Martin Lee @ Sg
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Berkshire Hathaway 2011 Annual Meeting

The Berkshire Hathaway annual meeting takes place tomorrow.

During the meeting, Warren Buffett and his long time partner Charlie Munger, will take questions for a solid five hours. No questions are off-limits other than on what Buffett is buying or selling.

For a sneak preview, you can refer to this 2-hr question and answer session that Warren Buffett had with Maryland’s MBA students in March this year.

I would also like to share with you this short writeup on “Life and Debt” extracted from Warren Buffett’s annual letters to shareholders this year.

It talks about why Warren is very cautious with respect to using leverage, and also the importance of always having cash on standby. It is having this kind of reserves that enabled Berkshire to rapidly invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008. And with good effect.

Life and Debt

The fundamental principle of auto racing is that to finish first, you must first finish. That dictum is equally applicable to business and guides our every action at Berkshire.

Unquestionably, some people have become very rich through the use of borrowed money. However, that’s also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you’re clever, and your neighbors get envious. But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices.

And as we all learned in third grade – and some relearned in 2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.

Leverage, of course, can be lethal to businesses as well. Companies with large debts often assume that these obligations can be refinanced as they mature. That assumption is usually valid. Occasionally, though, either because of company specific problems or a worldwide shortage of credit, maturities must actually be met by payment. For that, only cash will do the job.

Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that’s all that is noticed. Even a short absence of credit can bring a company to its knees. In September 2008, in fact, its overnight disappearance in many sectors of the economy came dangerously close to bringing our entire country to its knees.

Leave a Comment:

Musicwhiz says 10 years ago

It’s the old-fashioned way versus the gaudy, appealing nature of speculation. Which will win in the end? Slow and steady wins the race as I always believe, and I practice what I preach too.

TravelKid says 10 years ago

Well said. This is a good word of caution on borrowing money by Warren Buffett. Beware when you read Robert Kiyosaki (of Rich Dad Poor Dad) books on using leverage to be rich.

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