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.
Lesson 3: “If you instead focus on the prospective price change of a contemplated purchase, you are speculating.”
It is not uncommon for stock investors to be guided by price, thinking the low price will move higher or that a stock with momentum indicates further upward movement.
But the Omaha Sage deflates such pretensions when he declares that he at least lacks the ability to succeed with such an approach.
“I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so,” he writes. “Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game.”
For good measure, Buffett adds that past price performance — i.e., momentum — is “never” a reason to buy a stock.
Lesson 4: “I thought only of what the properties would produce and cared not at all about their daily valuations.”
The fact that Buffett’s farm, and a retail real estate property he also bought, do not enjoy the constant price quotation characteristic of equity securities should be a disadvantage for real estate, but because of human psychology this advantage of stocks becomes a curse to most investors.
Buffet writes that he himself — and other disciplined investors — would benefit from constant price quotations:
“If a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his — and those prices varied widely over short periods of time depending on his mental state — how in the world could I be other than benefited by his erratic behavior?” Buffett writes.
“If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.”
Stock investors, though, typically react in panic to an implied message of “Don’t just sit there — do something.”
Such reactions, especially to extreme events like market crashes, “can’t hurt an investor any more than an erratic and mouthy neighbor can hurt my farm investment,” he writes, adding that they can actually boost the bottom line of an investor with available cash.
Lesson 5: “Forming macro opinions or listening to the macro or market predictions of others is a waste of time.”
Indeed, the Berkshire chairman confidently states that in 54 years he and Munger “have never foregone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions.”
But it is not just that such factors don’t enter the investment equation; rather, Buffett regards macro views as outright dangerous — a peril he humorously describes as follows:
“When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: ‘You don’t know how easy this game is until you get into that broadcasting booth.’”
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