Warren Buffett: Sage for the ages

How does Buffett’s wisdom from the 1980s apply to ASX stocks today?

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

I have recently been reading Warren Buffett’s famous annual Berkshire Hathaway (NYSE: BRK.B) letters, starting from 1977. The same Buffett quotes are frequently repeated – for good reason. However, I’ve been struck by just how much I have missed out on by reading only shortened quotes, without understanding the context in which they were written.

The below quotes are all from the 1980s. One point that features in every letter of that decade is the importance of companies achieving a good return on investment. This was the decade, after all, that he finally liquidated the textile business. I had a lot of difficulty selecting just three quotes, and if you have time to read some but not all of Buffett’s letters from the 80s, then I recommend 1987, 1989 and the appendix on goodwill and amortization in 1983.

Writing about businesses that can grow profits faster than inflation, Buffett described two characteristics of such companies:

“(1) an ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume, and (2) an ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.” (1981)

Fast-forward to 2013 and the software sector is one place to look for such companies. However, investors must note that yearly R&D and product stickiness depend on the specific software product.

Amongst my holdings, Energy Action (ASX: EAX), which sells software-based solutions and secures favourable electricity supply contracts for clients, best fits these criteria. This is because the company takes a percentage commission on contracts and will grow with the price of electricity (and inflation). Further, higher electricity prices further incentivize clients to retain the company’s services, allowing for a modicum of pricing power.

On the other hand, another of my favourite quotes counts against Energy Action. On the subject of management consultants, Buffett wrote:

“CEOs who recognize their lack of capital-allocation skills (which not all do) will often try to compensate by turning to their staffs, management consultants, or investment bankers. Charlie and I have frequently observed the consequences of such ‘help.’ On balance, we feel it is more likely to accentuate the capital-allocation problem than to solve it.” (1987)

I can’t say I was delighted to read that earlier this year Energy Action appointed Fort Street Advisers to help “assess growth opportunities in the market.” It truly is a pity for Energy Action shareholders that Valerie Duncan is retiring as Managing Director. If only she would continue.

This is something investors should consider when one of their companies announces it is paying for expensive external consultants. When the current management has proven to be wise capital allocators, external advisers have a difficult job adding value. However, as Buffett says, there are plenty of inadequate capital allocators who remain firmly in denial about their abilities – leading to what he calls “spurious accounting goodwill.”

Prospective investors in Coca-Cola Amatil (ASX: CCL) would be interested in this childhood anecdote pertaining to Berkshire’s investment in Coca-Cola (NYSE: KO).

“I believe I had my first Coca-Cola in either 1935 or 1936. Of a certainty, it was in 1936 that I started buying Cokes at the rate of six for 25 cents from Buffett & Son, the family grocery store, to sell around the neighborhood for 5 cents each. In this excursion into high-margin retailing, I duly observed the extraordinary consumer attractiveness and commercial possibilities of the product.

I continued to note these qualities for the next 52 years as Coke blanketed the world. During this period, however, I carefully avoided buying even a single share, instead allocating major portions of my net worth to street railway companies, windmill manufacturers, anthracite producers, textile businesses, trading-stamp issuers, and the like. (If you think I’m making this up, I can supply the names.) Only in the summer of 1988 did my brain finally establish contact with my eyes.”

Foolish takeaway

Reading every Berkshire letter is more than a pastime; it’s part of an education I should have had at university. And what is investing, according to Mr Buffett? “When investing,” he says, “we view ourselves as business analysts — not as market analysts, not as macroeconomic analysts, and not even as security analysts.” (1987)

Interested in our #1 dividend-paying stock? Discover The Motley Fool’s favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of “The Motley Fool’s Top Dividend Stock for 2013-2014.

More reading

Motley Fool contributor Claude Walker owns shares in Energy Action. Find him on Twitter @claudedwalker.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

asx share price competitions represented by businessmen arm wrestling
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

person reading news on mobile phone
⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »