abstract
Warren Buffett (Warren Buffett) is a recognized "stock god" in the investment world. After he insisted on his investment philosophy for many years, his wealth has always been among the top in the world. His investment philosophy has also been widely read and praised by everyone. Today we re-read Buffett’s letter to shareholders and summarize what we have gained.
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Speaking of Buffett, many people immediately think of his investment philosophy:
1. "Trust America"
2. "Principle 1, don't lose money; principle 2, follow principle 1"
3. "Buy and hold for a long time"
4. "Value Investment"
5. "Be greedy when others are fearful, and fear when others are greedy"
These old-fashioned ideas sound clever, but realize that they lack details. You cannot make trading decisions based on these ideas.
Most commentators missed many of Buffett's wisdom. (To make matters worse, many commentators deliberately misinterpreted Buffett's remarks in order to support their views.)
Below are our notes taken from Buffett’s letter to shareholders.
Patience>Smart
Is leverage good?
Ignore the pessimism of the salesperson
The most important skill in the financial industry-marketing
If you start investing now, why wait
The true meaning of risk (this is very important)
Why doesn't Buffett like models
How Buffett evaluates a company
Why Buffett likes the entire company instead of individual stocks
How Buffett defines "valuation"
Don't be a reverse investor just to be a reverse investor
What makes Buffett special is his unique thinking ability. His thinking is contrary to many traditional ideas.
1 Patience>Smart
If Buffett’s teachings have a common theme, it is that patience is more important than intelligence. Buffett’s strategy is not necessarily “smarter” than others. His outstanding performance is not because he has more complex algorithms or smarter-sounding indicators than others.
Buffett's outstanding performance comes from simple common sense and more patience than others. In the 1990s, he didn't chase online stocks just because everyone else was chasing them. He is not trying to avoid every 10% drop in the stock market, which usually misses more gains (that is, underperformance).
2 Don't use leverage unless you have a special leverage
On the surface, Buffett's statement about leverage seems to be contradictory. On the one hand, Buffett said that investors should not use leverage because they simply don’t know how far the stock will fall in the short term.
This is basically correct. Before October 19, 1987, people did not believe that the stock market could plummet by more than 20% in one day. However, something incredible happened.
But on the other hand, Buffett himself uses a special kind of leverage called insurance float ( insurance float). The vast majority of investors, traders and investment funds are unable to obtain such leverage.
So how can we combine these two seemingly contradictory statements?
If you want to use leverage, you need to ensure that there will be no "bank run", in which case your leverage is called when it is most inappropriate. You need to be able to hold your leveraged position until you are right.
For example, this means you should not trade on margin. Your broker can withdraw your deposit at its own discretion. When the market crashes, your broker may ask you to make a margin call after your position has collapsed. You will be forced to close the position at the worst price (the bottom of the market).
Buffett's insurance float meets this "smart leverage" test.
Insurance float cannot cause an impact on banks because it has nothing to do with the financial crisis. Insurance claims come from natural disasters, car collisions, etc.-all of which have little to do with financial markets. According to Buffett's way of constructing its insurance float, Berkshire Hathaway's insurance float will not exceed 3% of the subscription ratio at any point in time.
3 ignore the pessimism of sales staff
Buffett knows what's popular in the financial industry: a pessimistic tone that sounds smart. Sell on bad news.
Buffett wrote in his 2016 shareholder letter:
4 The most important skill in the financial industry-marketing
Buffett has criticized the financial industry in many letters, such as the letter to shareholders in 2014:
Next time you read some analysis that sounds smart (ie, marketing tools), ask yourself, "Is this just an analysis that sounds smart, or is it actually smart?" "Sounding smart and doing smart are two different things People like things that sound smart.
The mantra of the financial industry is "I win on the positive side and you lose on the negative side." If financial professionals sound smart and succeed in persuading investors to follow their advice, buy their products, invest with them, etc., they can earn money. But they do not repay the losses investors may suffer.
If their investment advisers tell them to buy and hold the S&P 500 index, most investors' lives will be better. But why don't investment advisers tell them to do this? Because doing so would be a career suicide. Tell investors to do nothing and be patient, there is no charge. Charging is achieved by telling the customer to continue to do something now. Or as Buffett said, "If you need a haircut, don't ask the barber".
As a group, active performance is not as good as passive. This does not mean that any active investor/trader can outperform the market. This simply means that as a group, active investors/traders perform poorly after deducting fees.
5 If you start investing now, why wait
As Buffett said in his letter to shareholders in 2014, “the main danger is that timid or novice investors will enter the market during periods of extreme prosperity and then be disillusioned when paper losses occur”.
The best time to start investing is after the economic downturn (and bear market), not when the economic expansion is nearing its end. It is much easier to make money after a recession, because economic expansion and bull markets have more room for maneuver.
6 The true meaning of risk
This is a very important insight. Apart from Buffett, I have never seen anyone talk about it. This is the reason why Buffett is great-his thinking is very different from others.
Buffett is famous for this sentence:
Rule #1: don’t lose money
Rule #2: follow rule #1
After the 2008 financial crisis, investors and traders became obsessed with "risk" and "risk management." When Buffett said "the first rule: don't lose money," too many people use it to support their belief that risk management is essential. (Many people only selected part of Buffett's remarks to support their prejudices, without carefully studying the entire statement to understand what Buffett really meant).
Not that "risk management" is not important. Risk management is very important. But the problem is that "risk management" is not what everyone thinks.
