06 February 2023

On today’s episode, Clay reviews Warren Buffett’s shareholder letters and shares his takeaways and distills some of the biggest lessons he learned.

If you asked a lot of value investors, they would tell you that reading Buffett’s letters is equivalent to an MBA on value investing and business. Buffett has a lot to teach us as investors as he has grown the value of Berkshire shares by over 3,600,000% since he took control of the business in 1965.

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  • What Berkshire’s “Big Four” businesses are.
  • What Buffett looks for when investing in a business and what he looks for in a management team.
  • Why Buffett loves share repurchases and why they give me further vindication that a stock is cheap.
  • Why it pays to treat your colleagues and shareholders like partners.
  • Why industries with constant change should be avoided by investors.
  • How Buffett views cash and leverage in his capital allocation strategy.
  • What Buffett looks for when selecting him and Charlie’s successors.


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

[00:00:03] Clay Finck: Hey everyone. Welcome to The Investor’s Podcast. I’m your host, Clay Finck. On today’s episode, I’m going to be talking about my biggest takeaways from reading Warren Buffett’s shareholder letters. If you ask a lot of value investors, they would probably tell you that reading Buffett’s letters is equivalent to getting an MBA on investing and business.

[00:00:23] Buffett graciously shared the investing in business practices he has used for decades to grow. The market value for Berkshire Hathaway shares by 20.1% annually from 1965 through 2021, which over that entire time period was a 3.6 million percent return relative to 30000% for the S&P 500. Not only is there so much to learn from Buffett with regards to investing, but there are many life lessons as well.

[00:00:51] This reminds me of my previous episode I released talking about Guy Spier’s book, The Education of a Value Investor. Before we dive into the episode, I thought it would be a good opportunity to mention that TIP will be at the Berkshire Hathaway Annual Shareholder Meeting this year on May 6th, 2023.

[00:01:10] We’re hosting four free social events where you can meet Stig, Trey, and myself, as well as socialize with the rest of the TIP audience members. I’m also doing a get together prior to the meeting in front of the CenturyLink Center for the TIP members to meet and sit together at the annual meeting.

[00:01:26] Our social events are already getting a ton of attention as many people have already registered and 150 people have joined our WhatsApp Group Chat for details on our events, how to register, how to join the chat. Be sure to check out the itinerary and the show notes if you’re interested. For more details, you can also check out Episode 500 where Stig, and I discuss our events, the Berkshire meeting, and common questions asked by the audience members about the Berkshire weekend.

[00:01:52] I am beyond excited for Berkshire weekend, as I always have a fun time there connecting with other like-minded investors. It’s always one of the highlights of my year, and it will be even better getting to hang out with other TIP hosts as well as the audience members. Can’t wait to see all there.

[00:02:09] Without further delay, let’s dive right into today’s episode covering Warren Buffett’s shareholder letters.

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[00:02:18] Intro: You are listening to the Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

[00:02:37] Clay Finck: All right, so rather than taking the time to pull up each individual letter, Luckily for me, Lawrence Cunningham put together a book called The Essays of Warren Buffett, where he compiles all of his letters so you aren’t reading the same thing multiple times, and he makes it a little bit more digestible as he breaks the sections up into all these different topics that Warren has wrote about over the years.

[00:02:59] Berkshire’s most important business is insurance. However, the conglomerate owns businesses across all of the United States economy, ranging from phones, food, clothing, railroads, newspapers, financial products, and much more. Some of these businesses are wholly owned businesses like Geico and Sees Candy, while others are partial ownership in publicly traded companies such as Apple and Coca.

[00:03:22] Buffett views Berkshire Hathaway as a partnership among him, Munger and the other shareholders, and Buffett himself has virtually all of his net worth tied up in Berkshire Hathaway stock. Cunningham states that Buffett’s economic goal is over the long term to maximize Berkshire’s per share intrinsic value by owning all or part of a diversified group of businesses that generate cash and earn above average returns.

[00:03:47] In achieving this goal, Buffett forgo expansion just for the sake of expansion and forgo divestment of businesses so long as they generate some cash and have good manage. Berkshire retains and reinvest earnings when doing so, delivers at least proportional increases in per share market value over time.

[00:04:07] Berkshire uses debt sparingly and sells equity only when it receives as much value as the equity gives. If you go to Berkshire’s website where all of his letters are at, you’ll find that these go back all the way to 1977. And there are other sources that show, you know, his even earlier letters prior to 1977.

[00:04:25] But I wanted to take a look at what was shown on their website too. His early letters were much shorter than they’ve been in more recent years, as his audience has continued to grow. But what amazes me is the level of consistency he has. Pulling up his 1977 shareholder letter, for example, I see that he has public holdings in just seven companies with nearly half of it being Geico preferred and common shares in Washington Post.

[00:04:50] And right after he lists his common stocks, he says that we select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be one that we can understand with favorable long-term prospects, operated by honest and competent people and available at a very attractive price.

[00:05:11] We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price. And if you read Buffett’s more recent letters, you’ll find him saying more or less the exact same thing.

[00:05:35] And this is a good reminder that good investment principles really never change. You’ll see him say over and over again that he wants to own a number of great businesses that produced a lot of cash, and they’re run by honest and competent managers. In his most recent letter, which was for 2021, I love how even at the age he is, which is 92, he’s just a really eloquent.

