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February 28, 2017 at 09:21 AM
The past weekend included a big snafu at the 2017 Oscars on Sunday, when the winner of the Best Picture award was announced incorrectly. A day earlier, Berkshire Hathaway investors and admirers received nothing but happy surprises.
According to Chairman Warren Buffet, the market value of the company’s shares has roared ahead at a compound annual growth rate of 20.8% since 1965 — more than double the S&P 500’s 9.7%.
In 2016, Berkshire shares soared 23.4%, beating the S&P’s 12.0% improvement. A year earlier, the shares dropped 12.5%, while the S&P gained 1.4%.
(Check out last year’s investing wisdom here: Buffett’s 6 Nuggets of Investing Advice: Berkshire Shareholder Letter)
While the information on returns is always welcome by investors and market watchers, it is the Oracle of Omaha’s musings on a variety of topics that are eagerly anticipated.
Read on for the top 8 nuggets of wisdom gleaned from this year’s 28-page letter to investors:
1. America the Bountiful
As investors watch the Dow Jones industrial average top 21,000, there is a mix of euphoria and concern. Buffet focuses on the upside of this achievement.
“America’s economic achievements have led to staggering profits for stockholders,” he said in the letter. “During the 20th century, the Dow Jones industrials advanced from 66 to 11,497, a 17,320% capital gain that was materially boosted by steadily increasing dividends.”
And the trend continues. By Dec. 31, 2016, the index advanced a further 72%, to 19,763, he points out.
“American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that.”
2. Fear Is Your Friend
Regardless of whether or not an equity downturn is a day or a decade away, Buffett says market movement is a positive, not negative, phenomenon.
During a period of panic (or worse), don’t forget: “First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted,” he explained.
In other words, put your eggs in a well-priced basket – and keep them there.
“Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively financed American businesses will almost certainly do well,” he explained.
3. Buybacks = Bonus
Though considered controversial by some investors, repurchases are always a plus for existing shareholders.
“Though the day-to-day impact of these purchases is usually minuscule, it’s always better for a seller to have an additional buyer in the market,” Buffet pointed out.
For shareholders keeping their investment, repurchases only make sense when the shares are bought “at a price below intrinsic value,” he says.
“When that rule is followed, the remaining shares experience an immediate gain in intrinsic value,” Buffett said.
For instance, in a business with three equal partners worth $3,000, if one is bought out for $900, the other partners have an immediate gain of $50.
“It is puzzling, therefore, that corporate repurchase announcements almost never refer to a price above which repurchases will be eschewed,” he stated.
Still, Buffet adds that repurchases should not take place when a business needs its available funds to protect or grow operations and is not comfortable taking on more debt.
Another exception concerns an acquisition that offers much more value than do the undervalued shares of a potential repurchaser.
CEOs and boards, according to Buffett, should always remind themselves: “What is smart at one price is stupid at another.”
4. Regulatory Rewards
Two firms – Berkshire Hathaway’s holdings in BNSF railroad and Berkshire Hathaway Energy (BHE), the utility business of which it owns 90% – accounted for 33% of Berkshire’s after-tax operating earnings in 2016.
“A key characteristic of both companies is their huge investment in very long-lived, regulated assets, with these partially funded by large amounts of long-term debt that is not guaranteed by Berkshire,” Buffet explained.
Berkshire Hathaway’s credit is not needed, since each company has earning power “that even under terrible economic conditions would far exceed its interest requirements.”
BHE, for instance, has recession-resistant earnings (as do many utilities) and “an ever-widening diversity of earnings streams, which shield BHE from being seriously harmed by any single regulatory body,” Buffett stated.
Last year, BHE and BNSF invested close to $9 billion in plant and equipment, representing “a massive commitment to their segments of America’s infrastructure.”
Buffet says such investments are “relished” by investors, as long as they promote “reasonable returns.”
