts share in times when stock markets are frothy (like they were as recently as 2008).

In such times, the concept of intrinsic value is thrown out of the window because everyone wants to enjoy the ride to the top – often forgetting that the higher the markets rise in relation to intrinsic value, the greater would be the reversion to the intrinsic value.

Like here is the chart showing Sensex over the past many years, as compared to the average earnings of companies that form part of the index. Notice that the Sensex has largely moved in line with the earnings (a variable used in calculation of intrinsic value).


Whenever there have been sharp gaps created between stock prices and intrinsic value, stock prices have risen or fallen to come back to the level of intrinsic value prevalent then.

Most of us rarely give any credibility to such a simple concept, but Buffett cared about it way back in 1957.

In fact, he was even ready to employ borrowed money (not advisable for you) to buy stocks if the markets were to fall below intrinsic value.

But then, he clearly stated…

All of the above is not intended to imply that market analysis is foremost in my mind. Primary attention is given at all times to the detection of substantially undervalued securities.

That is the number one rule for you as well, dear investor.

Cut the Sensex nonsense…don’t given the index any importance in your decision to buy individual stocks – except knowing whether the general markets are way too high or way to low as compared to the general intrinsic value of listed stocks.

Like what Prof. Sanjay Bakshi suggested in a recent interview with Safal Niveshak…

The simple rule that I can give is that the Indian stocks have hovered from 11x P/E multiple on the lower end for the NSE-Nifty to a 27x on the higher side.

So obviously if you are buying stocks when the P/E multiples are 23, 24 or beyond, you should be a bit careful. You shouldn’t put a lot of money in stocks.

But if the stock that you like a lot is available to you in an environment where the aggregate multiples are 12-14, or even right now, which is about 15, then it’s a good environment to buy into long term stocks.

In other words, worry about Sensex or Nifty only to check the “general environment” in which stocks are trading, but never to make a decision whether to buy or sell individual stocks (this decision must solely be guided by the study of intrinsic values).

Ignore the noise
Buffett writes…

The past year witnessed a moderate decline in stock prices. I stress the word “moderate” since casual reading of the press or conversing with those who have had only recent experience with stocks would tend to create an impression of a much greater decline.

I can recount several examples from my early life as an analyst and investor, when even a slight fall in stock prices, and especially prices of stocks I owned, sent me to a state of shock!

Business media also does a good job to add fuel to such sparks, thereby leading small investors to run for cover under a bunker when it’s just drizzling outside!

That is why you read terms like “Black Monday”, Black Tuesday”, “Black Everyday”…for days when the Sensex crashes by a few hundred points.

This is despite the fact that such “black” days do not mean much when you are looking to invest with a 10-20 year timeframe.

These are just heartburns that the experts want you to see as heart attacks!

The best thing you can do is ignore short term movements in stock prices, even if they are sharp.

You must only be concerned with comparing stock prices with intrinsic values, and that’s it!

Give “luck” its due credit
The US markets declined by 8.4% in 1957. Despite this, Buffett’s three partnerships gained by 6.2%, 7.8%, and 25% respectively.

If I can eke out such great outperformance over the broader markets, I would call myself “genius”.

Buffett called himself “lucky in the short term”! That’s humility for you, another important attribute a value investor must have.

What is more, over the long term, Buffett just expected to beat the markets by 10% per annum on an average. So he did not expect a big outperformance from his investments, unlike what most of us think these days.

I can recollect meeting a fund manager sometime in 2006, who boasted how his fund’s NAV had outperformed the competitor’s by 10 paise! Then there was this fund manager who earned a big bonus for “losing less” money as compared to his peers.

Such weirdness is widely prevalent in the markets, so you must watch out when a mutual fund asks you for money showing the “shiny” past out-performance. In most cases, that out-performance must have been due to sheer randomness and not due to the fund manager’s ability.

Patience is a virtue for value investors
The last part of Buffett’s 1957 letter carries a very important lesson in patience for value investor. Here is what he wrote…

To some extent our better than average performance in 1957 was due to the fact that it was a generally poor year for most stocks. Our performance, relatively, is likely to be better in a bear market than in a bull market so that deductions made from the above results should be tempered by the fact that it was the type of year when we should have done relatively well. In a year when the general market had a substantial advance I would be well satisfied to match the advance of the Averages.