[00:05:57] He writes, Charlie Munger, my longtime partner, and I have the job of managing a portion of your savings. We are honored by your trust. Our position carries with it the responsibility to report to you. What we would like to know if we were the absentee owners and you were the manager, we enjoy communicating directly with you through this annual letter and through the annual meeting as.

[00:06:20] Then he goes on to talk about Berkshire’s business. Quote. Berkshire owns a wide variety of businesses, some in their entirety, some only in part. The second group largely consists of marketable common stocks of major American corporations. Additionally, we own a few non-US equitieS&Participate in several joint ventures or other collaborative activities.

[00:06:43] Whatever our form of owner. Our goal is to have a meaningful investment in businesses with both durable economic advantages and a first class CEO. Please note particularly that we own stocks based on our expectation about their long-term business performance and not because we view them as vehicles for timely market moves.

[00:07:02] That point is crucial. Charlie and I are not stock pickers. We are business pickers. I make many mistake. Consequently, our extensive collection of businesses includes some enterprises that have truly extraordinary economics, many others that enjoy just good economic characteristics and a few that are marginal.

[00:07:22] One advantage of our common stock segment is that on occasion it becomes easy to buy pieces of wonderful businesses at wonderful prices. That shooting fish in a barrel experience is very rare in negotiated transactions and never occurs in. It is also far easier to exit from a mistake when it’s been made in the marketable arena.” end quote.

[00:07:44] Then a couple pages down is the section titled, Our Four Giants. The Big Four make up a good majority of Berkshire’s value. The first is their collection of insurance businesses. Regarding that segment, he says the insurance business is made to order for Berkshire. The product will never become obsolete, and sales volume will generally increase along with both economic growth and inflation.

[00:08:07] Also, integrity and capital will forever be important. Our company can and will behave well. There are, of course, other insurers with excellent business models and prospects. Replication of Berkshire’s operation, however, would be almost impossible. Next, he lists Apple, which as of his most recent 13 F Berkshire owns over 120 billion worth of Apple share.

[00:08:31] Apple was just added to his portfolio in 2016, so it’s a fairly new or recent holding relative to many of the other businesses, and it’s grown substantially ever since then in terms of the number of shares they owned and the price of those shares increasing substantially as well. Buffett says that the look through earnings for Apple that were attributable to Berkshire was a staggering 5.6 billion.

[00:08:53] Much of these earnings were used to issue dividends and conduct Sherry purchases, which Buffett says he applaud. Berkshire’s. Third Giant is BNSF, the railroad company he considers to be an indispensable asset for America, as well as for Berkshire. This portion had record earnings of 6 billion in 2021, and then the fourth and final giant is Berkshire Hathaway Energy, which also had record earnings in 2021 at 4 billion, and this is a 30 fold increase since the year 2000.

[00:09:23] Buffett stated that under David Soles and Greg Abel’s leadership, BHE has become a utility powerhouse and the leading force in wind, solar, and transmission throughout much of the us. And then Berkshire, of course, owns a number of other publicly traded stocks and wholly owned businesses. He doesn’t mention here.

[00:09:41] If you’ve read enough of Buffett’s letters or listened to him at the shareholder meetings, you know that he’s about the most honest and straightforward person that you could ever come across. If accounting earnings were artificially inflated up or down, then he would be the first to publicly state what is happening with those figures.

[00:10:00] When communicating business results, he simply tells it like it is. He doesn’t want to lead on investors to purchasing shares in the company if the investors are being misled or if the price of the stock is trading far above its intrinsic value. It’s funny that as I was researching for this episode, I was also reading the book, Influence by Robert Cialdini, which is one of Charlie Munger’s favorite and most recommended books.

[00:10:23] The book gives a masterclass on human psychology, and in the chapter covering how we react to authority, it mentions how Warren Buffett consistently reminds shareholders of all the mistakes he has made in the past. Cialdini writes that rather than burying, minimizing, or papering over difficulties, which seems to be the tack taken all too frequently in other annual reports, Buffett demonstrates that he is first fully aware of problems inside the company and second, fully willing to reveal them.

[00:10:53] The emergent advantage is that Winnie then describes the formidable strengths of Berkshire Hathaway. Readers are ready to trust in them more deeply than before because they know they’re coming from a trustworthy communicator. Perhaps the clearest illustration of Buffett’s zelle. For demonstrating his transparency by admitting his shortcomings appeared in his annual report of 2016, a banner year in which his company’s share price increase doubled that of the S&P 500 and in which there were no investing missteps to report.

[00:11:25] What did Buffett do to ensure that evidence of his openness and honesty would’ve remained top of mind for shareholders? On the report, second page of text, he noted a previous year’s investing mistake that he described as the particularly egregious error of acquiring Dexter’s Shoe for 434 million in 1993.

[00:11:45] Dexter’s value promptly went to zero. Immediately thereafter, he detailed what he’d learned from the fiasco. He had not only misjudged the future worth of Dexter, but made the mistake of paying with Berkshire Hathaway stock something he promised shareholders he would never do again. It’s clear to me that Buffett knows more than how to be an impressively successful investor.

[00:12:06] He knows how to communicate impressively about being an impressively successful. So my big takeaway from reading this piece from Cialdini’s book is that since Buffett puts so much emphasis on his mistakes, this leads to his shareholders and investors trusting him more because they believe that he will always be on the lookout for mistakes where bad things happening.

