Note: While reading a book whenever I come across something interesting, I highlight it on my Kindle. Later I turn those highlights into a blogpost. It is not a complete summary of the book. These are my notes which I intend to go back to later. Let’s start!

  • Some companies—not all, but some—have businesses that create fairly consistent earnings and earnings growth. Charlie and Warren believe that the common stock in those special businesses can be valued like bonds. So if a company is earning $1 a share and the stock is selling at $10 a share, one can argue that the stock is like an equity bond that is earning 10%. If the company’s earnings are growing at 5% a year, our two boys can argue that they just bought an “equity bond” that is earning 10% a year and growing at 5% a year. They think of it as an “equity bond” with an expanding rate of return, which, over time, lifts the underlying value of the company and thus its share price.

  • EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.” Charlie considers interest, depreciation, and taxes to be very real expenses that have to be paid. Interest and taxes have to be paid in the current year. Depreciation is a cost that has to be paid at a later date—for example, when a plant and equipment eventually need replacing. That eventual replacement is a capital cost. And capital costs can destroy what otherwise appears to be a really great business. According to Charlie, if we use EBITDA to determine the earnings of a company, we will get an unrealistic view of the company’s true economic nature.

  • What makes financial companies so complex? Derivatives make it possible to hide risk from the prying eyes of regulators and investment analysts. With AIG it was impossible to see all the credit default swaps it had written on subprime mortgages, because it never set aside any reserves to cover its losses. That meant the company’s risk exposure was hidden from the investing public. You could have read Lehman Brothers’ annual report a hundred times and never realized that it was borrowing hundreds of billions of dollars short term and lending them out long term to finance subprime mortgages that they then used as collateral to borrow even more money. A commercial bank might be using derivatives to take a massively speculative position in the currency markets, but accounting regulations are such that the position would be impossible to ascertain—until the company loses several hundred million dollars and we read about it in the financial press. Charlie’s rule for financial firms is really simple: what looks good on the outside may be seriously rotten on the inside.

  • An isolated example that’s very rare is much easier to endure than a perfect sea of misery that never ceases.” – Charlie is talking about the difference between an excellent company, which might confront a major problem a few times in a span of twenty years, compared with a mediocre company, which might go from problem to problem, year after year. A perfect example of an “excellent company” is the Coca-Cola Company. Over the last fifty years Coca-Cola has screwed up twice—once when it got into the movie business and again when it reformulated its flagship product and came out with New Coke. It solved both problems by getting rid of them. The perfect example of a mediocre business that goes from one problem to another is any airline—which has union problems and fuel cost problems and is in a price-competitive business. This bit of wisdom is also applicable to our personal lives; it is far easier to endure a brief moment of intense pain than it is to suffer a misery that drags on year after year.

  • A FEW GOOD COMPANIES – If you buy something because it’s undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That’s hard. But, if you can buy a few great companies, then you can sit on your ass. That’s a good thing.” – We touched on this point earlier, but it is so important that we will go over it again. The old Benjamin Graham method of buying undervalued stocks required an investor to set a valuation on a company and then, when the company reaches that valuation, sell it. This approach fails because it requires us to sell not only mediocre companies as they approach their valuation but also great businesses that have a durable competitive advantage, thus killing all opportunity to profit from the expansion of the underlying value of a business that occurs over time. Charlie and Warren’s theory is that a company with a durable competitive advantage has business economics that will expand the underlying value of the business over time, and the more time passes, the more the company’s value will expand. Thus, once the purchase is made, it is wisest to sit on the investment as long as possible, because the longer we own the company, the more it grows in value, and the more it grows in value, the richer we become. This can best be seen with Berkshire Hathaway, which over the last fifty years has traded anywhere from below book value in the early 1970s to almost twice book value in the late 1990s. If we had bought in at below book value and sold it at twice book value, we would have made great money, but we would have missed the giant moves Berkshire made in the period from 2000 to 2016, when it more than tripled in value. If we pick the right company, as Charlie says, sitting on our ass can really pay off.  
  • OWNERSHIP OF A BUSINESS – “View a stock as an ownership of the business and judge the staying quality of the business in terms of its competitive advantage.” – Benjamin Graham, the dean of value investing, looked at owning a stock as owning part of a business. If we look at investing from the standpoint of buying a fractional interest in a business, we can make a determination of whether we are getting a bargain or paying too much. Charlie begins by figuring out what an entire company is selling for, by multiplying the share price by the number of shares outstanding. For example, a $6-per-share stock multiplied by 1 million shares outstanding equates to a market value for the whole company of $6 million. Then he asks himself what the company is worth as an economic entity from a long-term perspective. If the company is worth a lot more than its market valuation, it is a potential buy. If it is worth less, he gives it a pass, but if it has a “durable competitive advantage,” he will keep an eye on it in the hope that at some future date it will be selling at a bargain price or even a fair price. Finding a business with a durable competitive advantage means determining whether it has staying power. If we are going to buy and hold a company for twenty years, we don’t want the product it is selling to become obsolete in year five. A great number of Berkshire’s investments have been in companies that have manufactured the same product or provided the same service for fifty or more years. In fact, most of the wonderful businesses that Charlie and Warren own—such as the Coca-Cola Company, Wells Fargo Bank, American Express, Swiss Re, Wrigley’s Gum, Kraft Foods, and even Anheuser Busch before it was bought out—have been selling the same product or service for more than a hundred years! When it comes to the truly great businesses, time is almost always on the investor’s side.  