Despite calling ourselves “value investors”, a lot of us lose patience when stock prices are falling and get elated when they are rising.

But as Buffett wrote, a true value investor is likely to perform better in a bear market than in a bull market.

This is simply because when you are value investor, you buy good quality stocks and that too only at reasonable margin of safety (around 30-50%).

So when stock prices fall in a bear market, your good quality stocks bought at reasonable margin of safety may earn you lesser losses than the broader markets.

On the other hand, in a bull market, when even garbage is considered a dessert, and people are lapping up everything that’s rising in price, Mr. Market usually ignores good quality “boring” businesses which you hold in your portfolio…

…and thus you must be happy to earn just as much as the broader markets. That’s when you must not try to ride the bull but instead tell those riding it – “I’ll see you in the next bear market!”

This wouldn’t be arrogance on your part. This would be sensibility, as Buffett has proved over the past six decades.

Welcome stagnant or falling markets
A stagnant or falling market – especially when the stagnation or fall is spread over a number of years – leads most investors to self-doubt their strategies.

I meet a lot of investors who sold out most of their stocks at huge losses post the 2008 crash and have not returned to the market again. When I ask them the reason, most would say, “Who says stocks do well in the long run? Look what they have done in the past 4-5 years!”

Then there are others who are elated after a stock they bought jumps up in price.

The young Buffett did not think anything like this in 1957. As he wrote…

During any acquisition period, our primary interest is to have the stock do nothing or decline rather than advance. Therefore, at any given time, a fair proportion of our portfolio may be in the sterile stage. This policy, while requiring patience, should maximize long term profits.

Importantly, Buffett made a mention of an “acquisition period” here and not an “acquisition date”. He seemed interested in buying a particular stock over a period of time instead of what most investors generally do – utilize all excess cash to buy the maximum shares of a stock they can using that cash.

I have done this in the past, thereby creating problems when some stocks I bought fell in price (after I bought). The better thing I would have done was to buy stocks in a systematic manner – bit by bit, and over a period of time.

If you are to practice this philosophy, you would require immense degree of patience. But, as Buffett wrote, that would lead to maximization of long term profits.

In later years, Buffett used a different story to talk about the importance of “acquisition period” and “falling stock prices” for long term investors.

Here is what he wrote in his 1997 letter to shareholders…

If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?

These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?

Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall.

In effect, they rejoice because prices have risen for the ‘hamburgers’ they will soon be buying! This reaction makes no sense.

Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

Now at 34, I expect to be a net buyer of stocks over the next 10 years. And this is the reason I would be happier seeing sinking (or just moderately rising) stock prices…not a bull market that takes stock prices beyond my comfort levels.

What about you?

“Special situations” as part of investment strategy
In Part 3 of my interview of Prof. Sanjay Bakshi, he said…

The business of investing is a highly competitive business, so you must find an edge.

You may decide to specialise only in “special situations”. You may say – “I only want to work in event-driven strategies. I don’t want to take bets on India’s long-term growth story because almost everyone else is doing that. I know there are often mis-priced bets in the field of tender offers, share buybacks, large dividend payouts, spinoffs, going-private transactions, mergers and acquisitions, capital structure changes, asset sales etc.

The 27 year old Buffett was beautifully practicing this – of specializing across investment situations – in 1957.

He termed his special situations as “work-outs”. Here is how he defined the same…

A work-out is an investment which is dependent on a specific corporate action for its profit rather than a general advance in the price of the stock as in the case of undervalued situations.

Work-outs come about through: sales, mergers, liquidations, tenders, etc. In each case, the risk is that something will upset the applecart and cause the abandonment of the planned action, not that the economic picture will deteriorate and stocks decline generally. At the end of 1956, we had a ratio of about 70-30 between general issues and work-outs. Now it is about 85-15.

Nothing can be simpler than the above paragraphs to define the complex subject of “special situation investing”.