[00:12:27] Within Berkshire plus Buffett’s long-term success really just speaks for itself. As of recent years, Buffett has been repurchasing shares of Berkshire, which means that Buffett believes that Berkshire shares are actually undervalued. So if Buffett who understands Berkshire better than anybody believes that Berkshire shares are undervalued, then that is probably a really good entry price for long-term investors.

[00:12:51] And another thing I really appreciate about Buffett is that he writes these letters in a way that really anybody can understand. A lot of people will write or talk in a way to try and impress others or try and show others how smart they are, and that is not what Buffett is about at all. He wants to communicate to shareholders in a clear and a straightforward way about, you know, covering how the business is performing and how Berkshire will operate for the years to come.

[00:13:16] And he’s been extremely consistent with that approach and that message. One of the most critical pieces of the success of Buffett’s investments is identifying able, honest, and diligent managers who act with integrity. He says that special attention especially should be paid to selecting A CEO because the standards for measuring a CEO’s performance are inadequate and easy to manipulate.

[00:13:40] So it can be difficult for Buffett to measure the performance of a company’s most important worker. Plus there’s no one senior to the CEO. So if the CEO is acting irrationally or selfishly, how can you not expect others in the company to follow that CEO’s? Buffett also wants to align management and shareholder interests.

[00:14:01] There have been many ways. Wall Street has tried to do this. Oftentimes stock options are used. However, these may actually incentivize managers to try and increase stock prices in the near term or short term. To maximize the value of those options rather than trying to maximize long-term shareholder value.

[00:14:19] Another issue that Buffett has with stock options is that by simply retaining and reinvesting earnings, managers can report annual earnings increases without hardly lifting a finger. Just about any manager could do that. But what you really want to do is incentivize managers to be encouraged to improve real returns on capital.

[00:14:39] It can be a slight conflict of interest in that regard. However, Buffett does say that stock options can encourage the managers to think more like owners, but he doesn’t believe it’s the perfect tool to do so. He says that shareholders of the company are exposed to the downside risks of, you know, sub-optimal capital deployment and option holders aren’t really exposed to that in the same manner.

[00:15:02] One of Buffett’s best solutions to selecting the right managers is to try and select someone who will just do the right thing, even if poor incentives happen to be in place. Managers who act honestly and act with integrity don’t need much Overwatch from the board or from Buffett. The CEOs at Berkshire’s, various operating companies enjoy a unique position in corporate America.

[00:15:24] Buffett gives them a simple set of rules. That’s to run the business as if they were the sole owners. It is the only asset they own and they can never sell it to anyone in 50 years. This simple framework is Buffett’s way of telling them to act in the best interest of long-term shareholders. And this is an idea that’s pretty alien to a lot of Wall Street.

[00:15:45] As far as Berkshire’s own managers, Warren says that quote, most of their directors have a major portion of their net worth in the company. We eat our own cooking. Charlie’s family has a majority of their net worth in Berkshire’s shares. I have more than 99%. Charlie and I cannot promise you results, but we can guarantee that your financial fortunes will move in lockstep with ours for whatever period of time you elect to be our partner.

[00:16:12] So not only does Buffett want to own stock in companies where managers own a lot of shares in the company, he acts in that manner himself, essentially having his entire net worth in Berkshire Hathaway. To help show Buffett’s admiration for the managers he works with. Here’s what he wrote in his 1988 shareholder letter.

[00:16:30] The earnings achieved by our operating businesses are superb weather measured on an absolute basis or against those of their competitors. For that, we thank our operating managers. You and I are fortunate to be associated with. At Berkshire associations like these last a long time, we do not remove superstars from our lineup merely because they have attained a specific age, whether that be the traditional 65 or the 95 reached by Mrs.

[00:16:57] B on the eve of Hanukkah in 1988. Superb managers are too scarce of resource to be discarded simply because a cake gets crowded with candle. Moreover, our experience with newly minted MBAs has not been that great. Their academic records always look terrific, and the candidates always know exactly what to say, but too often they are sure on personal commitment to the company.

[00:17:21] In general, business savvy, it’s difficult to teach a new dog, old tricks. Later on in that letter, he talked about his purchase of Borsheim, which is a jewelry store out of Omaha. I can assure you that those who put their trust in Ike Friedman and his family will never be disappointed. The way in which we purchased our interest in their business is the ultimate testimonial.

[00:17:43] Porshes has no audited financial statements. Nevertheless, we didn’t take inventory, verify receivables, or audit the operation in any way. Ike simply told us what was so, and on that basis, we drew up a one page contract and wrote a large check porshes. New links to Berkshire will change nothing in the way that business is run.

[00:18:03] All members of the Fridman family will continue to operate just as they have. Charlie and I will stay on the sidelines where we belong. And when we say all members, the words have real meaning. Mr. And Mrs. Friedman at 88 and 87 respectively are in the store daily. The wives of Ike, Alan, Marvin, and Donald, all pitch in at busy Times in a fourth generation is beginning to learn the ropes.

[00:18:28] It is great fun to be in a business with people you have long admired. The Friedmans, like the Lumpkins, have achieved great success because they have deserved success. Both families focus on what’s right for the customer, and that inevitably works out well for them. Also, we couldn’t have better partners.

