10 lessons in Warren Buffett's 2015 shareholders letter
Guest post by Coftea
I have been hearing great things about how Warren Buffett, one of the greatest investor of our times writes his shareholder letters. Often, they are mentioned as well written, thoughtful and loaded with sound investment advices. With succinct quotes such as be “fearful when others are greedy and to be greedy only when others are fearful” and “rule no.1 is not to lose money and rule no. 2 is not to forget rule no.1”, I have the feeling that he is also quite a humorous guy. My curiosity had finally overwhelmed me and I decided to read Berkshire Hathaway’s 2014 shareholder letter, on a quest for inspirations.
Facts of Berkshire Hathaway are always astonishing no matter how many times I come across them. For the uninitiated, it is a conglomerate that owns many businesses such as railways, insurance, private jets, fast food chain and has significant shares in American Express, Coca Cola, IBM and Heinz. According to the latest Forbes Global 2000, it is the largest corporation in United States, ranked 5th in the world, with one class ‘A’ share costing > USD200k. So yeah, the money for a premium continental car can only get you 1 share in this company that holds more than 20 billion in cash reserves. It has a 21.6% compounded annual gain in market value over the past 49 years (versus 9.9% in S&P 500), in which a $1000 invested in 1965 becomes $11.9mil in 2014. The power of compounding compounded with an investing genius produces mind blowing results.
- Always try to own wonderful businesses
- Amortization is subjective to the industry a company operates in
- Depreciation is real
- Making mistakes is unavoidable, but make sure the same mistake never happens again
- Don’t be afraid of making a loss to fund a more valuable purchase
- Investing in stocks protects our money in the long run
- Investing is only as risky as the investor’s behavior
- Tune out the noise, no one can predict the market
- Don’t put off a company which doesn’t give dividends
- AGM can be fun The last lesson for me is that I never knew a AGM can be so fun-filled. There are cowboys on horses, Newspaper Tossing challenge with Mr Buffett himself, table tennis with participation from Mr Gates and one thing many seemed to enjoy, shopping! Yes, shop with attractive shareholder’s discounts. Being a conglomerate that owns a multitude of companies, Mr Buffett unabashedly make it known that that “yes, we also try to sell our visiting shareholders our products while they’re here”. What a great way to market your products and drive up sales! And in true spirits to finding value, to avoid the plane and hotel price hikes due to Berkshire’s AGM, Mr Buffett also recommended taking an alternative route to fly in to Kansas and rent a car to Omaha, by which a shareholder could save more than $1000. So save some money, spend them at the discounted merchandises, busk in the activities and listen to genuine investing principles. What a AGM.
At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business. It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone.Hope Diamond, also known as the King’s Jewel is the world's most famous diamond weighing at 45.52 carats. Rhinestone, on the other hand, is usually used to make crystals that imitate diamonds. Hence, owning 1% of Hope Diamond is much more valuable than having 100% of a Rhinestone. As normal investors, we do not purchase a business entirely, but we do buy ourselves a small portion of a business once we made that trade. Nibbling (as the wise AK calls it) into excellent business at a higher price can be better than going all out at an okay, more affordable business. Now that we can accumulate 100 shares with SGX, price should be the last criteria we consider.
..serious investors should understand the disparate nature of intangible assets. Some truly deplete over time, while others in no way lose value. For software, as a big example, amortization charges are very real expenses. The concept of making charges against other intangibles, such as the amortization of customer relationships, however, arises through purchase-accounting rules and clearly does not reflect reality."Amortization in this context is similar to depreciation, but is applied to intangible assets. On top of customer relationships, other examples include Intellectual Property (IP), Trademarks, Franchises and Goodwills. A business can own certain intangibles that differentiates itself from competition and it doesn’t make a lot of sense to expense its competitive advantage. Thus, for businesses which possess these characteristics, we might find that their intrinsic earnings may be higher than what is reported on paper.
Depreciation charges, we want to emphasize, are different: Every dime of depreciation expense we report is a real cost. That’s true, moreover, at most other companies. When CEOs tout EBITDA as a valuation guide, wire them up for a polygraph test.Oh, so EBITDA is all a lie!? As opposed to amortization, depreciation of tangible assets is a tangible (real) expense. Examples of these assets are land, buildings, machineries and vehicles. Land may be more tricky due to complexities in land valuation, but physical assets like machineries and vehicles have limited lifetime. They must be replaced at some point of time and money must be expensed to continue business operations.