In fact, Buffett also mentioned a couple of key checklist points for investors who are interested in working on special situations:

  1. A special situation is “dependent on a specific corporate action” for its profit rather than a general advance in the price of the stock as in the case of undervalued situations. So the checklist point is to answer what is the probability of the corporate action to happen. Higher is better for an investor to deal in that special situation.
  2. The risk with special situations is that something will upset the applecart and cause the abandonment of the planned action, not that the economic picture will deteriorate and stocks decline generally. So when you deal with special situations, a view on the economic or stock market picture may be excluded from your checklist.

Another key aspect of investing that Buffett hinted here was that of “allocation”. So in a year when stock markets fell a bit and Buffett identified attractive businesses to invest in, he reduced his allocation to special situation investments, from 30% in 1956 to 15% in 1957.

Here is an important takeaway for investors dealing/not dealing in special situations – It’s important to set a proper asset allocation strategy before you start to invest…and then it’s equally important to follow that strategy in stock market ups and downs.

Key ideas from Buffett’s 1957 letter
Here is a summary of the key ideas we discussed in this review of Buffett’s 1957 letter to partners:

  1. Give due importance to intrinsic value while making your investment decisions.
  2. Over time, stock prices generally revert to intrinsic value.
  3. Ignore the Sensex (what it is doing, where it is going) except to check the pulse of the “general investing environment”.
  4. Ignore short term movements in stock prices, even if they are sharp. You must only be concerned with comparing stock prices with intrinsic values, and that’s it.
  5. Give luck its due credit (but luck, like love, is a verb…so practice hard to get lucky, like Buffett did).
  6. Humility is one of the most important attributes of a value investor.
  7. Over the long term, if you can do your work properly, expect to outperform the broader market at just a reasonable rate. Never expect a big outperformance, for such an expectation might lead you to commit grave errors of commission.
  8. Being a value investor, expect to perform better in a bear market than in a bull market.
  9. Patience is a virtue, and especially if you are a stock market investor.
  10. It’s important to set a proper asset allocation strategy before you start to invest…and then it’s equally important to follow that strategy in stock market ups and downs.

And, by the way, read “The Intelligent Investor” before making your first stock purchase.

Anyways, this was my review of Buffett’s 1957 letter to partners. Let me know if I missed something. Also, let me know your own lessons from this letter.

Finally, I would appreciate your view on my notes to the letter – have they really added value to your learning as an investor.

Next Friday, we will review Buffett’s 1958 letter to partners, which you can read here.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. So here it comes!!
    This was really wonderful, Vishal..:) So nicely written, explained..
    It was such a pleasure to read it..:)

  2. Yes, I also expect myself to be a net buyer for next 10 years and even beyond that and would like to see market SINKING !!!!!!

  3. I would suggest we can have a separate folder on top of the website, for this Wit, Wisdom, Warren, as we are going to have more than 40 reviews!

  4. Well Nice One… Wit and Sharp.. thts buffet style …

  5. There is more learning from reading all his letters than any other single source ive come across ! The thought and application is way ahead of common wisdom, attitude and behavior ( no wonder his results are astounding )… Vishal , kudos once again for putting all of them ( 57 to 70 letters ) up !!

  6. sanjeevbhatia says:

    Great Start to a wonderful series.

    The WB letters collectively can impart more wisdom than hundreds of books combined. You have done very well to nicely explain the salient points. Distilled Versions of his profound vision will need some explanation at some places, and you are well equipped to tackle that. 🙂

    Another hall mark of his writing is that he writes in very simple, engaging language. His wry humour drives home the points wonderfully. Looking forward to more gems from the Great Master.

    Thanks for starting this wonderful series.

  7. sanjeevbhatia says:

    BTW, pls send the link where one can access the next scheduled letter so that we can read and analyse it before the next posting.

    Thanks

  8. sanjeevbhatia says:

    Sorry, Didn’t realize that the link in previous post contained ALL the letters upto 1970. Just read the 1957 one and closed the file. 🙁

  9. Excellent Kick Start to the “Wit, Wisdom, Warren” series. The way you extracted the knowledge from the letter and presented it in a simple way is awesome. I agree with Mr. Shankar’s & other similar suggestions for a separate folder / page for this series to get quick excess to the past ones. As there will be more than 50 letters and if we assume around 40 – 50 valuable discussions & comments for each issue. In totality this will be complete valuable package for us.