[00:18:46] So as many are familiar with Buffett’s early investment style of buying something cheap, it’s pretty cool to see how much emphasis he puts on purchasing companies with quality management and how seriously he takes the idea of treating the managers and his shareholders like partners. He not only treats his shareholders like partners, but he encourages his shareholders to think the same way.

[00:19:07] He says, Charlie, and I hope that you do not think of yourself as merely owning a piece of paper whose price wiggles around daily, and that is a candidate for sale. When some economic or political event makes you nervous, we hope you instead visualize yourself as a part owner of a business that you expect to stay with indefinitely, much as you might if you owned a farm or apartment house in partnership with members of your family.

[00:19:31] When you look at all Buffett’s letters, you’ll find that the first thing he shows is how much Berkshire’s value has moved over the year and what that performance has been since Buffett took hold of the company in the early days, he would show how much the company’s book value had changed from year to year, because that was a good measure to show how much the stock and the company was increasing in value over time.

[00:19:52] However, he eventually transitioned to just show the increase in the market value of Berk. Rather than the book value because of the decreased importance of book value over time. In the economy of the past with steel mills and manufacturing companies, book value was highly relevant to determining the value of a business.

[00:20:10] However, with a continued rise of things like intangible assets, which are increasingly difficult to put a value on, this makes book value less and less relevant over time. Thus, it was just recently that Buffett started putting in the increase in the market value of the shares rather than book value, and then showed the increase in the S&P 500 as well.

[00:20:28] Buffett’s pretty quick to point out that it’s the increased operating earnings of the businesses and that capital being redeployed effectively is what’s going to drive the continued growth of Berkshire’s Intrinsic value In his 1992 letter Buffett noted that him and Charlie aimed to grow intrinsic value by at least 15% annually, and they were quite certain that they were going to be able to beat the S&P 500 over the decade ahead, which isn’t something you’d hear them say today because of the much larger capital base they’re operating.

[00:20:57] I recall from either the 2017 or 2018 annual meeting I attended, he said he expected Berkshire to compound at roughly 10% per year, which is still quite remarkable given their size today. And to achieve that 15% target in the growth of the intrinsic value that they said in the early nineties, he knew he’d have to grow earnings by 15% as well.

[00:21:18] So in 1992, earnings were 604 million. And if you compound that at 15% annually, this would need to grow to 1.8 billion by the year 2000 to meet that goal. He says that for us to get there, our operating subsidiaries and investee must deliver excellent performances and we must exercise some skill and capital allocation as well.

[00:21:40] We cannot promise to achieve the 1.8 billion target. Indeed, we may not even come close to it, but it does guide our decision making when we allocate capital today, we are thinking about what will maximize look through earnings in 2000. So I think there’s a little bit of a subtile difference here in how Warren presents potential future growth versus how a lot of other managers.

[00:22:04] And this isn’t me trying to say that these managers are bad people. I think it goes to show how honest and straightforward Warren tries to be with these letters. So Warren essentially says that they intend to try and grow Berkshire’s look through earnings by at least 15% annually. And they may definitely fail, but.

[00:22:21] That’s what they’re going to try and do. Whereas what I see with some other managers is that they’ll project earnings to grow by 15% per year over the next five years, and they’ll state how confident they are in their ability to do that. So they’re really trying to sell shareholders on these projections rather than simply telling them what they’re targeting for growth and earnings.

[00:22:40] Buffett believes that projecting these earnings with confidence over the short run is oftentimes a fool’s errand. And investors should be skeptical of managers who act confident that they know where earnings will be next year or next quarter. Managers shouldn’t state their confidence in high growth rates because a very small percentage of large businesses are able to end up achieving a high growth rate of say, 15% over the long.

[00:23:04] Buffett says that Charlie and I tend to be leery of companies run by CEOs who woo investors with fancy predictions. A few of these managers prove prophetic, but others will turn out to be optimist or even charlatans. Unfortunately, it’s not easy for investors to know in advance which species they’re dealing with.

[00:23:23] Another aspect I find interesting is how Buffett thinks about his holding period and achieving those. You think that if a company became overvalued, then Buffett would be willing to sell an overvalued company and allocate it to something that’s undervalued, but that’s not really the way he approaches it.

[00:23:40] During the tech bubble, Warren and Charlie knew that Coca-Cola was likely overvalued and the stock was 10 x above their cost bases at the time, and it was their largest equity holding at the end of 1999 at over 11 billion. But they decided not to. On this topic, Buffett wrote quote, you should be fully aware of one attitude, Charlie and I share.

[00:24:00] That hurts our financial performance regardless of price. We have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell subpar businesses as long as we expect them to generate at least some. And as long as we feel good about their managers in labor relations, we hope not to repeat the capital allocation mistakes that led us to such subpar businesses.

[00:24:25] When we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. The projections will be dazzling and the advocates sincere, but in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand based on Buffett’s past actions.

[00:24:49] This leads me to believe that if he is holding a great company that produces a lot of cash, then he will lean towards not selling it, even if he believes the company is over. However, if his opinion about a company changes or he sees more risk in a company than he originally thought, then he may end up selling out of that position.

[00:25:06] For example, in 2017, Buffett stated that he was wrong about his thesis on I B M, so he decided to gradually sell out of that position as they faced more competition than he originally thought. And then he was also analyzing Apple and determined that he was much more certain and optimistic on Apple’s future.

