Buffett Letter: 1962 semi-annual 2

Semi-annual 2

Buffett likes clarity. Supreme clarity. He even proposes axioms for his investors in this letter.
He says his performance needs to be bench marked against the index Dow in this case. If he does better than the Dow they will be pleased if not he 'deserves tomatoes'.
5 year test for performance is what is preferable to him. 3 years is minimum.
Reiterates he is not in the business of predicting stock market.
He makes 3 promises to his investors

Investments will be based on value and not popularity
Risk of permanent capital loss will be minimized though there will be quotational losses. This he will achieve by having a margin of safety in his investments.
He has skin in the game because his family's networth is invested in this fund.

He makes an 'unscientific' opinion by saying that 10% alpha over Dow over a 10 year period is the maximum one can achieve.
One of the greatest point he makes again: Dow is no pushover as an index of investment achievement.
Buffett gives an anecdote on 'The Joys of Compounding' (reminds me of the book by this name by Gautam Baid a professional fund manager). He gives an example of compounding over centuries at 4%. Then puts is his typical humorous fashion as 'Such fanciful geometric progressions illustrate the value of either living a long time, or compounding your money at a decent rate. I have nothing particularly helpful to say on the former point.'
Just like the previous years in 1961 he lays out his 3 types of portfolios

Generals - Consisting of undervalues securities. Here he has large positions as a percentage to portfolio 5% to 10%. These investments sometimes work out fast and sometimes takes years. He holds 10-15 stocks in this category. Buffett is willing to leave something on the table and is not going after the last nickel in these investments. He makes an important point 'The generals tend to behave market-wise very much in sympathy with the Dow. Just because something is cheap does not mean it is not going to go down'.
Workouts - These are special situations in which certain corporate situations will unlock value. Not something which I am interested in personally. This is his second largest category. He could have 5 to 10 positions in this category.
Controls - These are where Buffett will take control of the company by being a major stockholder. He will unlock value by steering the workings of the company. Again something which I am not interested in. Sometimes a General ends up becoming a Control type of situation.

Buffett goes back to the Dempster example. He says when control of a company is gained the value of the assets of the company becomes all important and not the market quotation of a 'piece of paper' (share certificate).
In this case he gives the actual workings of how to apply appropriate discounts to the assets of the company.

This is the cornerstone of our investment philosophy: “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. The better sales will be the frosting on the cake.”
Conscious, perhaps overly conscious, of inflation, many people now feel that they are behaving in a conservative manner by buying blue chip securities almost regardless of price-earnings ratios, dividend yields, etc.
There is nothing at all conservative, in my opinion, about speculating as to just how high a multiplier a greedy and capricious public will put on earnings.
You wont be right simply because a large number of people momentarily agree with you. You wont be right simply because important people agree with you. In many quarters the simultaneous occurrence of the two above factors is enough two make a course of action meet the test of conservatism.
You will be right, over the course of many transactions, if your hypotheses are correct, your facts are correct, and your reasoning is correct. True conservatism is only possible through knowledge and reason.
He again says that in down markets is what will separate men from the boys.
Buffett says that compounding at a moderate pace is important but more important is the length.
His core focus is to pile on advantages to the Dow and continue doing so for as long as possible.

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