    Further, Mr. Buffett put his views on market titled under “The General Stock Market Picture” are very educative which will build our strength to overcome our emotions. These views were value investor’s frame of mind and we as value investors should keep the same general views for market. In every line Mr. Buffett emphasizes on the value of the stocks not the price of the stocks.

    Will write more about my lessons soon.

  10. Arun Ramakrishnan says:

    I think some of the thoughts of buffet about patience, long term thinking and developing a sound methodology has been elucidated in detail by Amit Wadhwaney. He gives practical examples of how one evaluates investment risk, holding companies. He also gives an example of how luck played a large part in acquiring an australian asset. I think it fits very well with buffet’s thoughts.

  11. Well written Vishal !!! You captured the essence of the letter very well.

  12. You have analyzed the letter beautifully.

    I ensured that not only I read the 1957 letter twice but also wrote down the finer points mentioned by Mr. Buffet before coming to your post.

    The simplicity of your explanation of these points (which I also noted down) is very helpful.

    I also have a personal confession to make.

    I have been investing in the stock market from 2007 and just like most hapless small investors had been chasing that SENSEX figure all along. Making few profits and more losses :-). Until, I came across the book Intelligent Investor by Mr. Graham – my Financial Bible. The book changed a lot in me. It has brought a sense of calmness in my method of stock analysis (lesser from Price movement and more on the fundamental side now). The book helped me get a better understanding of how often the irrational behavior of day to day price movements are captured by small investors like us only to see ‘red’ in our portfolios at the end of the day.

    Your site and Rohit Chauhan’s blog has helped me connect to like-minded individuals with whom I can share and learn the beauty of long term value investing.

    Thank You Vishal !

  13. Good article. Thanks

  14. Trupti Agrawal says:

    Hi Vishal,

    I went through the comments of the ‘tribesmen/women’ as you call them when you first luanched this initiative and found everything that I wished to say about your initiative already out there. I congratulate, thank and appreciate once again in addition what people have already said, from myside too.

    I would like to seek your clarification on one point in your post: How can you find out the PE of the market as at any point in time. I could not locate the same in the NSE website.

    Thank you!

    Regards,
    Trupti

  15. R K Chandrashekar says:

    Warren 50+ letters is a lavish spread- finest buffet meal ( investment meal!! ) one could lay hands on without getting an indigestion! Even at raw age of 27, he is talking of how the market is trading higher than the intrinsic value, understands money is made in a bear than a bull market and is willing to wait for the bear market to buy.
    What is amazing is that he is already talking of special situations-‘Work-outs’ and has the asset allocation in place. There is one thing I like of America- teenagers do odd jobs in summer-and fund their education. We have social taboos here!! ( My masters in the US in the early 70’s was funded by my dad)

  16. well vishal…we need an article on the sudden spurt of the share prices today.. 440 Points… I dont think as such any great happening except diesel price and LPG Limit…

  17. A very good explanation. I really appreciate Vishal

  18. Anindya Karmakar says:

    Vishal,

    Great summarization of key points. Its simple and well written. The question is how can you precisely calculate the intrinsic value.

  19. Very well explained Vishal . Thanks

  20. I think most of these letters are lessons or philosophies. One should not use them at face value. For example if it says “buy stocks that are at 30-50% discount to their fair value” this means you should pick companies that are trading at massive discount. If one goes filtering for such companies you would be left with a lot of mid and small cap dud stocks that will become worthless over the next cycle. Further, the idea of buying below book value is practically difficult or not possible in India. The reasons is simple….most financial statements show book values which are based on very old historical data, and revaluation of assets are not frequent. This means your assets (atleast a majority of them are based on acquisition price or cost), which makes your book value very low in relation to stock prices, which reflects current market conditions. In markets like US where the asset values are revalued and updated regularly (lets say under IFRS format), the Price to Book value can be lesser ….or below 1. In India since book value is too old and lower in value, most mid and small companies would also trade well above book value. The blue chips will never be available at close to book value, so thats ruled out.
    So the idea of buying below book value practically fails in Indian context. However, we can use value investing with a different scale (say with criteria like P/B below 3.0) to be more realistic.
    I personally believe in using a mix of strategies rather than saying I invest only in “value stocks”. Smart investors also choose blue chips, growth stocks, gold, etc to build a diversified war chest.
    These are my views. Though I like Warren Buffet and his strategies I dont think it can be applied in Indian context because the environment here is completely different. HOwever, the lessons are timeless.

