Berkshire Hathaway Chairman and CEO Warren Buffett has released his annual letter to shareholders, and just like everything else the "Oracle of Omaha" says, the letter quickly attracted the attention of institutional and individual investors alike.
Berkshire Hathaway Chairman and CEO Warren Buffett has released his annual letter to shareholders, and just like everything else the “Oracle of Omaha” says, the letter quickly attracted the attention of institutional and individual investors alike.
The letter contains plenty of pearls of wisdom, a few great one-liners, and some harsh words for big banks.
The entire 38-page letter is worth a read, but his “Next 50 Years” section, located at the end of the document, contained a number of key lessons for investors and managers. Here are some
1. Even a great stock isn’t great when it’s overpriced. Buffett says the chances of a permanent capital loss for “patient” Berkshire shareholders is as low as exists at any single company. He said the intrinsic business value of the company is “almost certain” to grow over time. However, he added one caveat. He can’t offer a guarantee of growth to people who buy the stock when its price is “unusually high.”
“In other words, a sound investment can morph into a rash speculation if it is bought at an elevated price,” he wrote. “Berkshire is not exempt from this truth.”
He also said short-term investors are likely to see their return affected most by movements of the general stock market, rather than by any change in the value of Berkshire. He suggests investors steer clear of buying the company’s shares unless they plan to stick around for 5 years or more.
2. Cash matters. Buffett says companies need 3 things to be successful in the long term: “(1) A large and reliable stream of earnings; (2) massive liquid assets; and (3) no significant near-term cash requirements.” He writes that many companies ignore the third part, to their detriment.
Buffett goes on to note how in 2008 his company was able to supply more than $15 billion in cash to American businesses, thanks to Berkshire’s policy of keeping at least $20 billion in cash equivalents on hand at any time. He prefers US Treasury bills. In short: “When bills come due, only cash is legal tender. Don’t leave home without it.”
3. Panic is unpredictable, except insofar as it’s guaranteed to happen. Buffett notes that his company is sometimes characterized as being overly conservative. For instance, he notes the company’s insurance holdings will not write contracts that allow policyholders to cash out at their option. He says life insurance policyholders will sometimes rush to cash out at times of economic panic.
“The reason for our conservatism, which may impress some people as extreme, is that it is entirely predictable that people will occasionally panic, but not at all predictable when this will happen,” he said. “Though practically all days are relatively uneventful, tomorrow is always uncertain.”
4. “The bad news is that Berkshire’s long-term gains—measured by percentages, not by dollars—cannot be dramatic and will not come close to those achieved in the past 50 years. The numbers have become too big."
Buffett believes Berkshire will continue to perform better than the average American company for many years, but he said at some point in the next couple of decades, the company’s earnings and capital resources will become so large as to preclude the company from “intelligently” reinvesting all of Berkshire’s earnings. He’s confident will successors will adopt the right strategy to deal with that situation when it arises.
5. Beware the “ABCs of business decay." At the close of his letter, Buffett alludes to his eventual departure, and lays out some thoughts on what makes a good CEO.
“My successor will need one other particular strength: the ability to fight off the ABCs of business decay, which are arrogance, bureaucracy and complacency. When these corporate cancers metastasize, even the strongest companies can falter.”
He notes that Berkshire doesn’t have a legal department at its headquarters, nor a human relations, public relations, investor relations department.
“We do, however have an active audit function,” he notes, “no sense in being a damned fool.”