This post is a continuation in a series on portfolio management and the Buffett Partnership Letters. Please refer to the initial post in this series for more details.
Volatility
“…widespread public belief in the inevitability of profits from invest in stocks will led to eventual trouble…prices, not intrinsic value in my opinion, of even undervalued securities can be expected to be substantially affected.”
Price does not always equal intrinsic value, and the resulting impact is volatility due to price, not intrinsic value, movement. Unlike some value investors today, Buffett (especially in the Partnership days) never ignored volatility because he recognized the impact of this phenomenon on his performance return stream. Instead, he anticipated sources of possible price volatility and stood with cash or “work-outs” ready to deploy in case price, not intrinsic value, declined. Please see the 1957 Part 1 and 1957 Part 2 commentary for more details on “work-outs.”
Diversification, Liquidity, Catalyst, Activism
“Commonwealth only had about 300 stockholders and probably averaged two trades or so per month…”
“Over a period of a year or so, we were successful in obtaining about 12% of the bank at a price averaging about $51 per share…our block of stock increased in value as its size grew, particularly after we became the second largest stockholder with sufficient voting power to warrant consultation on any merger proposal.”
“This new situation is somewhat larger than Commonwealth and represents about 25% of the assets of the various partnerships. While the degree of undervaluation is no greater than in many other securities we own…we are the largest stockholder and this has substantial advantages many times in determining the length of time required to correct the undervaluation.”
“To the extent possible…I am attempting to create my own work-outs by acquiring large positions in several undervalued securities.”
Not surprisingly, Buffett was never one to preach the merits of diversification or liquidity, even in the pre-Berkshire days when he did not have permanent capital. (Side Note: At the 2012 DJCO Shareholders’ Meeting, Charlie Munger stated that the Volcker Rule would actually improve the markets by decreasing trading liquidity.) He seemed unafraid of liquidity constraints created by little/no trading activity, holding 12% of total shares outstanding of a company, or making a single position 25% of portfolio NAV.
In the Partnership days, Buffett conducted some degree of shareholder activism (this was to change down the road). In certain instances, he held the belief that the value of a holding increased once a large enough stake was accumulated due to the intangible control premium and higher potential to create your own catalyst, thereby controlling the expected annualized return.