“Abraham Lincoln once posed the question: “If you call a dog’s tail a leg, how many legs does it have?” and then answered his own query: “Four, because calling a tail a leg doesn’t make it one.” Abe would have felt lonely on Wall Street.”
-Warren Buffett, Berkshire Hathaway shareholder letter 2018
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 by clicking the link at the end of this article.
Below are some of Warren’s highlighted thoughts, featured in italics, that I found particularly entertaining and interesting with some of my own commentary.
“For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice. The fact is that the annual change in Berkshire’s book value — which makes its farewell appearance on page 2 — is a metric that has lost the relevance it once had. Three circumstances have made that so … That combination causes the book-value scorecard to become increasingly out of touch with economic reality.”
Valuing companies on a metric like price to book value can often be misleading and sometimes outright useless. Buffett briefly mentions the three reasons this has become the case for Berkshire, noting the failure of accounting for certain items and share repurchases. Accounting conventions require a whole host of assets to be valued at book value, which may be materially different than market or economic value. Share repurchases can shrink book value, but allow remaining shareholders to retain a bigger portion of the same pie. Maybe more important is the subtle aspect that he is noting: simple metrics such as book value or price to book value are not in themselves very useful to score the true value of a company. Investing is just not that simple. As Buffett later mentions in the letter, the prime goal in his opinion is “to buy ably-managed businesses, in whole or part, that possess favourable and durable economic characteristics. We also need to make these purchases at sensible prices.” In my opinion, the penultimate consideration here is the assessment of favourable and durable economic characteristics.
“Over the years, Charlie and I have seen all sorts of bad corporate behaviour, both accounting and operational, induced by the desire of management to meet Wall Street expectations. What starts as an ‘innocent’ fudge in order to not disappoint “‘he Street’ — say, trade-loading at quarter-end, turning a blind eye to rising insurance losses, or drawing down a ‘cookie-jar’ reserve — can become the first step towards full-fledged fraud. Playing with the numbers ‘just this once’ may well be the CEO’s intent; it’s seldom the end result.”
Buffett hits on a very important aspect in life and investing. Show me how you get paid and I’ll show you what you think, what you’ll do, and what your opinion is. Incentives matter … a lot. Throughout my life I cannot count the times I have come across people, businesses, or groups whose very ethos is dictated by biases and cognitive blindness solely attributed to personal incentives. Therefore, incentive schemes and structures are so vital to driving correct results and, or, actions. It also, unfortunately, is a massive contributor to unethical corporate cultures, or stubborn ignorance. For some, unfortunately, it is tough to see the big picture in an ethical or moral sense if that picture doesn’t align with what they need to do get paid.
Micro Over Macro
“Charlie and I do not view the $172.8 billion detailed above as a collection of ticker symbols — a financial dalliance to be terminated because of downgrades by ‘the Street,’ expected Federal Reserve actions, possible political developments, forecasts by economists or whatever else might be the subject du jour.”
If your style of investing is that in which you own a smaller set of concentrated equity positions, then micro tends to be far more important than the macro considerations. What individual companies you own and their operational performance metrics over time will be far more important than 4th quarter GDP, Federal Reserve pontifications or butter production statistics in Bangladesh (unless you’re a butter company in Bangladesh). I am constantly amazed how much focus is given to some of these macro elements when discussing a portfolio of securities, which success or failure has more to do with the micro constructs of the individual businesses or the industry they operate in. I think it may be easier for many to talk about political machinations rather than the competitive dynamics associated with certain business models or industries. Micro business characteristics and economic moats can be more challenging to understand, but far more important if you’re not running a macro trading fund.
American Tailwind“Those who regularly preach doom because of government budget deficits (as I regularly did myself for many years) might note that our country’s national debt has increased roughly 400-fold during the last of my 77-year periods. That’s 40,000 per cent! Suppose you had foreseen this increase and panicked at the prospect of runaway deficits and a worthless currency. To ‘protect’ yourself, you might have eschewed stocks and opted instead to buy 31/4 ounces of gold with your $114.75. And what would that supposed protection have delivered? You would now have an asset worth about $4,200, less than 1 per cent of what would have been realised from a simple unmanaged investment in American business. The magical metal was no match for the American mettle.”
The last few pages of the later are maybe the most interesting given the tone of optimism, and not so much on the disparaging comments on gold. Betting against the advancement of society and the evolution of mankind has been a horrible strategy. So is being pedantically negative or having a track record of attempting to stifle change. Being insular, defensive and sclerotic is a losing strategy. A growth mindset, in my opinion, is far superior. I have always admired American culture for their propensity to innovate and fail. The future success of nations, companies or individuals will be predicted to a large extent on their flexibility, resourcefulness and resilience.
• Berkshire Hathaway shareholder letters: http://www.berkshirehathaway.com/letters/letters.html
• Nathan Kowalski CPA, CA, CFA, CIM is the Chief Financial Officer of Anchor Investment Management Ltd. and can be contacted at email@example.com Disclaimer: The sole responsibility for the content of this article, lies with the author. It does not necessarily reflect the opinion, policy or position of Anchor Investment Management Ltd. The content of this article 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 or for any other purpose. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable. They are not necessarily all-inclusive, are not guaranteed as to accuracy and are current only at the time written. 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 professional financial advisers prior to any investment decision. The author may own securities discussed in this article. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. The author respects the intellectual property rights of others. Trade mark or copyright claims should be directed to the author by e-mail.