  • As a hamburger rises in price, so does the price of the shares of the company that sells the hamburger. Inflation raises the prices of both commodities and assets, and shares in a company represent ownership in the company’s assets. Inflation is the friend of people who own assets. Inflation is also the enemy of the people who own cash or bonds. Why? When the Federal Reserve prints money and circulates it into the economy, interest rates go down. This drives up the prices of financial assets such as stocks and real estate. But the Fed’s printing of more money also means that our dollars buy less and less, which means that things cost more and more. Fifty years ago a hamburger cost $0.40, now it costs $7; and a house that cost $50,000 in 1965 now costs $500,000; and the Dow Jones Industrial Average, which stood at 910 points in 1965, now stands at 17,000. If you hang on to cash, it will buy less and less every year. If you bought twenty-year bonds in 1996 and cashed them in 2016, the cash you got back bought less than it did when you bought the bonds. Inflation really helps the banking and insurance industries. Since that $50,000 house is now a $500,000 house, people have to borrow $450,000 more from the bank. And there will be a hell of a lot more bank fees for a loan that size than for a $50,000 loan. The property insurance company is also going to earn a whole lot more on insuring a $500,000 property than it ever earned insuring our $50,000 property. In the example above, both the bank and the insurance company saw inflation cause a 1,000% rise in business, but neither institution had to add any more employees or increase the size of its operating plant. Now you know why Charlie and Warren are so big on insurance companies and banks: not only are they the perfect hedge against inflation, they actually benefit from it. For banks and insurance companies, inflation truly is the gift that keeps on giving.

  • The one thing that all of Berkshire’s businesses have in common is that they are managed by people who are willing to go to great lengths to keep costs low. That goes for Berkshire’s home office as well—it doesn’t have a public relations or investor services department, and for many years the annual report was printed on the cheapest paper possible and had no expensive color photos. (Note: In recent years the paper quality has improved and the annual report now sports one color photo—which may be a sign that management is starting to slip.)

  • “There are two kinds of businesses: The first earns 12%, and you can take it out at the end of the year. The second earns 12%, but all the excess cash must be reinvested—there’s never any cash. It reminds me of the guy who looks at all of his equipment and says, ‘There’s all of my profit.’ We hate that kind of business.”

  • Early in Charlie’s career as an investor he got involved in a high-tech business that was manufacturing sophisticated measuring devices for science. The company had good sales, but every dollar it earned had to go right back into the business. Luckily for Charlie, he sold the company right before the technology changed and rendered the company’s product obsolete. He had the same experience with Berkshire’s textile business: in good times it made money, even created a small surplus, but as time went on the textile business became so competitive that every dollar the company made had to be spent trying to keep the business afloat. Charlie had the exact opposite experience with See’s Candies—the pots that hold the chocolate were fifty years old and still didn’t need replacing, and the product was the same year after year. The business required very little in capital expenditures, so it was possible to take money out of it every year to invest in other businesses.

  • “The difference between a good business and a bad business is that good businesses throw up one easy decision after another. The bad businesses throw up painful decisions time after time.” – A lifetime of investing and owning companies has taught Charlie and Warren many lessons. They have both owned a few bad businesses in their day: a department store, a windmill manufacturer, a textile factory, and an airline. Why are those businesses bad? Because they are involved in intensely competitive industries that beat each other up over price, which brings their profit margins down, kills their cash flow, and diminishes their chances of long-term survivability. But Charlie and Warren’s education in misery has been our gain. Now we know that the secret is always to go with the better business that has a durable competitive advantage and can raise prices at will. This allows it to keep its margins high, which creates lots of free cash flow to spend on new business opportunities.

  • “I try to get rid of people who always confidently answer questions about which they don’t have any real knowledge.” – The problem here is one of trust. If people don’t have the integrity to admit when they don’t know something, how can one ever trust them? It is much better to jettison such a person and find someone with a bit more intellectual honesty. Again, Charlie shows that he is as interested in knowing what is unknown as in knowing what is known. The opinion of someone who can’t tell the difference is useless.