[00:25:24] So during that year, he had been selling outta IBM and accumulating shares of Apple, which in hindsight was a very good move for him. Now, I think a big reason for this approach is because Buffett wants to be known as holding wholly-owned companies indefinitely. I think a big reason that Buffett wants to be known as holding these wholly owned companies forever is because people who build a business oftentimes care about who the business is going to be sold to.

[00:25:49] If you spent your whole life building a company up, you probably don’t want to sell your company to someone who wants to get involved in the business, make unnecessary changes, and then try and flip. A lot of business people would rather sell to someone like Buffett who let the managers do their job and don’t intend to ever sell the business.

[00:26:08] Now, I think that Buffett wants to try and portray himself as that type of investor to attract those quality businesses with quality managers. Buffett says that most business owners spend the better part of their lifetimes building their business. By experiences built upon endless reputation, they sharpen their skills in merchandising, purchasing, personnel, selection, et cetera.

[00:26:29] It’s a learning process, and mistakes made in one year often contribute to competence and success in succeeding years. In contrast, owner managers sell their business only once frequently in an emotionally charged an environment with a multitude of pressures coming from different direct. Often, much of the pressure comes from brokers whose compensation is contingent upon the sale, regardless of the consequences for the buyer and the seller, the fact that the decision is so important both financially and personally, this can make the owner more prone to error and mistakes made in the once in a lifetime sale of a business are not reversible.

[00:27:07] Price is very important, but often is not the most critical aspect of the. If you should decide to sell, I think Berkshire Hathaway offers some advantages that most other buyers do not. Then he describes how most buyers are either companies in a similar industry trying to acquire a business in their industry to create synergies, or the other type of buyer is a financial maneuverer, oftentimes using leverage in the purchase to try and resell the business.

[00:27:34] If the sole motive of the present owners is to cash in their chipS&Put the business behind them, either type of buyer that I’ve just described will work for them. But if the seller’s business represents the creative work of a lifetime and forms an integral part of their personality and sense of being buyers of the either type, really have serious flaws.

[00:27:54] Berkshire is another kind of buyer and a rather unusual one we buy to keep, but we don’t have and don’t expect to have operating people in our parents’ organization. When we buy a business, the sellers go on running it just as they did before the sale. We adapt to their methods rather than vice versa.

[00:28:14] And I had just talked about how Buffett wants the managers of the companies he owns to have skin in the. For those who owned businesses. He says that he wants the operating members of the family to retain 20% interest in the business. Then he goes on to say that he does get involved in capital allocation decisions as well as the compensation and selection of the top managers.

[00:28:36] The purchases that Berkshire makes are with cash and no businesses are ever used as collateral in any. Buffett wants to buy from someone who truly cares about their business and values the blood, sweat, and tears that they’ve put into it. And he also wants someone that really cares about who they’re selling the business to.

[00:28:54] When you find a family or a group of managers who care intensely about the business, many good qualities are likely to be found in that business that Warren would want as well. Regarding Berkshire Hathaway’s shareholder base. I couldn’t find which letter this was pulled from, but in one of them, Buffett stated, in some ways, our shareholder group is an unusual one, and this affects our manner of reporting to you.

[00:29:18] For example, at the end of each year, about 98% of the shares outstanding are held by people who also were shareholders at the beginning of the year. Therefore, in our annual report, we build upon what we have told you in previous years instead of restating a lot of the. Furthermore, perhaps 90% of our shares are owned by investors for whom Berkshire is their largest security holding.

[00:29:43] Very often, far and away the largest. Many of these owners are willing to spend a significant amount of time with the annual report, and we attempt to provide them with the same information we would find useful if the roles were reversed. End quote. I’ve been to a number of Berkshire’s annual meetings, but just reading these numbers further reminds me that his shareholder base just has so much trust in faith in what Warren and Charlie are doing.

[00:30:10] Warren even says himself that he isn’t trying to maximize the price at which Berkshire shares trade. Instead, he’d rather the stock trades roughly around its intrinsic value so that shareholders reap the rewards of the underlying business during that holding period. He also wants his shareholders to act like long-term business owners.

[00:30:27] He says that our goal is to attract long-term owners who at the time of purchase, have no timetable or price target for sales, but plan instead to stay with us indefinitely. Of course, some Berkshire owners will need or want to sell from time to time, and we wish for good replacements who will pay them a fair?

[00:30:47] Therefore, we try through our policies, performance, and communications to attract new shareholders who understand our operations, share our time horizons, and measure us as we would measure ourselves. Quote, Buffett’s goal with the letters is not only to be a teacher, but also communicate in an honest way the information they would want to know if they were shareholders themselves and the company.

[00:31:09] I’ve had a number of episodes covering Buffett’s investment philosophy, but it’s worth repeating, investing maxims and fundamental. Buffett said that he purchased a substantial position in the Washington Post in mid-1973 at a price, not more than one-fourth of the true underlying value of the enterprise.

[00:31:27] Quote, “Calculating the price to value ratio required. No unusual insights. Most security analysts, media brokers, and media executives would’ve estimated the Washington post’s intrinsic business value to be around 400 to 500 million, just as we did in its 100 million stock market valuation was published daily for all to see. Our advantage rather, was attitude. As we had learned from Benjamin Graham that the key to successful investing was the purchase of shares in good businesses when market prices were at a large discount from underlying business values.” End quote.