    • Sridhar, you can use Buffett’s principle in any stock market. You will get plenty of opportunities to buy large cap stocks at bargain prices.

      Persistent was available for 300 rs 1 year back its 421 now. Reliance was available for 680 in May its 841 now. Jindal Steel was available for 330 Rs last week its 370 now.

      These are some the companies in my portfolio which I bought using buffett’s principles.

      Buffett used to focus more on book value in 1950 and 1960 but after meeting Munger he started focusing on other factors like pricing power.

      There are two environments in stock market, fear and greed and these are universal, does not matter if you are in US or India.

      • Manish Sharma says:

        Krish,

        Can you please tell me what are the Buffett principles that you aplied for selecting Reliance and Jindal Steel…..

        • During April May, Reliance was in the limelight for K6 river basin. If you read the tv and news report that time all the experts were saying that this is end of the world for Reliance.

          So I applied Buffett’s first rule be greedy when other are fearful. I use Craytheon.com for fundamental analysis (it was recommended by another safal niveshak tribesman)

          That site has 10 year trend of all the key ratios which in Reliance’s case looked satisfactory. They also provide intrinsic value of different valuation models just like Vishal which is handy since calculating it manually is not feasible. The fair value came to around 900 Rs. per share.

          Reliance has around 100 Rs cash per share (its was actually 136 but I am being conservative) and Reliance had declared a buy back in Jan.

          A quick look at the chairman’s report and auditor’s and it looked ok i.e. there were no hidden surprises.

          Combining all the above factors Reliance at 680 Rs per share looked very undervalued so I bought it.

          Its not a complete rosy picture, Reliance has a geniune problem, its profit margins are falling every year so I am not sure that I am going to hold this for long term but at 680 it looked very attractive.

          Similar story with Jindal Steel when JSPL’s name came in CAG scam, the stock got hammered. I was hoping that the price would reached 300 Rs and I would have bought more but then the FDI report came in and the stock market shot up.

          I am actually sad that JSPL went up 🙂

          JSPL’s fair value was around 450 Rs according to the valuation models at craytheon, rest of the ratios also looked satisfactroy. A quick look in the annual report and I dont think that the CAG scam is going to affect the long term performance.

          Combine all above and the stock looked attractive at 330.

          Moral of the story is dont dismiss Buffett’s advice as philosophy. His advice – being greedy when others are fearful, exploiting the short term crashes in a stock of a good company, being passive most of the time but quickly going into active mode when you spot an oppurtunity etc his advice works in every market US or Indian and for big and small companies the only problem is that you have to spend a little more time actually going through the financial performance and annual report of the company.

          I hope that answered the question, Manish.

    • I’m sorry Sridhar, but if you use screens and find stocks trading below book value, you’ll find many in India. One of them is called “Punjab National Bank”, and I think its a decently sized company 🙂

      Nevertheless, just using P/B as a measure for undervalued stocks is a very dangerous strategy, and we must use multiple criteria – most important ones being qualitative…

      Regards
      Sunny

  21. His letters are a pieces of financial wisdom woven into a fabric.
    I too, thanks to you, have started to read them. You have summarised it well.
    As in America, which has mastered the art of monetising to the hilt, they have a book on his letters as well “The Essays of Warrem Buffet Lessons for Corporate America”. Has anyone read this ?
    A suggestion, the key ideas as condensed by you, of each letter can be copied on a document and pdf’d. What do you all say ?

  22. Thanks Vishal, excellent start

    I read it myself and then took notes, and glad to see my notes matching yours 🙂 Just couple of points where I’m a little confused

    WB mentioned about 2 positions in portfolio which have reached 20% of the portfolio, and he expects to “take part in some corporate decisions”. What does that point mean? Does it mean to balance the portfolio and take profits since these positions have grown big (and in that sense, does WB indicate some rule to limit exposure to one position)?

