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A Hot Trend Warren Buffett Guarantees Will Continue

The National Weather Service says there’s virtually no chance the drought in California will end by spring. And yes, we should all care.

Specifically, there’s a 0.1% chance the state will receive enough rain to qualify as an “average” wet season.

But you know what else has a 0.1% chance of ever happening? You and me matching wits and investing prowess with Warren Buffett.

He’s arguably one of the best investors of all time – and as a result, one of the richest people in the world.

Of course, we’re still smart enough to learn a thing or two from him. And thankfully, he’s more than willing to teach us via his annual letter to shareholders of Berkshire Hathaway Inc. (BRK.B).

With that in mind, yesterday we began our rundown on the 10 most shocking and important revelations in his latest letter. It’s time to pick up right where we left off…

~Buffett Shocker #6: Bet on the Urge to Merge

In the last year, many of Berkshire’s subsidiaries engaged in a growth-via-acquisition strategy.

As Buffett writes, “Our many subsidiaries are regularly making bolt-on acquisitions. Last year, we contracted for 25 of these… These transactions ranged from $1.9 million to $1.1 billion in size.”

Notice the deal size? They’re all small caps.

More importantly, Buffett reveals that this urge to merge is guaranteed to continue. “Charlie and I encourage these deals… Many more of these bolt-on deals will be made in future years.”

If Buffett is encouraging and betting on more small-cap M&A activity in the future, we should, too.

~Buffett Shocker #7: Mistakes Happen, Plan Accordingly

Even the Oracle of Omaha gets it wrong!

When discussing his various investments in companies, Buffett reveals that a few “have very poor returns, a result of some serious mistakes I made in my job of capital allocation. I was not misled: I simply was wrong in my evaluation.”

Buffett also confesses that these mistakes won’t be his last: “I have not… made my last mistake in purchasing either businesses or stocks.”

The key takeaways for us?

First, plan on getting it wrong from time to time, and plan accordingly.

By that I mean, position size. As Buffett shares, his “serious mistakes” involved “relatively small” positions. Doing so is the only way to minimize the impact of our stupidity.

Second, be proactive about reducing the number of mistakes. Here, too, Buffett offers up timely advice: “Call Charlie.” That is, his partner, Charles Munger.

In other words, we shouldn’t be afraid to get a second opinion on any investments we’re considering.

And remember, as Buffett writes, “A business with terrific economics can be a bad investment if the purchase price is excessive.” So always insist on buying at attractive valuations.

Hint, these stocks don’t qualify: Tesla (TSLA), Amazon.com (AMZN), Facebook (FB), Netflix (NFLX) and Twitter (TWTR).

~Buffett Shocker #8: Live Debt-Free

Dave Ramsey is the king of encouraging debt-free living for consumers. I’m a believer, too. And so is Buffett, apparently.

He writes, “We will always maintain supreme financial strength, operating with at least $20 billion of cash equivalents and never incurring material amounts of short-term obligations.”

If we learned anything from the financial crisis, it’s that too much debt kills. Literally.

We’d be wise to mitigate that risk entirely by demonstrating some “supreme financial strength” of our own. Specifically, by paying off our debts and stockpiling some cash for emergencies (i.e., irresistible buying opportunities).

~Buffett Shocker #9: Bottom’s Up!

Too many people try to figure out what’s going on in the world before investing. Buffett offers up an alternative – ignore it!

When talking about two of his smartest investments, he writes (emphasis added), “What the economy, interest rates, or stock market might do in the years immediately following – 1987 and 1994 – was of no importance to me in making those investments… We have never foregone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions.”

Put simply, bottom-up analysis is the only thing that matters over the long run. We need to spend the majority of our time on it, instead of trying to discern the direction of countless macroeconomic variables.

~Buffett Shocker #10: Mute the TV

In reference to the talking heads, Buffett writes, “When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: ‘You don’t know how easy this game is until you get into that broadcasting booth.'”

Amen!

In turn, Buffett believes that listening to the predictions emanating from the boob tube is a “waste of time.” So mute CNBC – until Buffett, and occasionally yours truly, comes on, of course. (All right, at least when he comes on.)

If you’re even more courageous, go ahead and cancel your cable service completely.

That’s it for today. Rest assured, there’s much more wisdom to be gleaned from Buffett’s letter to shareholders. If you haven’t already, I encourage you to read it in its entirety. Afterwards, don’t be afraid to let us know what you found the most shocking, insightful, or useful by clicking here.

Ahead of the tape,

Louis Basenese