Investors Take Note: What Can We Learn From Warren Buffett's Annual Letter to Shareholders?

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Mar 04, 2018
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Investing, Research, Current Events, Article, Behavioral Finance, Index Funds

The Oracle of Omaha is out again with Berkshire Hathaway's (his holding company) Annual Letter to Shareholders. It has become a must read for all investors as it is full of that common sense wisdom that Warren has become known for. I have purposely not read any of the commentary in hopes of completing the task with a fresh set of eyes. Here's some of the key investment insights from these 16 pages: 

  • Why acquisitions (when one company buys another) often don't work out as planned and destroy value

Why the purchasing frenzy? In part, it’s because the CEO job self-selects for “can-do” types...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.

  • Don't borrow money to buy stocks (a.k.a. buying on margin):

Even with its amazing performance, Berkshire has suffered four major dips (see below).

  • The best investors are prepared for adversity and don't act out of fear: (from Kipling's If): 

“If you can keep your head when all about you are losing theirs . . . If you can wait and not be tired by waiting . . . If you can think – and not make thoughts your aim . . . If you can trust yourself when all men doubt you... Yours is the Earth and everything that’s in it.”

  • Passive investing (investing in an index fund) trumps active investing as this decade long bet that Buffett won bears out: The bet: An unmanaged S&P 500 fund could beat hedge funds made up of the "best investors" that money could buy...

"I made the bet for two reasons: (1) to leverage my outlay of $318,250 into a disproportionately larger sum that – if things turned out as I expected – would be distributed in early 2018 to Girls Inc. of Omaha; and (2) to publicize my conviction that my pick – a virtually cost-free investment in an unmanaged S&P 500 index fund – would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those “helpers” may be. Addressing this question is of enormous importance. American investors pay staggering sums annually to advisors, often incurring several layers of consequential costs. In the aggregate, do these investors get their money’s worth? Indeed, again in the aggregate, do investors get anything for their outlays?

The Results? The S&P 500's return of 125.8% over that period trounced every one of the high-cost "professionally managed" funds 

  • Fees matter: ""Performance comes, performance goes. Fees never falter."
  • Eschew activity (i.e., Don't Trade...he might not think so highly of the Stock Market Game): "Stick with big, “easy” decisions and eschew activity. During the ten-year bet, the 200-plus hedge-fund managers that were involved almost certainly made tens of thousands of buy and sell decisions. Most of those managers undoubtedly thought hard about their decisions, each of which they believed would prove advantageous. In the process of investing, they studied 10-Ks, interviewed managements, read trade journals and conferred with Wall Street analysts.

Other nuggets:

  • The amazing growth of Berkshire over the past 53 years: Compound annual growth in per-share market value of Berkshire Hathaway from 1965-2017: 20.9% annually or 2,404,748% over the full period!!! That compares with 9.9% annual growth and 15,508% for the S&P 500?  That was our Question of the Day today too!
  • Big benefits from tax code for Berkshire Hathaway; my guess is that it will largely be returned to shareholders through buybacks and dividends: $29 billion of their $65 billion in earnings came "when Congress rewrote the U.S. Tax Code."
  • What drives Berkshire's performance?: "There are four building blocks that add value to Berkshire: (1) sizable stand-alone acquisitions; (2) bolt-on acquisitions that fit with businesses we already own; (3) internal sales growth and margin improvement at our many and varied businesses; and (4) investment earnings from our huge portfolio of stocks and bonds."

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If you have made it this far, you deserve applause and your investment portfolio will thank you too. We have lots of great investing resources that teach many of these concepts

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.