[00:32:03] Then he goes on to talk about how academics say there’s no use in trying to find bargains in the market because the market is fully efficient to which Buffett? We are enormously indebted to those academics. What could be more advantageous in an intellectual contest, whether it be bridge, chess, or stock selection, than to have opponents who believe that thinking is a waste of energy. End quote.

[00:32:28] He then mentioned a farm he purchased and his thought process on how much income that farm would produce over the years. Then he listed a few bullet points of his fundamentals of invest. First is you don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences.

[00:32:52] When promised, quick profits respond with a quick no. Second is focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. Third, if you focus on the perspective price change of a contemplated purchase, you are speculating.

[00:33:12] There’s nothing improper about that. I know however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin flippers will win their first toss. None of those winners has an expectation of profit if he continues to play that game.

[00:33:30] And the fact that a given asset has appreciated in the recent past is never a reason to buy. Fourth he says, with my two small investment properties, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field, not by those whose eyes are glued to the scoreboard.

[00:33:52] If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays. Fifth, and finally, forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.

[00:34:11] So Buffett, of course, is hyper-focused on what he believes is the true value of the business or investment he’s interested in. He doesn’t get caught up in the ever-changing daily stock fluctuations and recognizes that when fear occasionally strikes, it offers great opportunities to buy. I love this quote from him.

[00:34:29] A climate of fear is your friend when investing a euphoric world is your. And it stands so true today as everybody is expecting markets to crash, which probably means it’s a pretty good time to go shopping. While the majority of other investors are skeptical and hesitant, he says, quote, during the extraordinary financial panic that occurred in late 2008, I never gave a thought to selling my farm or selling my New York’s real estate.

[00:34:56] Even though a severe recession was clearly brewing, and if I had owned a hundred percent of a solid business with good long-term prospects, it would’ve been foolish for me to even consider dumping it. So why would I have sold my stocks that were a small participation in wonderful businesses? It’s true that any one of them might eventually disappoint, but as a group, they were certain to do well.

[00:35:19] Could anyone really believe the earth was going to swallow up the incredible productive assets and unlimited human ingenuity existing in America? When Charlie and I buy stocks, which we think of small portions of businesses, our analysis is very similar to that which we use in buying entire business.

[00:35:37] We first have to decide whether we can sensibly estimate an earnings range for five years out or more. If the answer is yes, we will buy the stock or business if it sells at a reasonable price in relation to the bottom boundary of our estimate. If however, we lack the ability to estimate future earnings, which is usually the case, we simply move on to other prospects.

[00:35:58] In studying the work of Buffett, I’ve personally embraced this idea that I don’t need to have an opinion on every single business. If I’m not confident that the business will be able to grow over the next five years, then I just stop my analysis there and not even have to develop an opinion on it because I can focus my efforts elsewhere.

[00:36:16] Of course Buffett doesn’t recommend others to purchase individual stocks. For those that don’t have an interest in picking stocks and doing all the necessary research, he recommends simply buying a low-cost index fund that owns a diversified set of American businesses such as the S&P 500.

[00:36:33] Additionally, you’ll want a dollar cost average into those businesses over time and hold them for the long term. He says, quote, by periodically investing in an index fund, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when dumb money acknowledges its limitations, it ceases to be.

[00:36:54] On the other hand, if you are a know-something investor, able to understand business economics and to find five to 10 sensibly priced companies that possess important long-term competitive advantages. Conventional diversification makes no sense for you. It is apt simply to hurt your results and increase your risk.

[00:37:14] I cannot understand why an investor of that sort elects to put money into a business that is his 20th favorite, rather than simply adding that money to his top choices. The businesses he understands best and present the least risk, along with the greatest profit potential. End quote, Buffett practices.

[00:37:32] What he preaches here as at the time of his Q3 20 22 13 F, he has over 40% of his stock portfolio in Apple, in his top five holdings comprised of almost 75% of his portfolio. I also love how in order to increase his win rate with his investments and certainty of making money, Buffett wants to own businesses that are unlikely to experience major change.

[00:37:57] He says that quote, the reason for this is simple making either type of purchase. We are searching for operations that we believe are virtually certain to possess enormous competitive strength 10 or 20 years from now. A fast-changing industry environment may offer the chance for huge. But it precludes the certainty we seek.

[00:38:17] I should emphasize that as citizens, Charlie and I welcome change fresh ideas, new products, innovative processes, and the like. Cause our country’s living standards to rise and that’s clearly good as investors. However, our reaction to fermenting industry is much like our attitude towards space exploration.

[00:38:36] We applaud the endeavor, but prefer to skip the ride. Buffett doesn’t just want certainty within a business, though he’s also well aware that he needs to pay a fair price for these certainties as he states. Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.

[00:39:00] Then he goes on to talk about scenarios where the management team gets sidetracked. A far more serious problem occurs when the management of a great company gets sidetracked and neglects its wonderful base business while purchasing other businesses that are so-so or worse. When that happens, the suffering of investors is often prolonged.

[00:39:20] Unfortunately, that is precisely what transpired years ago at Koch. Would you believe that a few decades back, they were growing shrimp at Coca-Cola? Loss of focus is what most worries Charlie and me when we contemplate investing in a business that is outstanding. All too often we’ve seen value stagnate in the presence of hubris or of boredom that caused the attention of managers to wander.

