Matt Franz : Zealous For Knowledge

John Templeton & Warren Buffett In 1985

I recently came across a 1985 interview with John Templeton and Warren Buffett. As usual with these two there was a lot of investing wisdom packed into a short conversation. Below are some of the notes I made while watching.

1. Location 

Templeton found that his performance improved when he moved from New York City to the Bahamas. Buffett says he’d be poorer if he lived in New York instead of Omaha.

Why? In investing you’re neither right because the crowd agrees with you nor wrong because the crowd disagrees with you. You’re right because your facts and thinking are correct. The most important thing is to have the right facts around and the time to think deeply about them. Even in 1985 you could get annual reports, news papers, and periodicals mailed to just about anywhere.

Guy Spier wrote about this in The Education Of A Value Investor. He was getting burned out living in New York. The culture there was encouraging him to think shorter term than he should be. He decided he would surround himself in the best environment possible for long-term value investing, which led him to move to Zurich. Zurich offered the benefits of an international financial hub and the serenity and solitude of the mountains.

2. Take The Long View

Templeton says that he is willing to estimate earnings power over longer periods of time than most. Buffett says that the test of whether you are investing is whether you would mind if the stock exchange closed for five years.

When you try to predict a stock price you need market data to validate you. But when you predict a business you only need its annual reports to know if you’re right. Business owners have confidence that over long periods of time the business will be correctly valued in the marketplace.

The only way to predict what a business will look like in several years is to understand it well enough to know the source of its earnings power. For example, is the company making high profits today because the particular commodity they sell is temporarily in short supply, or because they are the lowest cost producer of that commodity? Shortages of supply rarely last long but a low cost of production can endure.

If you read quarterly earnings conference call transcripts you’ll notice that 90%+ of the questions analysts ask are in the weeds. They’re trying to iron out the tiny details in their excel models they use to forecast next quarter’s earnings to the penny. What they miss in this exercise are the broad factors driving long term performance. These broad factors are the ones Templeton and Buffett focus on.

Most businesses don’t have a sustainable source of long-term earnings power. And you won’t be able to figure out many that do. This is okay. Unlike a professional analyst you aren’t required to have an opinion on every company. You only care about the ones you can understand. It’s not the size of your circle of competence that matters, it’s knowing the boundaries.

3. Focus On The Downside

Buffett says that the first rule is not to lose money and the second rule is not to forget the first. The reason Buffett focuses so much on the downside is simple math: any number times zero is zero. So any amount of prior success can be erased by a single failure. Digging out of a hole is also very difficult: it takes a 100% return after a 50% loss to get back to even.

So, how do you avoid losing money when you make an investment?

Buffett says: “If you buy things for far below what they’re worth and you buy a group of them you basically don’t lose money.”

If you know what something is worth and buy it for 33% less two things can happen:

  1. You’re right and the stock rises to its intrinsic value, where you sell. You make 50%.
  2. You’re wrong and discover that the intrinsic value is about 33% lower than you originally estimated. Once again you sell at intrinsic value. This time you approximately break even.

The purpose of a margin of safety is to increase profits when you’re right and decrease losses when you’re wrong. The more wrong you think you may be, the wider margin of safety necessary.

When you make several investments like this so that no single mistake will hurt you you’re unlikely to lose over the long run.

How do you buy companies with such a wide margin of safety? Templeton says to look where most investors are expecting bad news. At peak pessimism you get trough prices. By the time the bad news actually breaks the uncertainty is over and the markets are already repricing.

4. Figure Out What Works For You

After Templeton and Buffett there’s an interview with Robert Wilson. In many ways he is the opposite of Buffett and Templeton:

This sounds insane to me, but Wilson apparently amassed $800 million fortune which he largely donated. Without knowing more about him or his track record I can’t say if this philosophy worked or if his success was due to savvy marketing and high fees.

Regardless, his interview is a good reminder to figure out not just what works, but what works for you. Like Guy Spier, it’s a good exercise to think through what your ideal environment is. You don’t have to blindly accept your environment, you can chose it and shape it. This doesn’t necessarily mean moving from NYC to Zurich, the Bahamas, or Omaha. It can be as simple as keeping CNBC off at the office.

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