In the financial industry, "risk" and "risk management" mean:
Don't lose money today, tomorrow or any other day. The most important thing is, never have a day of failure.
Try to avoid reducing drawdowns.
Strategies with higher risk-adjusted returns and Sharpe ratios are better.
Buffett's definition of "risk" is completely different. The traditional way of defining "risk" (volatility, beta) is wrong.
In Buffett's 2014 letter to shareholders, he clearly pointed out that "risk" and "volatility" are very different.
Buffett explained this in more detail in his letter to shareholders in 2011:
Essentially:
Risk ≠ volatility (beta, Sharpe ratio, etc)
"Risk" is the possibility of an investment losing money throughout its life cycle. "Risks" need to be avoided. You don't want to make investments/transactions that lose money in your life.
"Volatility" (beta value, Sharpe ratio, risk-adjusted rate of return) is the decline that you may experience while holding the position. Volatility is inevitable.
Assuming that you can make an XYZ investment, it guarantees a 50% return in the next two years. But during this period, XYZ's investment will first fall by 20%.
According to Buffett's definition of "risk", this investment is risk-free. Although Standard Finance states that this is "risky" (20% of losses), in Buffett's definition, this is simply "unstable."
Why is the distinction between "risk" and "volatility" important? Because investors and traders do all kinds of stupid things when trying to avoid volatility (which they think is "risk"), and in fact They should avoid real risks.
By trying to avoid each drop (volatility), investors/traders will mostly hurt their overall performance. They sold stocks to avoid an expected 6% drop in the stock market. But the stock market rose by 10% and then fell by 6%, and they were forced to buy back their stock at a higher price (that is, underperforming).
True "risk management" does not mean that you can completely avoid falling.
Real risk management = to ensure that your position will not lose money during the time it exists, even if it shrinks significantly in the process.
Real risk management = ensuring that your strategy (very effective in the past) will continue to be effective in the future.
In short, in the long run, you never know whether a smart-sounding and complicated strategy will collapse before your account collapses.
The real "risk" tells you the probability that your strategy will succeed in a long time. You cannot attribute the "real risk" to a single number, such as the Sharpe ratio or the Sortino ratio. If a strategy has many components, it may have a high historical Sharpe ratio. But the more its ingredients, the greater the possibility of future outbreaks.
This is something no one talks about. Every financial professional is talking about "how effective my strategy has been in the past" or "how smart my strategy sounds". But how many people tell you why this strategy may fail in the future? Qualitative assessment is the true definition of "risk".
So, what makes a strategy more "risky"? What is "real risk"?
The more indicators of a strategy and the more complex its components, the greater the possibility of problems in the future. Think of Mercedes-Benz and Toyota. The more complex the auto parts, the more likely they are to face mechanical problems. But unlike luxury cars, luxury cars are not necessarily better than simple strategies. Just ask those financial companies with complex strategies, their marketing is better than performance (such as long-term capital management companies)
The more a strategy deviates from simple facts, the more likely it is to fail. For example, buying and holding is a very low-risk strategy. The success of buying and holding depends on a simple fact: if the world economy continues to grow in the past few decades, corporate profits will grow and companies will become more valuable. If the market changes, complex strategies that "Alpha relies on little tricks" will fail.
The more strategic transactions, and the stronger the short-term nature of each transaction, the greater the probability of its failure. History will not repeat itself. Compared with the long-term trend, the short-term price trend of the market is more likely to change.
Buffett talked about traditionally "safe" assets at the beginning of the comparison. I agree with his sentence: "Their beta coefficient may be zero, but the risk is huge."
Then Buffett talked about assets that are based entirely on beliefs. These assets have prices, but the basic value is very small, because these assets will never produce anything.
Finally, Buffett gave some very interesting insights on buying stocks. In an inflationary environment like the 1970s, you should invest in capital-light industries.
To summarize the difference between risk and volatility, Buffett mentioned an absurd scenario in his 1993 letter:
7 Why doesn't Buffett like models
Although many people disagree with Buffett's view on this point, some truth can be seen from his argument:
complex models are not good. Simple models are useful because a proper thinking framework is necessary. Otherwise, there is only a fine line between "analysis" and random guessing. As we prove in the market every day, many "analysis" of financial markets are not much better than smart-sounding guesses.
8 How Buffett evaluates a company
When Buffett evaluates a stock, his evaluation is like he is buying a company. This means that he did not estimate the price of the stock in 5-10 years. Instead, he is concerned about how much he needs to pay to buy a company's future earnings cash flow, as it does in an M&A transaction.
Why Buffett likes the whole company instead of a single stock
How Buffett defines "valuation"
—not the mainstream way of thinking Factor investing is all the rage. Although factors such as "value" have high returns, they do not perform better in real time. What Buffett means is that you cannot use numbers to define "value" and "growth". So far, the sales staff of these factor investments have proven this. Their products did not achieve the effect of publicity. Just because a company has a low price-to-earnings ratio, high dividend yield, and low debt does not mean it is a "valuable" stock worth buying. If Amazon (AMZN.US) launches an attack on it, it may still be priced as a business. There are many intangible attributes that define good value stocks, such as "does the company have a moat?" This is not something you can boil down to a number.
Buffett said in his 1992 letter that you should not classify or quantify stocks as "growth type" or "value type."
9 Don’t be a reverse investor in order to be a reverse investor
Reverse trading (technical indicators, sentiment) is popular because it makes you feel "smart".
Buffett wrote in his letter in 1990:
Don’t just do the opposite because everyone else is doing the opposite.