[00:39:44] That’s not going to happen again at Coca-Cola. However, not given current and perspective managements end expanding on that idea that we should stick with highly certain businesses that are simple to underst. Warren says, after 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems.

[00:40:06] What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one foot hurdles that we could step over rather than because we acquired any ability to clear seven footers. The finding may seem. But in Boths business and investments, it is usually far more profitable to stick with the easy and the obvious than it is to resolve the difficult.

[00:40:31] On occasion, tough problems must be tackled. In other instances, a great investment opportunity occurs when the marvelous business encounters a one-time huge but solvable problem. As was the case many years back at both American Express and Geico overall, we’ve done better by avoiding dragons than slaying them.

[00:40:49] I think this is both a great investment and business lesson. If you were one that wanted to start a business, I think addressing a simple need is oftentimes much more profitable than solving something entirely new and complex. A lot of people see entrepreneurs on Shark Tank trying to innovate and create something new and trying, you know, change the world.

[00:41:11] Oftentimes, the most reliable and the most profitable. To being a successful entrepreneur is just to take a business model that already exists, a business that’s fairly simple, fairly straightforward, and create a business that improves on that model in some way, or add your own twist to it. I bet that if you met a wealthy entrepreneur in your city, and if you’re outside of Silicon Valley, I’d venture to guess that they became wealthy through a boring or non-sexy business, such as lawn care or vehicle servicing.

[00:41:42] Entrepreneurs addressing a basic need are like Buffett and that they’re hitting consistent singles rather than swinging for the fence. I also really take to heart Buffett’s advice on debt. He knows that Berkshire’s financial results very likely would’ve been significantly better had he utilize debt in order to invest more and more over the years.

[00:42:02] But however, that slim chance that things go the other way, make debt not worth it because you’re risking financial catastrophe. He says that unquestionably some people have become very rich through the use of borrowed money. However, that’s also been a way to get very poor. When leverage works, it magnifies your gains.

[00:42:22] Your spouse thinks you’re clever and your neighbors get envious, but leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices and to repeat, as we all learned in third grade and some relearned in 2008. Any series of positive numbers, however impressive the numbers may be evaporates when it’s multiplied by single zero.

[00:42:46] History tells us that leverage all too often produces zeros even when it’s employed by very smart people. The story reminds me of Jesse Livermore. He was known as one of the greatest traders to ever live. Yet he continually took on risk throughout his life and most of the time successfully made a ton of money.

[00:43:05] He had become one of the richest people in the world by profiting from the crash of the great depression in the stock market, in inflation adjusted terms. He would’ve been a billionaire at that time. Throughout Livermore’s entire life, his net worth would skyrocket up and then come crashing down. And he even declared bankruptcy a number of times throughout his life.

[00:43:25] Just after the Great Depression, Livermore ended up taking his own life as he had accumulated debt that exceeded the assets he owned, reminding us that even the smartest people in the world can get out over their skis with leverage and then just take unnecessary risk. Leverage is not only dangerous for individuals, but it can be just as dangerous for businesses as well.

[00:43:47] Companies with large debts often assume that they will be able to refinance that debt on maturity, but there are times when that’s not really possible either when the company is going through issues themselves or there’s just a shortage of credit in the overall market, such as what we saw in the great financial crisis.

[00:44:03] Buffett says that. Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that’s all is noticed. Even a short absence of credit can bring a company to its knees in September of 2008. In fact, it’s overnight disappearance in many sectors of the economy came dangerously close to bringing our entire country to its.

[00:44:29] And just reading that, it reminds me of my previous episode covering Guy Spear where he talked about how CarMax was really dependent on credit and when they couldn’t get credit during the great financial crisis, you know, their business and their stock just totally cratered. Buffett always keeps ample amounts of cash within Berkshire.

[00:44:47] First, he needs to be able to, you know, pay off any large insurance claims within the business. And second is so he can seize investment opportunities when chaos strikes and fear becomes wide. Following the bankruptcy of Lehman Brothers in 2008, this allowed Buffett to invest over 15 billion in 25 days into the markets transitioning a bit.

[00:45:09] One of the biggest lessons from Buffett I’ve learned in recent years is the importance of share repurchases. One might believe that share purchases are unproductive because that’s money that could otherwise be spent on the business. However, share purchases have a tremendous benefit to shareholders.

[00:45:27] Here’s Buffett’s take on share purchases. Quote, the companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value. As shareholders, we find this encouraging and rewarding for two important reasons.

[00:45:46] One that is obvious and one that is septal and not always understood the obvious point involving basic arithmetic, major share repurchases at prices well below per share. Intrinsic business value immediately increases in a highly significant way that value. When companies purchase their own stock, they often find it easy to get $2 of present value for.

[00:46:09] Corporate acquisition programs almost never do well, and in a discouragingly large number of cases fail to get anything close to $1 of value for each $1 expended. The other benefit of share purchases is less subject to precise measurement, but can be really important over time. By making repurchases when a company’s market value is well below its business value management clearly demonstrates that it is taking actions that enhance the wealth of shareholders rather than taking actions that expand management’s domain, but that do nothing or even harm shareholders seeing this, shareholderS&Potential shareholders increase their estimates of future returns from the.

