The Buffett investment bible

I urge anyone with an interest in investing to read Warren Buffett's letter to Berkshire Hathaway's shareholders, published on February 25, and freely available on the company's website.

Foremost, it's a lesson to company executives and their investor relations advisers that you can communicate your financial performance to stakeholders in an easy-to-understand language, instead of the unfathomable slop we are dished out day after day by a number of local listed corporates.

For example, Buffett candidly explains that his substantial investment funds are sourced from his insurance businesses whichreceive premiums upfront and pay claims later.

This collect-now, pay-later model leaves his businesses holding large sums of money that he refers to as his "float". Eventually, these sums will be paid out to others, but not before he invests this float for Berkshire's benefit. Individual policies and claims come and go, but the amount of the float remains stable as the businesses grow.

Buffett regards his shareholders as partners and writes his chairman's statement as if he is conversing with them over a meal at a family function. He highlights his successes, but admits his errors.

A few years back he spent about $2-billion in bonds tied to the price of natural gas that he confesses was a big mistake. Shortly after he purchased the securities, the price of natural gas tanked and remains depressed. He acknowledges his miscalculation and compares his gaffe to an unforced error in tennis.

Caring for fellow shareholders is a matter Buffett and his lifelong business partner and friend, Charlie Munger, take seriously.

Last September, the two took a decision to buy back some of Berkshire's shares, believing the stock was trading at a material discount to its intrinsic value. Because the transaction would mean the sellers were cashing in at a cut-rate price, Buffett and Munger made a point of informing their exiting partners about the value of the assets they were offloading.

The shareholders' report reveals a lot about how Buffett and Munger value companies, with an obvious focus on earnings that will increase. They are happy when share prices languish while earnings are growing. This allows them the opportunity to build bigger stakes at effectively lower prices, although they acknowledge that their way of thinking doesn't win many converts.

They only invest in companies whose businesses they understand and lean towards high-quality operations with enduring competitive advantages. If you don't appreciate how a business earns its revenue, they argue, studying the financials won't provide any answers.

Buffett and Munger spurn complex financial models and claim that if you need a computer to decide on the merits of an investment, then it is best to walk away.

They advise youngsters to learn as much as they can about the world around them by reading newspapers and magazines and to absorb the teachings of investment giants such as Benjamin Graham and Phil Fisher, but they warn against the hazards of making use of equations with Greek letters in them.

Buffett remains optimistic about the outlook for the US economy and last year invested $8-billion in property, plant and equipment in the country. He believes demographics will soon restore the balance in the depressed housing market (living with in-laws, he writes, can quickly lose its allure). In turn that will lead to a drop in the unemployment rate as more residential units are built annually.

Buffett ends his letter with a survey of the three major categories of investment. Money market funds, bonds, mortgages and bank deposits are thought of as "safe", though he regards them as the most dangerous of assets.

Governments, he declares, determine the ultimate value of money and sometimes their policies spin out of control, producing inflation to the point where it now takes $7 to buy what $1 bought in 1965. The current low interest rates in money markets do not come close to offsetting the purchasing power risks that investors are assuming. Bonds, he counsels, should come with a warning label.

If Buffett is critical about the money markets, he is derisive about holding investments such as gold that will never produce anything, but are purchased in the hope that someone will pay more for them in future. Gold purchases are motivated by the belief that the ranks of the fearful will grow. Today, the world's gold stock is worth about $9.6-trillion, for which you could buy all the farmland in the US plus 16 Exxon Mobils (the world's largest company) and still have $1-trillion change.

A century from now the farmland would have produced a bounty of crops while Exxon Mobil would have delivered trillions of dollars in dividends.

Naturally, Buffett's preference is the third category, investing in productive assets, whether businesses, farms or real estate; assets that have the ability to deliver output that will retain its purchasing power value while requiring a minimum of new capital investment.

I am making plans to attend the Berkshire Hathaway annual meeting on May 5 in Omaha. It will be my seventh successive visit. Each year I attend I return wiser, but this year I hope to become more involved in the proceedings by participating in The Newspaper Tossing Challenge.

As a teenager, Buffett folded and delivered more than 500000 newspapers on his route in Omaha. This year, to commemorate the purchase of the newspaper he once delivered, he has challenged all comers to toss a copy of a local newspaper 35ft on to the porch of a mobile home. The prize? A Dairy Queen dilly bar.