It’s a ritual which no Warren Buffett fan wants to miss – the annual letter accompanying the annual report of Berkshire Hathway Inc.
Every year, the letter which Buffett writes to his shareholders is waited with a lot of eagerness. Apart from getting a peek into where his vision for the future lay, it is a pleasure to read his thought process and understand better about investments. This year’s letter, which he wrote to Berkshire shareholders was like a refresher course for us investors. This 13-page document is a book in itself and as usual it had nuggets of wisdom, more valuable than gold.
Buffett might not have spelt out his successor but this time around, the letter does carry the message all across about his mortality and immortality of Berkshire. He says in the letter, “We continue … to hope for an elephant-sized acquisition. Even at our ages of 88 and 95 — I’m the young one — that prospect is what causes my heart and Charlie’s to beat faster. (Just writing about the possibility of a huge purchase has caused my pulse rate to soar.)” Maybe they both, Buffett and Charlie Munger want to complete this one big deal “before they leave” or its more about how Berkshire will continue to last irrespective of any huge acquisitions – the message which comes across is that Berkshire should be looked upon as a collection of investments and not just as an individual business. Buffett also spends time explain how Berkshire is different from the rest where it stays away from debt and sits pretty with a big pile of cash, almost $112 billion and how it is much better at accounting practices with a much long-term orientation. And of course, there is the usual extolling about the strength of the American economy, calling it the “American Tailwind” and how it keeps of growing and enriching all those who invest in it.
What we discern from this year’s annual letter is that Berkshire’s model of work is an automatic insurance against most of the vagaries of the economy and markets. This makes it better than an index fund - a big deal in a country that thrives on index funds.
On succession, last year the company put Ajit Jain in charge of its insurance activities and Greg Abel of its non-insurance operations. This year, in the letter, Buffett says, “Berkshire is now far better managed than when I alone was supervising operations. Ajit and Greg have rare talents, and Berkshire blood flows through their veins. These moves were overdue."
And a very important point by Buffett – he has done away with book value metric being the all –important indicator of success and growth. For almost 30 years, all his letters opened with talk about book value growth but this year, there is no mention. He says, “ Long-time readers of our annual reports will have spotted the different way in which I opened this letter. 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."
Buffett says that huge size of Berkshire’s $173 billion investment portfolio has made book value irrelevant as it is just a fraction of its overall assets, which are now weighted to operating businesses, led by insurance. Buffett argues that new accounting rules undervalue these operating businesses.
In the fourth quarter, Berkshire marked-to-market a loss of $25 billion in a span of 90-days. Berkshire's investment portfolio was marked down by $27 billion and it recorded a $3 billion impairment. Explaining this loss, Buffett said, “ Investors who evaluate Berkshire sometimes obsess on the details of our many and diverse businesses – our economic “trees,” so to speak. Analysis of that type can be mind-numbing, given that we own a vast array of specimens, ranging from twigs to redwoods. A few of our trees are diseased and unlikely to be around a decade from now. Many others, though, are destined to grow in size and beauty... Fortunately, it’s not necessary to evaluate each tree individually to make a rough estimate of Berkshire’s intrinsic business value. That’s because our forest contains five “groves” of major importance, each of which can be appraised, with reasonable accuracy, in its entirety."
A quick look at some of the nuggets of wisdom in this annual letter:
- Book value is a metric that has lost the relevance it once had.
- 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.
- If Charlie and I think an investee's stock is underpriced, we rejoice when management employs some of its earnings to increase Berkshire's ownership percentage.
- In managing, I will make expensive mistakes of commission and will also miss many opportunities, some of which should have been obvious to me. At times, our stock will tumble as investors flee from equities. But I will never risk getting caught short of cash.
- Truly good businesses are exceptionally hard to find. Selling any you are lucky enough to own makes no sense at all.
- At Berkshire, the whole is greater -- considerably greater -- than the sum of the parts.
- For 54 years our managerial decisions at Berkshire have been made from the viewpoint of the shareholders who are staying, not those who are leaving. Consequently, Charlie and I have never focused on current-quarter results.
- Playing with the numbers "just this once" may well be the CEO's intent; it's seldom the end result. And if it's okay for the boss to cheat a little, it's easy for subordinates to rationalize similar behavior.
- Disciplined risk evaluation is the daily focus of our insurance managers, who know that the benefits of float can be drowned by poor underwriting results.
- We use debt sparingly. Many managers, it should be noted, will disagree with this policy, arguing that significant debt juices the returns for equity owners. And these more venturesome CEOs will be right most of the time. At rare and unpredictable intervals, however, credit vanishes and debt becomes financially fatal.
- Rational people don't risk what they have and need for what they don't have and don't need.
- On occasion, a ridiculously high purchase price for a given stock will cause a splendid business to become a poor investment -- if not permanently, at least for a painfully long period. Over time, however, investment performance converges with business performance.
- For 54 years, Charlie and I have loved our jobs. Daily, we do what we find interesting, working with people we like and trust. And now our new management structure has made our lives even more enjoyable.
Great words of wisdowm. When you read this, you feel, that he has not said anything new which you did not know. And that’s the crux of investing – the simpler it is, the more money you will make. In fact if your investment is not simple, clearly, you are not investing right!