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When to Change Vessels: Buffett's Wisdom on Leaving Sinking Businesses

By sagebytes —

Warren Buffett's Investment Best Practices: Lessons from 1985 Letter

Based on Warren Buffett's 1985 letter to Berkshire Hathaway shareholders, here are the key investment principles and best practices he advocates:

Business Fundamentals

  1. Focus on business economics, not market movements: The best managerial record is more a function of "what business boat you get into" than how effectively you row.
  2. Avoid commodity businesses: Industries with poor fundamental economics (like textiles) will struggle regardless of management quality. As Buffett noted, "When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact."
  3. Look for high returns on invested capital: Seek businesses that can grow while requiring minimal additional capital investment. The best businesses generate significant earnings without needing proportional capital reinvestment.

Valuation Principles

  1. Buy at a significant discount to intrinsic value: Buffett's Washington Post purchase exemplifies buying excellent businesses at 25% of their underlying business value.
  2. Intrinsic value trumps book value or replacement cost: The auction of textile equipment demonstrated how book value and replacement cost can be misleading. Economic goodwill is far more valuable than tangible assets.
  3. Be patient: For Capital Cities/ABC, Buffett acknowledged that economics would be "unexciting over the next few years" but this bothered him "not an iota" as Berkshire "can be very patient."

Management Assessment

  1. Partner with exceptional managers: Seek honest, shareholder-oriented managers with demonstrated skill. Buffett praised exceptional managers at Washington Post, Capital Cities, and Scott & Fetzer.
  2. Prefer managers who think like owners: Avoid situations where management focuses on short-term results or their own compensation at shareholders' expense.
  3. Watch management capital allocation decisions: Even in difficult businesses, judge management by how they deploy capital—whether they reinvest in low-return projects or return capital to shareholders.

Investment Approach

  1. Be rational when others are not: Buffett benefited from academic theories that taught "thinking is a waste of energy" in stock selection.
  2. Have a long-term perspective: Berkshire doesn't worry about quarterly figures and focuses on actions that maximize long-term value.
  3. Act decisively when opportunities arise: On Scott & Fetzer, Buffett wrote: "We have no master strategy... we simply hope that something sensible comes along—and, when it does, we act."
  4. Admit and learn from mistakes: Buffett acknowledged his mistakes in the textile business and insurance reserving, emphasizing that "the trick is to learn most lessons from the experiences of others."