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Lessons For Executives From Warren Buffett’s Company Letters

lessons for executives buffett berkshire hathaway letters

Warren Buffett is the most distinguished investor in existence today. Often ranking somewhere in the top 4 of the Forbes 100 list through a large ownership stake in the Berkshire Hathaway company, we can assume that he knows a thing or two about business. Within the book “The Essays of Warren Buffett: Lessons For Corporate America“, we receive a first-hand account of the way Warren Buffett perceives the responsibilities of corporate management. Buffett presents as a remarkably lucid investor and businessman. He frequently offer rational, yet strangely simple insights into how a business should be run. Below are the most interesting arguments I have found within the book:

#1: Management’s first priority is to the company’s shareholders.

The actual owners of the company are the shareholders. Management is entrusted to execute business plans that create more value by the owners. If management is recklessly wasting resources, they are a detriment to the company. Management should be held accountable for achieving business results. If they are unable to effectively operate with the hand they’re dealt, they should be removed. The best companies to invest in, are the ones with managers who have this priority in mind.

#2: Franchise value is what really counts.

While achieving business results are important, they should not come at the cost of franchise value. For example, you can raise the prices of your product or service by 20% this year and enjoy momentarily increased profits. It will look good on paper but by doing so, you could harm your brand’s value and destroy good relations you may have with any of your customer base. Some people might leave and never come back. They might tell their friends and family not to associate with your business. It’s a huge mistake to sacrifice your long-term brand to achieve short-term objectives. The reputation of the business is important to maintain.

#3: Bigger doesn’t mean better.

Just because a company has consistently increasing revenues, doesn’t mean that it’s a great company. If the business’s cost structure grows at the same rate that revenues do, then the company itself is never creating true growth. While increased revenues for a company might look good for the managers who can claim they have increased sales by x%, the more holistic look would be to check how operating profits have changed for the better.

If a company has a great business segment that is operating efficiently, management may also deal with a ‘corporate imperative’ to rationalize a dive into a new venture with their net profits. It would be very easy to create a rationale on how a new project will add value to the company but Buffett’s take is that the claims are often larger than the reality. Managers should critically evaluate the extent that new business projects will create true additional value for the company. If there are simple alternatives such as share buybacks or even distributing dividends, these actions would be preferable to speculative, ego-driven projects.

#4: Be discerning of who you associate with.

Having someone who is merely smart on your team is not enough. There are plenty of intelligent people out there. It is much more rare to find an intelligent person who is energetic and ethical. According to Buffett, if someone isn’t ethical, you may as well forget about intelligent or energetic. If you’re going to work with someone, you should make sure their first concern is doing the right thing, otherwise you run the risk of them making poor decisions on your behalf. Finally, life itself is enhanced along with the quality of our business matters when working with people we admire, like and trust.

#5: Focus on business economics, not business accounting.

Many managers become understandably focused with the “bottom-line” results of the work that they complete. Some executives may engage in accounting schemes to cover up their business mishaps.For example, selling a profitable business unit to maintain the image that a company is continually bringing in profits every quarter, even at the cost of long-term potential is a terrible move. Some executives may shy away from decisions that would look poor on paper but great in reality. If a company is losing money and requires more cash to make the appropriate investments into itself, keeping a high dividend rate for historical reasons makes no sense. The real focus should not be on how the business’s numbers would look on paper but on how the business is doing in reality. That type of focus will lead to profitable long-term results.

#6: Master your emotions.

This was a strong lesson implicitly resonating throughout the book. Buffett shows that its not just intelligence that matters for investors and business people but our ability to control emotions is a huge factor in our success. Greed can cause executives to overstate business success rather than showing reality. Fear can cause people to take actions that harms the business brand, employee morale, etc. If we can’t get past the discomfort of going against the crowd, then we can fall into group-think and make the same blunders that other people make. Our ability to think rationally and not let our pride get in the way is of the utmost importance. If we are unable to effectively control our emotions, we are bound for radical errors.

Compound Interest Explained Simply

compound interest explained simply

Compound interest is a term that many have heard often but is rarely well understood. The definition on wikipedia is as listed:

Compound interest – is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest.

Well, that sounds almost simple – the money you make, will make even more money in the future. But what exactly does that mean in practical terms? This may be where most of the confusion comes in from.

Compounding effect

In the above tables, we can see an assumption of different interest rates. These interest rates are tested on the growth of just $1 over different decades. What we’ll find is that the one dollar will grow to about $1.96 to $2.59, about double growth in 10 years for 7-10% interest rates. But by the 20th year, the growth is even higher, ranging from $3.86 – $6.72. The most astounding realization is that by the 40th year the dollar becomes $14.97 – $45.25, a 15 to 45 times return.

In effect, we can learn multiple lessons from this short example:

  • For every dollar we spend, we are not just losing only a dollar but we are losing all the future potential growth that the dollar would bring.
  • The amount of time that the dollar has to grow will have a huge impact. The difference between a dollar thats been invested for 20 years (at $3.86) and 40 years (at $14.97) is extreme. It’s better by a long-shot to have money to invest as early as possible than getting started later.
  • Small differences in interest rate assumptions can have a huge impact. Meaning if you are being charged large fees such as the financial industry’s normal of 1%, it can have a huge effect on your long-term gains. Thus, it is important that you assess whether there is a true premium of investment return if others manage your money vs investing the money into index funds.

There is also another large implication as a result of these calculations. If we know that the money can grow by a large amount, even with conservative expectations in long-term growth, then we shouldn’t fret over not being able to grow the “money fast enough”. For many, 7-10% growth per year sounds unexciting and even unreasonable. Why invest if we’re not going to go for the stars while doing so? The problem is that aiming for incredibly high returns is likely to increase the chance of risk as well.

