C&B Notes

Buffett Ranks Investments

Warren Buffett makes his case for long-term equity investing and the right way to think about risk.  We share the same biases:

“Investing is often described as the process of laying out money now in the expectation of receiving more money in the future.  At Berkshire Hathaway we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power — after taxes have been paid on nominal gains — in the future.  More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability — the reasoned probability — of that investment causing its owner a loss of purchasing power over his contemplated holding period.  Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.  And as we will see, a nonfluctuating asset can be laden with risk.

Investment possibilities are both many and varied.  There are three major categories, however, and it’s important to understand the characteristics of each.

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My own preference — and you knew this was coming — is our third category: investment in productive assets, whether businesses, farms, or real estate.  Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.  Farms, real estate, and many businesses such as Coca-Cola, IBM, and our own See’s Candy meet that double-barreled test. Certain other companies — think of our regulated utilities, for example — fail it because inflation places heavy capital requirements on them.  To earn more, their owners must invest more.  Even so, these investments will remain superior to nonproductive or currency-based assets.”

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