It is never a waste of time to read Warren Buffett’s letter to stockholders in the Berkshire Hathaway annual report. Published last month, the report suggests to me that the “Oracle of Omaha” should probably be added to Mount Rushmore when the time comes.
The letter coincides with the release of the HBO documentary “Becoming Warren Buffett,” which traces the life of this extraordinary man from his days as a child who had a paper route with 500 customers.
The documentary is interspersed with ancient 8 mm home movies of his childhood, including the hearse that was his personal car in high school. We also see snippets of Buffett’s life today, at age 86, as he conducts, for example, a high school class on investing. Talk about being down to earth.
Another endearing trait of Buffett’s is his lack of hesitation when it comes to pointing out his mistakes. One self-described “egregious error” was when he bought Dexter Shoes for $434 million and watched it drop to zero. “It gets worse,” he adds, because he paid for Dexter using Berkshire Hathaway stock. Those shares would now be worth more than $6 billion.
Having learned a lesson, Berkshire always pays cash for the businesses it buys, since Buffett “would rather prepare for a colonoscopy than part with Berkshire shares.” What makes the letter so readable is the total lack of self-aggrandizement that we’ve seen too much of lately from those of the tycoon persuasion.
The early days of Berkshire Hathaway involved an exercise of value-based stock picking, but today, owning stocks is a much smaller percentage of total holdings. Instead, the company buys other companies outright and assembles them in what is essentially a private equity company. The primary difference is in the holding period.
Berkshire is under no pressure to sell, because its own stock is for sale on the open market. There, investors are free to take their chips off the table anytime. Private equity firms, by comparison, are usually operating pools of money that have a specific time period — a beginning and an end — and a commitment on the part of their pension and endowment fund clients to remain invested, with limited opportunities for a “drawdown.”
The performance of private investments and public company share prices often are inversely correlated — meaning that when one investment medium is “hot” the other can be relatively cold. Having both in a pension fund creates diversification between the two ownership types and reduces risk.
As an example, in the stock market euphoria of the 1990s, newspaper headlines declared that “Warren Buffett doesn’t get It. He refuses to invest in tech!” In fact, the price of one of Berkshire’s shares at the time languished around $35,000. We all know who got the last laugh. While those original Berkshire “A” shares now sell for $265,000, one share of the newer so-called “B” shares can be had for a few hundred dollars. It offers what amounts to a private equity fund for the little guy.
The last third of the 30-page letter covers investment basics, including the famous million-dollar bet that a collection of hedge funds would not outperform a simple 500 index fund over a 10-year period, after fees. Time’s up, and Buffett has won hands down. He is quick to credit John Bogle, Vanguard’s founder and the champion of index funds, for the value Bogle has brought to the investing public.
The most encouraging news in the annual report is the optimism expressed by Berkshire’s founder. He points out that American business, as reflected in the value of stocks, is certain to be worth far more in the years ahead thanks to the inexorable rise of innovation, productivity gains, entrepreneurial spirit and abundance of capital.
We should expect market declines and even occasional panics, but widespread fear is your friend as an investor, because that’s when stocks can be a bargain.
Personal fear, on the other hand, is your enemy. It will prompt you to do something rash instead of just sitting patiently on a collection of conservative American businesses that will serve you well sooner or later.