Long-time readers of the blog know that I’m a big fan of Warren Buffett and in full disclosure, I’m also a big investor in Berkshire Hathaway.
Each year, Buffett releases his annual letter to shareholders, capping-off the most important activities and information from the previous year at Berkshire Hathaway. As you might expect, I consider Buffett’s annual letter to be a must-read, not only for shareholders, but for anyone wanting to build wealth and achieve success. You can download a copy of this year’s shareholder letter here.
Each year, I summarize the salient points from Buffett’s report. What follows below, are my notes and insights from this year’s annual sharehholder’s letter:
Berkshire’s gain in net worth
Buffett always starts off his letters by quoting Berkshire’s gain in net worth from the previous year. This past year the gain was an astonishing 10.7%! That’s incredible for a 52 year old company. Since 1965, the annual gain in the S&P 500 was 9.7%. And what of Berkshire? Berkshire’s compounded annual gain since 1965 is an incredible… 19%.
The gap between intrinsic value and book value
Once again, Buffett reminds shareholders that the Berkshire’s intrinsic value far exceeds its book value due to the unrecorded gains in the businesses it has purchased. While accounting rules requires goodwill write-downs, there are no such rules for write-ups. Intelligent investors should pay attention here. Companies whose intrinsic value consistently exceeds its book value tend to make excellent investments. Indeed, Buffett had this to say: “Over time, stock prices gravitate toward intrinsic value.” Friends, there’s gold in those words. They embody the very essence of value investing. Just as you want to buy groceries, clothes, cars and houses at a good bargain, so do you want to buy stocks at a bargain to their intrinsic value.
Berkshire’s returns will always be lumpy. That’s good!
Whenever a newbie comes to looking at investing in Berkshire’s stock, they invariably make the remark along the lines of this – “Although the stock’s return over the decades has been great, there are some years that it has been down. If Buffett were such a genius, why have there been down years!”. Good question, albeit naive. The hundreds of businesses that make up Berkshire are primarily American businesses. So it stands to reason that when there are periodic weaknesses in the U.S. economy, so will Berkshire’s earnings decline. There’s an intangible benefit to this as well – it lets you know that Berkshire is real. In the real world, economies go up and down. Recessions and inflationary periods are normal. What’s not normal is perfection. Friends, when someone shows you a perfect investment trend line, with no down years, don’t walk away from that investment. Run away.
When others are fearful, Berkshire will be greedy
Berkshire is often criticized for not paying dividends. Indeed, it ranks first among American businesses in the dollar volume of earnings it retains. Yes, Berkshire sits on a ton of cash. A ton of cash that they could pay out to shareholders in the form of dividends, but don’t. But that’s a good thing. You see, when investment opportunities arise, like in the Great Recession of 2008, Berkshire has plenty of capital to put to work, while others are stuck with no capital to put to work, or worse they are going bankrupt. But not Berkshire. Buffett goes to work for you the most as a shareholder when there are dark times, precisely because Berkshire has that cash warchest available. Here’s what Buffett had to say about this: “Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.” See that huge surplus of cash as an advantage, not a disadvantage.
America is already great. Always has been. Always will be.
Buffett reminds us of the system (capital, brains, labor) that has been so instrumental in America’s success. And success we’ve had – “America’s economic achievements have led to staggering profits for stockholders. During the 20th century the Dow-Jones Industrials advanced from 66 to 11,497, a 17,320% capital gain that was materially boosted by steadily increasing dividends. The trend continues: By yearend 2016, the index had advanced a further 72%, to 19,763.” I know that doomsayers and people hoping to get elected, will often make mention of America’s problems (she has some, for sure), but this country unleashes human potential like no other. It creates more millionaires and billionaires than any other country. If you have the work ethic and patience, you can get rich. I should know. It allowed a poor kid from the country to escape poverty, amass millions and become financially free! 🙂 So, when someone is trying to sell you fear, remember Buffett’s words as they relate to investing: “First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.”
Share repurchases, good or bad? It depends.
With companies sitting on a record amount of cash, share repurchases have become a hot topic lately. Shareholders tend to love the idea of a company buying back its own stock, but few do the math to confirm whether or not it actually increases the value of their holdings or decreases it. Buffett reminds us that in many cases, it’s the latter: “It is puzzling, therefore, that corporate repurchase announcements almost never refer to a price above which repurchases will be eschewed. That certainly wouldn’t be the case if a management was buying an outside business. There, price would always factor into a buy-or-pass decision. When CEOs or boards are buying a small part of their own company, though, they all too often seem oblivious to price.” Price should always be the deciding factor when a company is repurchasing shares. More specifically, a company should only buy back shares when it believes its shares are undervalued. Otherwise, it’s a poor use of your funds as a shareholder.
Berkshire will continue to buy back shares
Buffett reminds us that he is authorized to buy back Berkshire shares when the shares are trading at 120% or less of book value. By his estimate, 1.2 times of book is a significant enough discount to warrant Berkshire buying back its own stock, something it has done (albeit only for a short while because the stock quickly bounced back), in the past. Savvy investors will however make note of this. I’m often asked if I have any concerns about Buffett retiring in the near future. My answer is always this – No, no and more no! There are several reasons why, but one major reason has to do with this mandate to buy shares back if they reach a certain level. Think thru this with me – On the day that Buffett announces that he’s retiring, the market will most likely trade Berkshire’s stock down due to its normal fear and perceived uncertainty. This is what markets do. However, remember this important fact about stocks – all things being equal, stocks go up when there’s more buying of that stock than selling and vice-versa. To that end, if Berkshire’s stock goes down materially on the day Buffett steps down, we know for a fact that there will be at least one huge buyer (any many smaller smart buyers) who will be buying Berkshire’s stock –Berkshire Hathaway itself! Now, with $86 billion with cash and equivalents to put to work (and even more when that time comes), that will give Berkshire an enormous amount of capital to use to buy back shares. What might all that buying of Berkshire’s stock do to Berkshire’s stock price? Hmmm. Friends, it’s important to think thru things. Most don’t when it comes to investing. They buy high and sell low, reacting to what they see happening in the news. I’ll repeat Buffett’s words again here, because they are so important: “First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. Remember, all investing is intelligent. Everything else is speculation.
With those words, I’m going to bring part one to a close. Please come back next week as I provide part two of my insights and thoughts from Warrren Buffett’s annual shareholder’s letter.
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