    Second, since WB expects to outperform the market by just 10%, what does it mean? If average return from markets are 16%, does WB expect 26% or 17.6% returns from his portfolio.
    Accordingly, does it mean he uses this value (26% or 17.6%) as his discount rate in arriving at Intrinsic Values?

    Finally, does “special situation” mean same as “sin money”? Or, one can allocation say
    a. 70-90% in undervalued stocks
    b. 30-10% in special situations
    and
    c. Upto 5% in sin money to curb speculative emotions

    Once again, a great start, and for sure all these 50 discussions will be a great treasure of knowledge for us 🙂

    Regards
    Sunny

    • Thanks Sunny! “Corporate decisions” here means that Buffett’s stake in this company reached such a level that he might’ve become a part of the Board.

      On your second point, yes Buffett was looking at a 10% outperformance, but in the long run and not in one specific year. If you were to see his latest letter (2011), Berkshire’s book value has grown at a CAGR of 19.8% over the past 46 years, while the S&P 500 has risen by 9.2%…suggesting that Buffett has infact outperformed by 10% 🙂

      On the third point, “special situations” does not mean “sin investing”. The former are more of investments based on special corporate situations like mergers, liquidations, open offers, buybacks, etc. These are like well-calculated arbitrage opportunities that can earn you good money in a short time, but not really speculations. Regards.

  23. Thanks Vishal for clarifying 🙂

    One last point on corporate decisions. I understood that these investments had grown to become more than 20% of the partnerships’ portfolio. am I correct?

    Or, instead, WB’s holdings in these companies had grown to as large as 20% such that now it was mandatory for him to become a “promotor”?

    • Trupti Agrawal says:

      Sunny, I think what WB meant that some of the stocks were @ 20% of his portofolio (which in itself is a large position). Also the same were sizeable in the context of the Company and hence as Vishal mentioned, would get him representation on the board. There is no connection with 20% holding and becoming a promoter. You are a majority shareholder in a company when you individually own the highest stake when compared to all the shareholders individually. However even if one holds a sizeable stake in a Company, yet less than 50% in the Company, he still stands the chance of being overruled if the shareholders holding the remaining 50%+ stake vote otherwise on any particular matter. There is a concept of special resolution in the Companies Act. Special resolution means the number of votes for a motion should be atleast three times more than the number against the motion. Hence holding anything more than 25% in a Company gives you the stake necessary to get the special resolutions passed. Some of the situations requiring special resolution by the shareholders: Buy-back of shares, issue of sweat equity shares, rights issue etc.

      • Thanks Trupti for the nice explanation, ok, so WB is talking about potentially going from 20% to 25%+ and then take “controlling” stake in the company.

        An interesting question arises: how do existing promoters, with less than 75% holding protect someone else to take 25%+ stake and then “veto” what promoters do – like, consider an example. I’m an indian company, but for fundraising, etc, they had to dilute equity in the past to less than 25%, and now some other outside entity, possibly a competitor, holds more than 25% stake. Can this be detrimental to the business, since this other stakeholder of 25% may “veto” crucial decisions for the business, hence impacting business in longer run?

        That ways, how does the recent SEBI requirement of holdings to be less than 75% work? I’m probably missing something, but, if I’m not wrong, does it mean one should analyse in detail the shareholding – like, if top two shareholding entities have less than 75% but more than 25% holding, the higher one being business beneficiary, but the lower one having not so benign intents…

  24. Excellent post!
    Good initiative to analyze Buffet’s letters. We need to read them repeatedly to internalize the learnings 🙂

  25. Look at S&P CNX 500 P/E ratio instead of just Nifty for a better overall market picture. Its best to download the entire P/E P/B and DY data from 1996 and plot in excel. See this link.

  26. Hi Vishal,

    Am a recent joinee, so pardon my naive-ness(if applicable)!

    This note/query is about “work-outs” or “special situation”—
    1.Exactly how much should my allocation(as a % of my portfolio) to these ideally be?Can I call myself a value investor while having 50+ % allocation to these?
    2.Would you classify the recent dip and rise of Onmobile Global as a speculation or work-out opportunity?

    Warm Regards
    Akash

  27. Amit Kumar says:

    Great job Vishal. It will turn out to be one of the finest material for understanding value investing. Kudos 🙂

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