Don't Lose Money

I came across the transcript for the most recent press conference held by Warren Buffett and Charlie Munger following the Berkshire Hathaway annual meeting from a couple of weeks ago. It's amazing the little pearls of wisdom that come out their mouths even when they're answering somewhat simplistic questions from the general press. This is why I'm not afraid to call myself a Buffett and Munger "junkie".

One "pearl" was what Buffett says here (the first part I've heard him talk about numerous times but it was the last sentence that really struck a chord with me):

During the Internet boom, I gave an exam to a class, with but a single question. That is, describe an Internet company, and then tell me what it's worth. Anyone who gave an answer flunked. That's the problem in high tech -- a few will profit, but a lot will have problems, and it's hard to see who does what in advance. We know that Snickers bars will still be sold and do well in 10 years. That doesn't make candy a better business; it's just that we know who the winner is.

"That doesn't make candy a better business; it's just that we know who the winner is."

I believe this is the most underrated part of the whole Buffett philosophy for wealth generation. Buffett has mentioned in passing many times that there are 2 rules in investing:

1. Never lose money.
2. Never forget rule #1.

Buffett also has clearly stated in the past that he only focuses on companies within his "Circle of Competence". His circle is clearly defined for him and one of the main parts of that circle is his requirement that he have the highest CONVICTION of estimating the future cashflows of the particular business he's interested in. These companies just happen to be in businesses that have some sort of a long term competitive advantage and that CONSISTENTLY grow cash flows and thus earnings over time.

Over the next 10 years, there will be certain businesses that will do better (and many much better) than what a company like Wrigley's will do. But how can one know for certain which they will be? The obvious answer is that no one can truly know. One could say the same about Wrigley's then no? Well, that is true. However, the ODDS of Wrigley still doing what they're doing 10 years from now and doing it well are fairly high. Can one say the same thing of say a company like Google or Yahoo!?

When someone is able to identify great businesses that are not likely to change much over the long-term, the analysis becomes easier. The higher one's comfort level in estimating the future cash flows of a company, the more the analysis becomes comparable to the valuation of a bond where the cashflows are written right into the contract. And the lower the price paid for those future cash flows, the better the return.

Most businesses will have future cash flows that are just too difficult to estimate. These will end up in what Buffett calls the "Too Hard" basket.

So in summary, the number one rule is to not lose money. This is paramount in the goal of maximizing compounding over time.