Fortunately, my blunders normally involved relatively small acquisitions. Our large buys have generally worked out well and, in a few cases, more than well. I have not, nonetheless, made my last mistake in purchasing either businesses or stocks. Not everything works out as planned.Life is about growing from our own mistakes. Our investment methodologies may fail us from time to time, but don’t be discouraged, even the best makes them. If we have a sound strategy, the right things we do should outweigh those done wrongly and most importantly, as we learn from our mistakes, we improve and will do more of the right things.
We sold Tesco shares throughout the year and are now out of the position. (The company, we should mention, has hired new management, and we wish them well.) Our after-tax loss from this investment was $444 million, about 1/5 of 1% of Berkshire’s net worth. In the past 50 years, we have only once realized an investment loss that at the time of sale cost us 2% of our net worth. Twice, we experienced 1% losses. All three of these losses occurred in the 1974-1975 period, when we sold stocks that were very cheap in order to buy others we believed to be even cheaper.I often hear people holding on to companies that aren’t performing well with hopes that they could turnaround. Some just shrugged it off as only a book value loss. Holding on is acceptable as long as the business foundation is still solid, but I guess a significant part of the reason is that we dread selling off our investments at a loss. We must however, be aware of the opportunity cost when our money is locked in these investments, and be constantly on a lookout for better ones out there. Moving on to a better investment could just make the losses seem insignificant.
During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196% shown on page 2. Concurrently, the purchasing power of the dollar declined a staggering 87%. That decrease means that it now takes $1 to buy what could be bought for 13¢ in 1965 (as measured by the Consumer Price Index).This point emphasizes the importance of investing and not let our money lose value. The money in our bank does nothing and generates interest that couldn’t beat inflation. The money we put in a diversified portfolio grows with the economy and if one day we were to cash out, we get an amount equivalent to its market value. It is thus further noted in the letter that over long term, currency-denominated instruments such as treasury bills or certificates are much more riskier investments than stocks. I highly doubt that we can still get a decent plate of chicken rice at 3 bucks 10 years down the road.
Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy.Investing in stocks is often framed for being risky, volatile and unpredictable. It causes financial woes to individuals and families who has ‘burned their hands’ in the stock market. A knife on a chef’s hands creates delicacies, but becomes a murder weapon on the hands of a killer. A tool is only as good as the person using it. The ability to invest in stocks is a formidable tool for building wealth on someone who does not speculate and use leverage.
Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.The 13 May 2015 piece of the always insightful Take Stock, by Motley’s Fool David Kuo gave a very concrete example of not listening to market pundits. In essence, when oil prices plummet towards the end of 2014, gloomy markets were predicted. And when oil prices rebounded, did the market celebrate? No, problems of high oil prices took over. Therefore, unless you are a trader, it is extremely important to discern and filter out the incessant noises that happen everyday. No matter how good the hedge fund manager or the investment guru have performed, no one can predict the future. We need to have more confidence in what our understanding, methodologies and belief.
Not surprisingly, the A shares – owned by relatively few shareholders, each with a large economic interest – voted “no” on the dividend question by a margin of 89 to 1. The remarkable vote was that of our B shareholders. They number in the hundreds of thousands – perhaps even totaling one million – and they voted 660,759,855 “no” and 13,927,026 “yes,” a ratio of about 47 to 1. Our directors recommended a “no” vote but the company did not otherwise attempt to influence shareholders. Nevertheless, 98% of the shares voting said, in effect, “Don’t send us a dividend but instead reinvest all of the earnings.”Dividends are great. We get payouts for being passive owners in a company. It is also very popular to use dividend yield as an indicator when we screen stocks. But we must know that dividends are paid out using cash which a growing company can put to better use - setting up new offices, upgrading machineries, increasing marketing outreach or developing new products drive businesses. Look at how far Berkshire has went without distributing dividends, so don’t focus too much on dividend yield if you are into growth companies. Try to look past the attractive short term benefits.
Berkshire's AGM attracts a huge turnout every year with attendees from all over the world
Wall Street Journal
Coftea
If you have benefited from this post, support our first business venture at snackfirst.com or like us on Facebook!
%2B(6).JPG)
Great summary. Thanks for sharing.
ReplyDeleteHi Lizardo,
DeleteDon't mind me for taking so long but I just want to say it's my pleasure to share :)