Warren Buffett: Risk, Volatility and Farmland

Warren Buffett (Trades, Portfolio) does not associate volatility with risk. This has been part of his investment strategy since the beginning and he will never change.

Volatility and risk are separate things. An unstable stock market does not necessarily mean that the company is riskier than any other company and vice versa.

Indeed, I think that a large percentage of small-cap companies with low market shares are probably the least volatile stocks in the market, but that does not make them any less risky. Overall, these are probably the most risky companies.

Buffett's favorite way of describing the difference between risk and volatility is his farm analogy. He likes to say that you do not buy a farm based on whether it will be worth more or less tomorrow or in a week. You buy it as a business – for the cash flow that it will generate.

At the 2007 Berkshire Hathaway (NYSE: BRK.A) shareholders meeting (NYSE: BRK.B), Buffett told his investors:

"I mean, in fact, take that with farmland.Here, in 1980, or the early 1980s, farms sold at $ 2,000 an acre were expensive at $ 600 an acre. I bought one during the collapse of banks and the farm. "

However, according to market theory, this fall in prices implies that farmland is more risky:

"And the beta of holdings has risen sharply and, according to standard economic theory or market theory, I was buying a much riskier asset at $ 600 an acre than the same farm did. was 2,000 acre. "

But, since farmland prices are not posted publicly second-by-second, most homeowners would think that this concept is crazy and certainly not worth all the time and effort spent analyzing the beta :

"Now, people, because farmland does not trade often and prices are not registered, you know, they would consider it nonsense that my purchase at $ 600 an acre of the same farm that it's sold at 2,000 acres a few years ago was more risky. "

Unfortunately, the same can not be said of the actions:

"But in stocks, because prices fluctuate every minute, and because that allows finance teachers to use the mathematics they 've learned, they have – in fact, they' ll have it. would explain a little more technically – but they have, in fact, reflected volatility in all kinds of – past volatility – in terms of all kinds of risk measures. "

According to Buffett, this type of risk analysis is nonsense, and you could argue that investors are plunged into a false sense of security when it comes to analyzing the risks. company specific:

"The risks come from the nature of certain types of businesses. It can be risky to be in some companies simply because of the economic characteristics of the type of business in which you are, and this comes from the fact that you do not know what you are doing.

And, you know, if you understand the economics of the business in which you are engaged, if you know the people you are dealing with and if you know that the price you pay is reasonable, you do not run at all. real risk. . "

I'm sure many readers of this article will already know and understand the difference between risk and volatility, but it's still worth going back to the Buffett archives to remember what he said on the subject.

It's never worth it to go back over old tips and use the knowledge you already know. Compiling such an essential financial concept is never a waste of time.

Disclosure: The author owns shares in Berkshire Hathaway.

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