Berkshire Hathaway’s Buffett Imparts Investing Wisdom In Shareholders’ Letter

Warren Buffett, the ‘Sage of Omaha’, is widely regarded as the most successful investor of modern times, primarily because of his consistent record in outperforming the major market indices. Just take the performance of the ‘Class A’ stock, which as of this Friday (March 3) closed at the dizzying height of US$263,160 a pop.

Berkshire Hathaway’s gain in net worth during 2016 was $27.5 billion (bn), which increased the per-share book value of their ‘Class A’ and ‘Class B’ stock by 10.7%.

Over the last 52 years – since 1964 – when Buffett wrote his first letter to Berkshire’s shareholders, the per-share book value of the company had grown from $19 to $172,108 as stated in the latest annual report for 2016, which contains Mr Buffett’s latest annual letter to shareholders.

This represented a rate of 19% compounded annually – for Berkshire Hathaway’s ‘A’ shares – and around double the performance of the S&P 500 (with dividends included) of 9.7% over the period between 1964 to 2016.

The overall gain of Berkshire’s per-share book value in that time was an incredible 884,319% (1,972,595% in Berkshire’s Per-Share market value) and compared to 12,717% for the S&P 500. It should be noted that  figures for the B shares are 1/1500th of those shown for the A shares in 2016’s annual report.

According to the Forbes Global 2000 list and formula, Berkshire Hathaway is the fourth largest public company in the world behind China’s ICBC, China Construction, and Agricultural Bank of China, and the largest conglomerate in the world.

The Berkshire Hathaway investment vehicle holds not just stakes in publicly quoted companies but a wide range of wholly owned operating companies and Buffett’s net worth has been put at $78.7bn as of March 2017.

Berkshire Hathaway chairman Warren Buffett attending the ‘Becoming Warren Buffett’ World Premiere on January 19, 2017, at The Museum of Modern Art in New York City. (Photo: Jamie McCarthy/Getty Images).

After 52 years at the helm there are as usual some pithy comments to be found in the latest edition of his annual letter to investors. But let’s just track back to comments made two years ago contained in the company’s 2014 annual report to get a flavour for some of that pithiness and some of the highlights.

Past Mistakes & Truths

Buffett is pretty open about his past mistakes and often talks about the original history of Berkshire, which was a US cloth mill that traces its origins to textile manufacturing company established in 1839 in Valley Falls, Rhode Island, as the Valley Falls Company.

The business under Berkshire Hathaway was wound down after failing to compete with low cost foreign producers and in 1985 the last textile operations – Hathaway’s historic core – were shut down.

It was in October 2010 that Buffett had in fact claimed that acquiring Berkshire Hathaway was the biggest investment mistake he had ever made, claiming that it had denied him compounded investment returns of around $200bn over a period of 45 years.

He stated in his letter to shareholders from 2014’s annual report that: “I’ve mentioned in the past that my experience in business helps me as an investor and that my experience has made me a better businessman”.

Add to that: “Some truths can only be learned through experience”. The clear message here is that if one wants to be a really good stock market investor – even though he has pointed out he does not make stock recommendations – it helps to have some experience of actually running companies.

Another failure he has mentioned is his former investment in Tesco, the UK supermarkets group. He had owned 415 million (m) shares at a cost of $2.3bn as at the end of 2012. The following year he sold some shares in having “soured somewhat on the company’s then management” and made a small profit.

However, he admitted that his “leisurely pace in making sales would prove expensive”. So it did. While he sold shares in Tesco across 2014 and exited completely from the position, he ended up losing $444m. But put in perspective that equated to just 0.2% of Berkshire’s worth. So small fry in the grand scheme of things.

Depreciation & Amortization

He has commented too in recent years on the issue of depreciation and amortization of balance sheet items under U.S. GAAP (generally accepted accounting principles). Yet he emphasized in 2015 that depreciation charges are different – they are a real cost and that is true of most companies. He said for instance: “When CEO’s tout EBITDA as a valuation guide, wire them up to a polygraph test”.

Business Schools & Teaching

Bemoaning the teaching of business schools that volatility can be used as a proxy for risk, he has said: “Volatility is far from synonymous with risk” and “Popular formulas that equate the two terms leads students, investors and CEOs astray”.

And, he warned too that investors through their own behaviour can make stock ownership highly risky. Active trading, attempting to time market movements, poor diversification, high fees and borrowing money can jeopardize and destroy returns.

Business Acquisitions & Marriage

So what wise words are contained in this year’s edition. Well, in his chairman’s letter within the latest annual report (2016), which runs to 28 pages out of the 130-odd page document, he referred to business acquisitions and marriage in the same sentence.

He states: “As is the case in marriage, business acquisitions often deliver surprises after the ‘I do’s.’ I’ve made some dumb purchases, paying far too much for the economic goodwill of companies we acquired.”

And added: “That later led to goodwill write-offs and to consequent reductions in Berkshire’s book value. We’ve also had some winners among the businesses we’ve purchased – a few of the winners very big – but have not written those up by a penny.”

Buffett noted that “we have no quarrel with the asymmetrical accounting that applies here”, but said that over time it necessarily widens the gap between Berkshire’s intrinsic value and its book value.

“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold.” So when downpours like this happen, Buffett asserted that “it’s imperative that we rush outdoors carrying washtubs, not teaspoons.” And, speaking for myself one has to wonder if the current market bullishness on equity markets is a real question for concern and investors need to watch out.

On a page sub-headed ‘What We Hope To Accomplish’ to the 2016 report, in referring to a “cautious approach” and a gradual shift from a company that derives most of its gains from investment activities to one which grows in value by owning businesses mention is made to “one particularly egregious error” through the acquisition of Dexter Shoe for $434m back in 1993.

The value of that company went to zero, but having used Berkshire stock (25,203 shares to be precise) to fund the purchase the securities would at the end of 2016 been worth over $6bn.

Making up for this faux pas or what he labelled “that folly”, in early 2000 Berkshire bought 76% (subsequently increased to 90%) of utility business MidAmerican Energy, which has delivered a number of large, “profitable and socially useful investment opportunities”. He stated directly after that in brackets to stress a point: “Today, I would rather prep for a colonoscopy than issue Berkshire shares.”

Succession

Two years ago Buffett signed of his the annual letter to shareholders by saying that he had chosen the ‘right’ CEO to succeed him, but did not disclose the name. However, his son Howard was to become the non-executive Chairman.

Warren Buffett is now 86 and his partner Charlie Munger, Berkshire’s Vice Chairman and Omaha-born Buffett’s partner is 93. But even two years ago succession was clearly on the chairman’s mind.

Aa always the Berkshire newsletter is worth reading for investment wisdom from the founder even now after fifty plus years.

Berkshire Hathaway’s 2016 annual report, which includes Buffett’s annual letter to shareholders as well as information about the company’s financial position and results of operations will be mailed to shareholders on or about March 15, 2017.

The annual shareholders meeting is scheduled to take place on Saturday, May 6, 2017, at the CenturyLink Center Omaha in downtown Omaha, Nebraska. Expect some tough questions to be asked there from shareholders (selected by a panel), which is just the way apparently that Buffett and Munger like it.

The latest letter to shareholders from Warren Buffett, which is contained in Berkshire Hathaway’s 2016 annual report, is available to read via the company’s website.

 

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