[00:46:53] This upward revision in turn produces market prices more in line with intrinsic business value. These prices are entirely rational. Investors should pay more for a business that is lodged in the hands of a manager. With demonstrated pro-shareholder leanings than for one in the hands of a self-interested manager marching to a different drum.

[00:47:13] I cannot overstate how important I believe share purchases are when I’m analyzing a business I think is undervalued, that is producing a lot of cash, and I see that managers are buying back a lot of shares. That gives me further vindication that the stock is truly undervalued. Management is buying back shares themselves.

[00:47:32] But another added bonus is that management cares about the shareholder interest because they’re redirecting a lot of that cash that the business produces and sending it right back to the shareholders through those repurchases. I recently took a position in a company that has seen their sales and earnings increase over time, and while the stock is traded down in, in recent months, management has been aggressively buying back shares as well as increasing their dividends.

[00:47:56] This gives me further vindication because as long as the business is good and the fundamentals remain strong, then I almost see share repurchases as putting a floor on the stock price because eventually the market’s going to realize the stock is undervalued. Buybacks continue to be high relative to the stock price, then new buyers will come in and eventually push the stock price up or to look at it another way.

[00:48:18] I think the sell side or people selling the stock eventually becomes exhausted and there’s simply no one left to sell the shares at these low prices. Historically, Buffett hasn’t repurchase his own shares in Berkshire Hathaway, but has changed that More recently, it was in 2020, Berkshire Reed, 24 billion in their own shares, and then 27 billion in 2021, and that slowed down drastically in 2022 as well.

[00:48:43] And Buffett started to see better opportunities elsewhere. Buffett being one of the best capital allocators on the planet. When he is heavily repurchasing shares, it’s a pretty good sign that he believes the stock is undervalued. Otherwise, he wouldn’t do it. He believes that shareholder value is destroyed when shares are repurchased at a price above their intrinsic value.

[00:49:04] Another odd thing to consider with Berkshire repurchasing shares is that the volume of shares traded relative to the market value of those shares. It’s very low since not many people are buying and selling these shares. If a big buyer like Buffett comes in with billions of dollars, it might take him, you know, quite a bit of time to buy back those shares, and he’ll really move the market quite a bit if he brings in a lot of money.

[00:49:28] And then I wanted to round out today’s episode by talking about Berkshire’s successors. This topic has been quite popular for many years as Buffett and Munger have approached the end of their own tenure. Buffett says that, Choosing the right CEO is all important and a subject that commands much time at Berkshire board meetings.

[00:49:48] Managing Berkshire is primarily a job of capital allocation, coupled with selection and retention of outstanding managers to captain or operating subsidiaries. Obviously, the job also requires the replacement of a subsidiary CEO when that is called. These duties require Berkshire’s, CEO to be a rational, calm, and decisive individual who has a broad understanding of business and good insights into human behavior.

[00:50:14] It’s important as well that he knows his limits character is crucial. A Berkshire, CEO must be all in for the company, not for himself. He can’t help but earn money far in excess of any possible need for it. But it’s important that neither ego nor Avaris motivate him to reach for pay matching his most lavishly compensated peers, even if his achievements far exceed theirs.

[00:50:39] A CEO’s behavior has a huge impact on managers down the line. If it’s clear to them that shareholder interests are paramount to them, they will, with few exceptions also embrace that way of think. My successor will need one other particular strength, the ability to fight off the ABCs of business decay, which stands for arrogance, bureaucracy, and complacency.

[00:51:02] When these corporate cancers come to light, even the strongest of companies can falter. The examples available to prove the point are plentiful. So this Xer is well in line with the management principles that Buffett is looking for that I talked about on the episode I did, covering Warren Buffett’s 12 investment principles.

[00:51:21] In that episode, I talked about how Buffett wants to invest with managers who are honest and competent, as well as good capital allocators in acting and shareholders’ best interest. Also, he wants to invest with managers who are candid with shareholders. They’ll talk about the business exactly as it is, rather than trying to be dishonest, making accounting maneuvers to try and make the business look better than it is.

[00:51:43] And finally, he wants to invest with managers who resist the institutional imperative and who are really able to think for themselves and come to their own conclusions rather than just follow what all the other CEOs are. Today Todd Combs and Ted Weschler manage a smaller portion of Berkshire’s overall portfolio.

[00:52:01] Buff has said that these two people were the only ones they could find who read as much as they did. In one interview, Todd Combs was asked what his typical day looks like at Berkshire and he said he gets to the office around seven or eight in the morning and then he reads until seven or eight at night.

[00:52:16] So definitely wired similarly to Buffett in that he’s just a learning machine, always trying to bring in new inform. So I think that Berkshire will inevitably be in really good hands once Warren and Charlie pass the torch to the next managers. Alright, that wraps up today’s episode. If you don’t already, be sure to click follow on the podcast app you’re on so you can get notified of all of our future episodes coming out.

[00:52:40] Also, if you enjoyed this episode, I would really, really appreciate it if you shared it with just one person you think would also enjoy it. This will really help us out as we continue to provide these episodes to you all for free. And if you don’t subscribe to our daily newsletter, We Study Markets, be sure to get signed at theinvestorspodcast.com/westudymarkets. With that, thank you so much for tuning into today’s episode, and I hope to see you again next.

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