It was a banner year for Berkshire Hathaway, Warren Buffett’s storied holding company, whose stock gained 18.2% in per-share book value — the value manager’s preferred metric — in 2013.
While the S&P 500 outperformed Berkshire last year, Buffet has bested the market over the long haul, and his annual letter to shareholders proudly remarks on the 19.7% compounded annual growth in book value over the past 49 years — just over double the 9.8% rate of the S&P 500 index with dividends reinvested.
So his current shareholder letter sports the 69,518% growth in book value that shares of his firm have delivered since 1964 compared with the 9,841% return of the S&P 500.
But behind the numbers are words — words of wisdom about investing that induce many investment professionals to pore over his report seeking any competitive advantage they might derive. Herewith, a few nuggets of sagacity from the Oracle of Omaha.
Lesson 1: “You don’t need to be an expert in order to achieve satisfactory returns.”
Indeed, Buffett needed just two pieces of critical information in deciding whether to invest in a 400-acre farm in northern Nebraska for his son in 1986:
a) how many bushels of corn and soybeans the farm would produce; and
b) what its operating expenses would be.
Those data enabled him to estimate a satisfactory 10% annual return, which could go higher if productivity improved and crop prices rose, which they in fact did.
Buffet’s farm today is worth five or more times its purchase price.
Investors not astute at making these two calculations should just buy a stock index fund. In fact, Buffett plans to bequeath such a fund, preferably a Vanguard fund, to his heirs.
Lesson 2: “Focus on the future productivity of the asset you are considering.”
Buffett makes participatory equity investments in businesses where he can “sensibly estimate an earnings range for five years out or more” and where the price is reasonable in relation to the bottom boundary of his estimate.
This near-term visibility is the essence of business investment, and the Berkshire CEO emphasizes that stock investors must recognize that they are buying into a business, albeit as equity shareholders.
Buffett and his long-term investing partner Charlie Munger therefore focus on that business’ future productivity and will go ahead and purchase shares if future earnings are sufficient to give a satisfactory return based on the current stock price.
“If, however, we lack the ability to estimate future earnings — which is usually the case — we simply move on to other prospects,” he writes.