Growth5 Blog

Thursday, March 19, 2009

Notes from the Berkshire Hathaway Shareholder Letter

Berkshire Hathaway recently released Warren Buffett's annual letter. The letter opens with annual returns. From 1965-2008 Mr. Buffet and Charlie Munger have produced an annual compounded gain of 20.3% vs. the S&P 500's 8.9%. Which means if you had invested $10,000 in BH and $10,000 in the S&P 500 in 1965, your money would look like this today:

BH: $36,231,900
S&P: $427,600

Are the BH returns correlated to the overall market? Of course, but they have been so much better for so long, they are clearly doing something right. How they value businesses and their investment philosophy is just flat out better than almost everyone else. Important lessons for any entrepreneur or investor.

Ten sections worth sharing:

1. In good years and bad, Charlie and I simply focus on four goals:
  • (1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash;
  • (2) widening the “moats” around our operating businesses that give them durable competitive advantages;
  • (3) acquiring and developing new and varied streams of earnings;
  • (4) expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results.
2. Berkshire’s two most important businesses – our insurance and utility groups – produce earnings that are not correlated to those of the general economy. Both businesses delivered outstanding results in 2008 and have excellent prospects.

3. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation. Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.

4. ...the market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market. This does not bother Charlie and me. Indeed, we enjoy such price declines if we have funds available to increase our positions. Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.

5. Berkshire is always a buyer of both businesses and securities, and the disarray in markets gave us a tailwind in our purchases. When investing, pessimism is your friend, euphoria the enemy.

6. Home ownership is a wonderful thing. My family and I have enjoyed my present home for 50 years, with more to come. But enjoyment and utility should be the primary motives for purchase, not profit or refi possibilities. And the home purchased ought to fit the income of the purchaser.
The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future.

Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income. That income should be carefully verified.

Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective. Keeping them in their homes should be the ambition.

7. Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas.

8. When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.

9. On shutting down General Re's 23,218 derivative contracts over the past five years. "Upon leaving, our feelings about the business mirrored a line in a country song: 'I liked you better before I got to know you so well.'

10. ...the CEO of any large financial organization must be the Chief Risk Officer as well. If we lose money on our derivatives, it will be my fault.

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