The Berkshire Hathaway’s annual shareholder letter has always been a special event for this writer as I continue to be a devout follower of Warren Buffett. Warren is not shy to admit his mistakes, offer timeless wisdom on investing and remind us all of the positive and beneficial nature of markets. No summary can really do justice to his insights and witty writing, so I would urge you to take some time and read the originals, if you have not done so already. The letters can be found in their entirety at the link provided in the sources section following this article. Below are some of Warren’s highlighted thoughts that I found particularly entertaining and interesting with some of my own commentary.
Acquisitions & an Investment Formula
“In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price.”
This simple five-part formula used to purchase companies is music to our ears. The first part refers to what is often categorised as a moat. A moat refers to a company’s ability to defend itself from competition and thus persist against forms of new entrants or current market participants. A high moat company can earn persistent and attractive rates of return for long periods of time. As a result, assuming management does not squander this gift, high returns on investments can compound unfettered.
Buffett’s comment on a sensible purchase price is also key. The purchase price is truly the only thing an investor controls. As a result, investors should be obsessively focused on ensuring the price paid is reasonable. In doing so it dramatically lowers the odds of a permanent impairment in capital. You really make money when you buy right and not when you sell.
Incentives and Biases
“Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.”
When it comes to deals or, in fact, many aspects in life, incentives matter. Show me how someone gets paid or show me what interest someone has in an action and I will tell you their opinion. Vested interests and self-serving biases perpetuate almost everything in life.
This doesn’t mean one needs to be jaded and hyper-sceptical about everything but it does suggest we should always take a minute to consider the other side and where they are coming from. In some endeavours it’s important to be cautious and really try to understand the opinions of others before you are led astray. As Warren says: “The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.”
How to Think of Stock Investments
“Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their ‘chart’ patterns, the ‘target’ prices of analysts or the opinions of media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well. Sometimes the payoffs to us will be modest; occasionally the cash register will ring loudly. And sometimes I will make expensive mistakes … Stocks surge and swoon, seemingly untethered to any year-to-year build-up in their underlying value. Over time, however, Ben Graham’s oft-quoted maxim proves true: ‘In the short run, the market is a voting machine; in the long run, however, it becomes a weighing machine’.”
It today’s market of high-frequency trading, swing trading, day-trading and low commissions, long-term thinking and patient investing seems to be becoming a contrarian field. Flipping cryptocurrencies offers a much higher dopamine rush than buying a company like Google and watching it compound wealth for decades.
Trying to get rich quick seems to be far more fun to many than actually getting slowly rich over time. We do not see stocks as ticker symbols - to us they are businesses and we are part owners. To us finding excellent companies is difficult but once you do find them it is best to stick with them and enjoy compounding your capital over time. Even the best companies plunge in price. In the latest report, Warren displays a table of four period’s where Berkshire’s stock price plunged more than 35 per cent. The key to sticking with investments is the confidence that comes with understanding them. To quote Warren: “Stick with big, ‘easy’ decisions and eschew activity”.
Temperament Matters More than Intelligence
“Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period — or even to look foolish — is also essential.”
In my profession, unfortunately, many believe that “getting it right” means you are smart, and “getting it wrong” means you are dumb. Investment outcomes, however, often hinge more so on one’s emotional intelligence and ability to remain unbiased. More emphasis, in my opinion, should be placed on the process conducted by managers and their ultimate philosophy (and the ability to stick with it) then selected periods of outcomes. Just ask all the team of PhDs and Nobel winners with complex models that used to run Long Term Capital (which failed in spectacular fashion).
Risk is Never eliminated, it is Simply Transformed
“Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date. “Risk” is the possibility that this objective won’t be attained … It is a terrible mistake for investors with long-term horizons — among them, pension funds, college endowments and savings-minded individuals — to measure their investment “risk” by their portfolio’s ratio of bonds to stocks. Often, high-grade bonds in an investment portfolio increase its risk.”
Nick Murray in Simple Wealth, Inevitable Wealth said: “There is no such thing as no risk. There is only the choice of what risk, and when to risk it”.
This jives with Warren’s comments. For example, one could choose to take no risk today only to find out they are at risk of not having enough money when they go to retire. Or one could take no risk once retired and find they have outlived their money. Sometimes investments like government bonds have unperceived risks that are not so obvious. For a portfolio there is more risks to consider than just short term volatility.
Berkshire Hathaway Shareholder Letters: http://www.berkshirehathaway.com/letters/letters.html
Simple Wealth, Inevitable Wealth, revised edition by Nick Murray: https://www.amazon.com/Simple-Wealth-Inevitable-Financial-Advisor/dp/0966976312
Nathan Kowalski CPA, CA, CFA, CIM is the Chief Financial Officer of Anchor Investment Management Ltd and the views expressed are his own. The author can be contacted at firstname.lastname@example.org
Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Index performance is shown for illustrative purposes only. You cannot invest directly in an index