Reading the Letter to Partners of Buffett Partnership 18 Jan 1965

In 1964, the overall result for the Buffett Partnership was plus 27.8% compared to an overall plus 18.7% for the Dow. The advantage of 9.1% on a partnership basis were the poorest since 1959.

Buffett's opinion for 2 largest open-end funds and 2 largest close-end investment companies underperform the Dow, an unmanaged index:

1. group decision - my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions;
2. a desire to conform to the policies and (to an extent) the portfolios of other large well-regarded organizations;
3. an institutional framework whereby average is "safe" and the personal rewards for independent action are in no way commensurate with the general risk attached to such action;
4. an adherence to certain diversification practices which are irrational; and finally and importantly
5. inertia.

Buffett's view of conservatism:
It is unquestionably true that the investment companies have their money more conventionally invested than we do. To many people conventionally is indistinguishable from conservatism. In my view, this represents erroneous thinking. Neither a conventional nor an unconventional approach, per se, is conservative. Truly conservative actions arise from intelligent hypotheses, correct facts and sound reasoning. These qualities may lead to conventional acts, but there have been many times when they have led to unorthodoxy. We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don't. A public opinion poll is no substitute for thought. When we really sit back with a smile on our face is when we run into a situation we can understand, where the facts are ascertainable and clear, and the course of action obvious. In that case - whether conventional or unconventional - whether others agree or disagree - we feel we are progressing in a conservative manner.

According to Buffett, to achieve an outstanding investment results, you need:

1. A long life, and
2. A high compound rate

Buffett's advice to newcomer of stock investment:
If a 20% or 30% drop in the market value of your equity holdings is going to produce emotional and financial distress, you should simply avoid common stock type investments.

Buffett's opinion on seeking third party for money management:
Any investment manager, whether operating as broker, investment counselor, trust department, investment company, etc., should be willing to state unequivocally what he is going to attempt to accomplish and how he proposes to measure the extent to which he gets the job done.

In "Our Method of Operations" section, Buffett added a new category known as "Generals - Relatively Undervalued", totally four categories. Below is the description of two categories of "Generals":

1. "Generals - Private Owner Basis" - a category of generally undervalued stocks, determined by quantitative standards, but with considerable attention also paid to the qualitative factor. There is often little or nothing to indicate immediate market improvement. The issues lack of glamour or market sponsorship. Their main qualification is a bargain price; that is, an overall valuation of the enterprise substantially below what careful analyzes indicates its value to a private owner to be. Many times in this category we have the desirable "two strings to our box" situation where we should either achieve appreciation of market prices from external factors or from the acquisition of controlling position in a business at a bargain price. While the former happens in the overwhelming majority of cases, the latter represents an insurance policy most investment operations don't have.
2. "Generals - Relatively Undervalued" - this category consists of securities selling at price relatively cheap compared to securities of the same general quality. We demand substantial discrepancies from current valuation standards, but (usually because of large size) do not feel value to a private owner to be a meaningful concept. We have recently begun to implement a technique which gives promise of very substantially reducing the risk from an overall change in valuation standards; e.g., we buy something at 12 times earnings when comparable or poorer quality companies sell at 20 times earnings, but then a major revaluation takes place so the latter only sell at 10 times.

Buffett's additional comments about "Controls": Controls in the buying stage move largely in sympathy with the Dow. In the later stages their behavior is geared more to that of workouts.

In my opinion, below is how the equity interests evolves over a period of time:

Generals - Relatively Undervalued (Minority Interest) -> Generals - Private Owner Basis (Largest Shareholder) -> Controls (Controlling Interest)

I'd love to hear your comments as usual.