Saturday, June 01, 2013

Don't "manage earnings." Instead, "build value."

I continue to get great insights out of the life of Warren Buffett.

One of Buffett's famous principles is the story of Mr. Market.  Here's an excerpt from his 1987 Berkshire Hathaway shareholder letter:
http://bit.ly/11jHDaG
"Without fail, Mr. Market appears daily and
names a price at which he will either buy your interest or sell
you his.
 

Even though the business that the two of you own may have
economic characteristics that are stable, Mr. Market's quotations
will be anything but.  For, sad to say, the poor fellow has
incurable emotional problems.  At times he feels euphoric and can
see only the favorable factors affecting the business.  When in
that mood, he names a very high buy-sell price because he fears
that you will snap up his interest and rob him of imminent gains. 
At other times he is depressed and can see nothing but trouble
ahead for both the business and the world.  On these occasions he
will name a very low price, since he is terrified that you will
unload your interest on him.

Mr. Market has another endearing characteristic: He doesn't
mind being ignored.  If his quotation is uninteresting to you
today, he will be back with a new one tomorrow.  Transactions are
strictly at your option.  Under these conditions, the more manic-
depressive his behavior, the better for you."
Buffett wanted his shareholders to take a long term view and focus on building value (in his case, "book value") rather than getting caught up in the latest Wall Street earnings release.

Some companies, like Coca-Cola, managed their earnings with accounting tricks to "make the numbers" (quite literally, in some cases!).  Even though Buffett owned Coca-Cola, his approach was to focus on increasing the long term value of Berkshire Hathaway, regardless of the short term somersaults of the market.

The same is true of startups.  Instead of quarterly earnings, you have board meetings.  But you should still resist managing earnings.  Instead, focus on building things of real value: A great product and happy customers.

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