Every year in March the financial media turns its attention to Warren Buffett's latest letter to shareholders. While it's always great to hear the latest, there is so much to be learned from all his letters – they are certainly made to last.
It's for this reason that I like to revise his older letters from time to time – and I hope readers will realise that the greatest investment you can make is in your own knowledge.
In any event there's no doubt that the same Buffett quotes are repeated ad nauseum, while other gems of wisdom are scarcely to be found anywhere other than in the letters themselves. As part of my ongoing mission to change that, here are three of his pearls of wisdom from the early 1980's:
1. On how companies report:
"The reaction of weak managements to weak operations is often weak accounting…even managements of integrity may subconsciously be less willing in poor profit years to fully recognise adverse loss trends."
This is something to look out for when managements suddenly introduce underlying earnings, or make comparisons that minimise a poor result. For example, in its 2013 full year (FY) results press release, Energy Action Limited (ASX: EAX) reported "operating NPAT" of $5 million. However, in the 2014 FY results press release they said that the "operating NPAT" was down 8% to $4.5 million, which is wrong if we're comparing $4.5 million to $5 million. Then, in the preliminary report they said it was down 8.2% from $4.9 million, "like-for-like." But there was no mention in the press release of the original forecast of 10-15% "operating NPAT" growth!
That sure was fortunate for the those directors who sold shares prior to the guidance downgrade in December.
2. On looking to the future:
"It's not only generals that prefer to fight the last war. Most business and investment analysis also comes from the rear-view mirror."
That's another one I should put on my wall.
3. And finally, this valuable advice about how to assess acquisitions:
"What really counts is whether a merger is dilutive or anti-dilutive in terms of intrinsic business value (a judgment involving consideration of many variables). We believe calculation of dilution from this viewpoint to be all-important (and too seldom made)."
This was something that came to mind when examining whether Energy Action had made a wise move acquiring Exergy in March 2014, and whether their most recent acquisition – funded by cash, debt and shares – is likely to pay off.
I increasingly suspect that the practice of remunerating based on earnings-per-share growth targets is actually a hazard to the intrinsic value of some ASX companies.
