Saturday, March 5, 2016

Berkshire Hathaway: Come For The Returns, Stay For The Philosophy

The release of Berkshire Hathaway's annual letter to shareholders is always a wonderful opportunity to learn from Warren Buffett. As usual, the letter has already been picked over by the media and blogosphere, but I wanted to record some of my own thoughts. This post can be read in tandem with an older piece I did on Buffett's shareholder essays

1) Simplicity. Buffett's letters are remarkable for their clarity. This is extremely unusual in a world where investment managers often aim to wow their clients with technical sophistication and jargon. Instead, with Buffett, we are left with the impression of someone who is able to take the complexities of investing and cut right to the core of the problem. Here's one example: Buffett notes that he and Munger expect Berkshire's normalized earning power to increase every year. This is a simple statement, but powerful in conveying that every investor can dramatically simplify his life and improve his returns by focusing on his portfolio's normalized earning power, rather than explicitly trying to generate high returns.

2) Dealing from strength. Buffett highlights Berkshire portfolio companies that pressed their advantage over competitors by making investments in new equipment. He notes, "Dealing from strength is one of Berkshire's enduring advantages." The source of strength is having dry powder when others don't, which requires patience and discipline. Buffett famously said, "Lethargy bordering on sloth is the cornerstone of our investment style." Similarly, there's a Munger quote that I love: "We don't mind long periods in which nothing happens...You look at [Buffett's] schedule sometimes and there's a haircut. Tuesday, haircut day." Instead of fretting about his portfolio, Buffett reveals that he spends ten hours a week playing bridge online - one way to combat boredom, which I've referred to in the past as the third emotion of investing. But of course the flipside of this is being aggressive when opportunities arise, and when competitors are unable or unwilling to act. 

Obviously, no-one sets out hoping to operate from a position of weakness, but prioritizing it as a strategic goal helps. As I've noted before, one of the mortal sins of investing is compounding earlier errors, and this typically happens when one is operating from a position of weakness and reacting to events in a haphazard fashion.

3) Business quality. For someone who is known as the doyen of value investing, Buffett makes surprisingly little mention of the prices paid for the businesses he purchased. Rather, he focuses on their quality. I'm not suggesting that Buffett ignores price; his discussion of insurance underwriting reveals, as always, a keen grasp of risk and reward, as does a note of caution on prices paid for bolt-on acquisitions. Nevertheless, his emphasis on quality, rather than cheapness, is telling. Despite his ability to be patient, Buffett is clearly not just waiting for cyclical lows. Unlike most investors who agonize endlessly over whether equities are cheap, Buffett continues to pour money into investments that he believes will pay off over the long run (Precision Castparts, Wells Fargo, Coca-Cola). 

4) Optimism. We're bombarded by soundbites from pundits (and truth be told, investors) who usually appear smarter for being negative. Buffett, on the other hand, comes across as unusually optimistic (a view shared by his friend, Bill Gates). Having a long-term horizon helps, but Buffett's success is supported by Dimson, Marsh and Staunton, who lauded the "Triumph of the Optimists".  

5) Come for the returns, stay for the philosophy. I'm guessing that most people start following Buffett and Munger because of the prospect of mimicking their investment success. I'm also willing to guess that most of those who stick around do so because they're attracted by the duo's integrity and life philosophy. In this year's letter, Buffett wrote, "There is no one more important to us than the shareholder of limited means who trusts us with a substantial portion of his savings." In a world of relentless asset-gathering masquerading as investing, Buffett's easy manner is why I, like many others, look forward to his letter year after year. 


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