The full audio of the 1978 Berkshire Hathaway Shareholders Letter is out. Here are my curated thoughts from the letter. This one is a long one, so grab a coffee and settle in.
Why you need to at least know the basics of accounting if you are going to pursue investments outside of index funds. You need to know how to read the three main financial statements and understand how they all interact and work together. I found How to Read a Financial Report by John Tracy very helpful as a starting point for the beginner.
Just to reinforce the idea that you need to have a working knowledge of financial accounting: you need to understand how the core economic engine of a business can become obfuscated by operating activities.
Buffett has been repeating the same thing since the 1970s: you – yes you – cannot predict with any accuracy the short term movement of stock prices. Your only advantage as a small investor is time arbitrage. All the pros play the short game – your only advantage is to find great companies, figure out a fair price to pay for them, and hold them forever.
Amazing to think that they have over 340,000 employees and generates revenue of $210,821 billion, making it fourth on Fortune’s list of largest revenue generating companies in the US today.
Showing very clearly the characteristics of a poor business: the textile operations of the original Berkshire Hathaway.
Going on about the characteristics of a poor business. Make a mental note to never get directly involved with businesses that exude these characteristics. Well, I mean if you have a wicked sense of enduring… adversity, I guess you can?
Even for a relatively mediocre business, Buffett was unwilling to part with it as long as those four conditions he outlined above were being met. In The Snowball, Alice Schroeder says that the experience with Dempster Mills, where Buffett bought a cheap mill and then brought in Harry Bottle to do the dirty work of firing people, trimming inventory, and squeezing cash from under-performing factories, haunted Buffett because of the ill feelings that were expressed by the towns folk of Beatrice, Nebraska. This probably had an effect on Buffett and his attitude towards the mediocre textile division of Berkshire.
What I got from this was that while prices can detach from reality for some time, eventually, economic reality and prices will converge. This principle is important to keep in mind when thinking of assets, be it stocks, real estate, pipelines, etc.
The quote “Price is what you pay, value is what you get” comes to mind. The footnote about pension fund mangers going crazy for full-priced stocks during the Nifty Fifty era contrasted by severe reluctance when prices fell to more attractive levels speaks volumes of how people act even to this day.
Sometimes fractional pieces of businesses (stocks) are cheap, and sometimes buying whole businesses outright is cheap. It’s the whole “be greedy when others are fearful and fearful when others are greedy.”
Stock markets were cheap in the late-1970s and Buffett was essentially yelling from the mountain tops letting everyone know. The exact opposite was the case in buying whole businesses as the M&A activity of the era was getting every horny about M&A and making it expensive and unattractive to buy whole businesses. I loved the second footnote about how pension managers, who were so horny to buy stocks during the Nifty Fifty era at the beginning of the decade that they would pay astronomical prices for their fractional pieces of businesses on the stock exchange, were no longer willing to commit money when prices got really, really attractive at the end of the decade. A great case study in herd mentality and the importance of thinking independently.
You want stocks to remain depressed for long periods of time, if you are buying great businesses where the economic engine remains intact. If you know a businesses well and are confident in your thinking and analysis, you should have the conviction to buy when the opportunity presents itself.
The idea that buying fractional shares of a great company via the stock market can be superior to purchasing the entire business when there is a price difference between buying fractional shares versus buying the entire thing. Sometimes, those disparities occur and you need to be ready for when they do.
Even if you could acquire the entire business, if it is an excellent business run by excellent managers, you would approach ownership of the business the same way: get the hell out of the way and let the people who do their jobs well do their work. Again, if it is cheaper because of an irrational market to buy fractional pieces of a great business instead of acquiring it outright, do what makes the most logical sense as it will lead to the most profitable outcome.
Buffett is touching on the concept of Owner Earnings, which is the idea that the total earnings in the earnings per share figure is just as valuable as the dividends that are paid out from the earnings per share. If a business pays out 50% of the earnings in dividends and retains the other 50% to grow the business, there is value in that retained 50% amount as it will (hopefully) lead to more goods being produced and more earnings coming in down the line.
Berkshire Hathaway’s financial statements do not report the retained earnings of the businesses in its stock portfolio, just the dividends. However, those retained earnings have greater value than the zero that is reported in the financial statements. Therefore, without proper adjustments, reported earnings figures might not be the most accurate look at the true economic value of a businesses.
Buffett still says this to this day, that Berkshire is lucky to have such dedicated, passionate, loyal, and intelligent managers operating its various subsidiaries. It makes you wonder if that trend will continue once Buffett exits the stage and what sort of implications that may have on the future performance of Berkshire Hathaway.