Gains needed

If you look at the above table, there is an assumption that you could start out with $10 and take an 8% return for a comparatively small 80 cents that year. Sounds unexciting right?

Some may feel tempted to aim for much more in their returns. Let’s assume this person took a huge risk and as a result, they take a substantial loss, ranging from 10-50%. That would represent $5 (50% loss) to $9 (10% loss). Now this person will have to achieve incredibly high returns to even achieve the same 8% growth as the relatively conservative investor. This can become a losing cycle because to achieve such high returns in many cases would require high risk bets, which can cause further losses. To avoid such psychologically dire situations, it would have been better to start off relatively conservative from the beginning. Even one major loss after years of relatively strong growth can cause the investment portfolio to do worse than it should have.

If we know in the long-term there will be truly high gains (despite seemingly small returns in the short-term), it will be easier to feel peace of mind as we pursue our goals. It might seem boring to some but it is a better alternative to risky strategies that are unnecessary to achieve long-term goals that most pursue in their life such as retirement.

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it. ” – Albert Einstein

 

When Is The Chase Sapphire Card Worth It?

 

chase sapphire reserve card worth

When you’re making a bit of dough, you may feel inclined to go traveling and try experiencing some of the finer things in life. Banks understand this, which is why credit cards exist that are completely based on giving you rewards for spending on traveling and dining. Trying to figure out which travel rewards credit card is best, I stumbled upon an analysis on Nerdwallet about which credit card is better, the Chase Sapphire Reserve card or the Chase Preferred card.

In the analysis, we learn that although the Chase Sapphire Preferred card charges $95 a year while the Chase Sapphire Reserve card charges $450 a year, you would have to spend $467 more on the Chase Sapphire Preferred card to break even on your costs. The Chase Sapphire Reserve card had better benefits overall, which is why I will be using it as a point of comparison for the rest of this post. The analysis was useful to see but I had two problems with how things were analyzed, which I touch upon below.

Problem 1: The analysis was focused on the break-even point for when the cards became profitable to use. However, looking at break-even that way didn’t make sense to me. The analysis should have considered the break-even point including the opportunity cost of using a regular no-fee credit card that offers 1% cash back. When you’re making purchases on dining/travel, you are losing an opportunity to make 1% back on those purchases and because of that, the cost of buying with a 1% card should be included in your calculations. I’ll explain this more later where I’ll be comparing the benefits of using the Chase Sapphire Reserve card vs the Chase Freedom Unlimited card which actually offers 1.5% cashback and has no fees.

Problem 2: The other concern I had was how much I would have to be spending on travel and dining already to justify getting the Chase Sapphire Reserve card in the first place. When using credit cards, you are ideally saving more money than you are losing. However, when you have credit cards, you may be incentivized to spend more than you should be. This incentivized spending is problematic. If your original intent was to save money by getting these credit card rewards, then it defeats the purpose of you using your credit card if you end up spending more overall anyway. This led to the question: “At what point is the Chase Sapphire Reserve card worth the $450 annual fee, without having to make changes to your lifestyle?”.

Let’s examine the policies of the Chase Sapphire Reserve card (we ignore the sign-up bonus because we are examining the long-term viability of owning the card, not only seeking short-term benefits):

Annual Fee: $450

Reward Points: 3 points per $1 spent on travel and dining and 1 point per $1 spent on everything else. 1.5 cents apiece when redeemed for travel through Chase Ultimate Rewards. Assuming each point is worth one cent in cash-back value, then you’re getting 3% back for travel and dining purchases. If you redeem through ultimate rewards, you receive an extra 50% value from your purchase, becoming a possible 4.5% back.

Annual Credit For Travel Expenses: You receive $300 automatically applied to travel spending.

Other Perks: Transfer Points: 1:1 transfer points between partners. Unlimited access to more than 900 airport lounges worldwide through Priority Pass Select. Up to $100 reimbursement every four years for Global Entry or TSA PreCheck application fees charged to your card.

Automatically, we learn quite a bit about the bare-minimum kind of lifestyle we should have to justify the cost of getting this card.

Break-Even Conditions for Spending on Chase Sapphire Reserve Card:

  • $300 travel credit means you’re expected to already be traveling for more than $300 a year.
  • The remaining $150 must be made up in points, which means you must be spending total $5000 a year on travel/dining, assuming 3 points per dollar.

So just to make nothing from your Chase Sapphire Reserve Card, you would have to be spending $5000 on travel and dining. What if we had spent 5000 on Chase’s Freedom Unlimited Card offering 1.5% cash back? You would get back $75. Doesn’t seem worth it to get a reserve card now. Why get a travel rewards card if it doesn’t really reward you.

Let’s try doubling spending for the year to $10,000. We find that the chase freedom unlimited card would get you $150, while your chase sapphire reserve would finally hit break-even for $150 as well. Ultimately, you would have to spend over $10k a year on travel and dining for the chase sapphire reserve to make sense over freedom unlimited.

Now let’s assume you were interested in redeeming your Chase Sapphire Reserve points at 50% more for only travel expenses. You would have to be spending over $5000 a year on travel for the chase sapphire reserve card to make sense over the chase freedom unlimited.

Our findings show that unless you’re already spending $10k a year on travel and dining, or $5k a year on travel alone through chase’s partners, then it doesn’t make sense to get the Chase Sapphire Reserve card. You could factor in the ability to transfer points between other institutions but that means to make this card viable for the long-term, you would need to be ready to spend dozens of hours hunting for deals every year. There are perks such as having access to airport lounges and the relative prestige of having the Chase Sapphire Reserve card, but unless you meet the spending conditions, the card is a drain on your resources. Hope this was helpful.