Many an investor have pored through the penned words of Warren Buffett in search of nuggets of wisdom nestled within Berkshire Hathaway’s shareholder letter. This year, the trend of progressively shorter letters continues as we barely crest the ten-page mark. Perhaps there is only so much to be said after so many decades.
There are a few recurring themes this year that Warren Buffett have highlighted previously. One of them is the significance of share buybacks. Various news articles outline Buffett’s rebuttal against the arguments that disparage all share repurchases as damaging. This defensive stance comes after the new bill that imposes a tax on stock buybacks in the US. Another point centres around the criticality of Berkshire’s float, which is the capital available for deployment into investment securities that is derived from its insurance business.
There is merit in reiterating some of these subjects as it serves to underscore their importance. Nonetheless, the latest annual letter included new elements that illuminate the way investors think. Buffett also goes a step further by sprinkling a dash of Charlie Munger’s thoughts. Here are seven things I learnt from the 2023 annual letter to Berkshire Hathaway’s shareholders:
1. Over time, it takes just a few winners to work wonders. Buffett uses Apple Inc. (NASDAQ: AAPL)and American Express Company (NYSE: AXP) to illustrate that behind the majestically successful image of Berkshire today lies many unremarkable investment calls. The company made far more average purchase decisions than spectacular ones. Yet, the disproportionately huge upside of these gems lifted the performance of the overall portfolio. Munger echoes this point, stating that one does not need to own a lot of things in order to get rich. Sensational accomplishment often hinges on that few big winners, provided that major crippling mistakes are avoided.
2. Market dislocation is always present. Buffett purports that efficient markets exist only as a theory and the behaviours of market participants can only be comprehended retrospectively. Coupling this with the establishment of public markets means that there is always value out there waiting to be discovered. He contrasts this with acquiring entire or majority stakes within a business, an endeavour that usually commands a high premium that is hardly justifiable. Thankfully, such takeovers are beyond the reach of retail investors like us anyway, and the opportunities accorded by publicly traded shares should suffice in paving the road to profit.
3. Size and diversification matters. Berkshire is the proud owner of behemoth corporations that are well diversified across a plethora of industries. In this case, Buffett alludes to the S&P500 and so we use market capitalisation as a proxy for size. Larger businesses are preferred due to obvious advantages. This could be due to them enjoying higher market shares, reaping economies of scale, and having greater alignment with a country’s economic future. The last point about alignment could result in favourable regulatory tailwinds such as the recent Bipartisan CHIPS and Science Act. The next point pertains to the importance of diversification. In fact, size and diversification are closely interrelated. Sprawling conglomerates tend to have their hand in various sectors across multiple geographies. Apart from risk reduction, larger institutions can share resources which translate to benefits. Take for example intangibles like reputation, which is more effectively exploited in multidivisional organisations than through the free market. Of course, one needs to weigh size advantages against the flipsides of being too large.
4. Risk remains a fundamental consideration for investors. Risk and return are two sides of the same coin; hence, risk management is crucial for all investors. Even well-regarded investment heavyweights like Berkshire have their fair share of safety margin, such as holding substantial liquid assets and staying clear of ill-advised and ill-timed cash drawdowns. Buffett further asserts that Berkshire’s CEO will always be the Chief Risk Officer. Along a similar vein, investors ought to select businesses where management has ‘skin in the game’. This could be in the form of insider ownership, senior employees’ compensation tied to stock options, or value-accretive insider buying (beware of value-destructive share buybacks). All these increase alignment between management and shareholders, especially for companies which operate in high-complexity and large-scale settings.
5. Be sceptical of firms that beat estimates. Buffett cautions investors to be wary of corporates manipulating earning figures and beating market expectations. For instance, the distinction between Berkshire’s operating earnings and GAAP earnings emphasise the pitfalls of focusing on GAAP figures. Harvard Business Review provides extensive reasons about the increased use of non-GAAP numbers. The long and short is that investors must understand what type of earnings are most relevant to the business they are analysing. This in turn, requires an intimate grasp of the underlying business. Savvy and legitimate business practices may be equally damaging to investors as criminal corporate actions like fraud, by virtue of their legality. Beyond accounting, executives may be incentivised to dress financial statements in fanciful ways that do not breach the law but are nevertheless misleading. One example is intentionally understating figures so that future targets become easier to beat. Sieving out earnings misrepresentation is a difficult endeavour but one that is sure to pay off.
6. Patience can be learned. This one comes from Munger, who affirms that ‘having a long attention span and the ability to concentrate on one thing for a long time is a huge advantage’. Our attention span has been gradually truncated. The culprit can be traced to a hodgepodge of social media options and nonstop distractions. Multitasking is also thought to be a myth. To assess a company’s investment attractiveness, one needs to understand how a company conducts its business. The process requires time and energy, which may be limiting resources to many retail investors, thereby encouraging speculation activities where one ‘invests’ based on hearsay or before conducting thorough due diligence. Going into a state of intense concentration (otherwise known as ‘flow’ or ‘being in the zone’) alleviates the stress that learning puts on the mind and body. Investors can immerse themselves in erudition while losing a sense of time and feel as they find the experience intrinsically rewarding. Deep learning can also be applied in other areas of life, making it a worthwhile skill to practise indeed.
7. Change is the only constant. Using the example of railroad stocks, Munger recounts how he previously disliked railroad stocks but ended up being an investor in four major railroad companies. He further adds that being slow to recognise change beats not acknowledging change at all. This also reverberates with another point he mentioned about the need to constantly learn in order to become a great investor. To be a constant, you have to change.
Berkshire will host its shareholder meeting on Saturday, 6 May 2023. The Q&A session live stream starts at 8:45am Central Time (GMT-6). To view the event, go to https://www.cnbc.com/brklive22. For those interested in reading Berkshire Hathaway’s 2022 shareholder letter, you can click here. Enjoy the read!
