Some more thoughts on Warren Buffett letter to shareholders

It would be incomplete and bias of me if I don't tell you this. My yesterday entry mentioned that there are some subtle changes in Warren Buffett's strategies. He diversify a bit and taking smaller size bets but his old habit of taking a big swing is still there. I choose to highlight first - he takes smaller swings on high payout bets but inherently higher risks of certain business, country, currency, management, and etc - will determine the size of his bet. Most of the retail players, including myself, taking far more larger size in relation to investable fund for riskier bets but under weight safer bets. We tend to misquote Warren Buffett or abuse his strategy. With that I hope my points are getting across now. I also hope I manage to unfreeze your mind. Let's go back to his famous focus investing strategy.

When he sees good opportunity of business that will be around for decades like oil, food or transportattion, he will take a big swing. In 2007, he has about $ 1 billion stake in Conoco Phillips but in 2006 he put in another $ 6 billion, tally to $ 7 billion. Unfortunately $ 7 billion at cost left him with $ 4 billion market value. There is no doubt he is sucking his thumbs now but I believe based on 10 billion BOE proved reserve alone will provide him a lot of margin of safety. At US $ 40/barrel crude oil, market capitalization/market oil of proved reserve = 52/400 = $ 0.13 which is very cheap. We are buying a dollar with US $ 0.13!!! [ Click here if you are interested to know on how dirt cheap are resource-based companies]

This is a good lesson that I picked up. Like most value investors, we tend to anchor our purchase price based on the intrinsic value that we derrived from the business. It is very cheap fundmentally but Mr. Market is still willing to sell his business far cheaper than we can imagine. Technical group on the other hand tends to anchor their purchse based on past prices. They sometimes forget that peak of old price was selling at the extreme valuation. For Shanghai Composite Index to go back to 6,000 plus will take a number of years. Both approaches have its shortcoming.

In 2007, he took an elephant size of US $ 4 billion position in Kraft Food. He lost 20% as at 31 Dec 2008 but I do not think this is going to wipe out his US $ 4 billion inventment in the long run. Yes we may buy lesser or cut on premium products that we used to pampered ourselves but we are still going to eat.

I really do not know what he did with his organization, it is seems like people work for him has exceptionally high quality of lending or underwriting discipline. All players in sub-prime mortgage already bled to death but this guy is still rocking and rolling.

One of his companies Clayton is in the business of lending to people in the sub-prime category. Their customers have median FICO score of 644 vs. a national of 723 but what is interesting is this, 35% of them are below 620. Yet the unit turned in $ 1 billion pretax in 2007 and $ 700 million plus last year. The major difference is they lend it to people who needed a house and will keep a home and not going for a quick flip. Thus they are able to escape the carnage of sliding house prices. This is basic lending 101, a lesson that I will remember well when evaluating banking stocks.