Last Friday (28/02/2014), Warren Buffett’s 2013 letter to the Shareholders of Berkshire Hathaway [PDF, 252 KB] was released. As always, I strongly encourage you to read it (23 pages).
From this year’s letter, I wanted to bring attention to the following passages, on value creation, insurance business, intangible assets amortization, simplicity of some transactions, fundamentals of investing and a sound investing strategy.
On what is the focus of Warren and Charlie to create value:
“Charlie and I hope to build Berkshire’s per-share intrinsic value by (1) constantly improving the basic earning power of our many subsidiaries; (2) further increasing their earnings through bolt-on acquisitions; (3) benefiting from the growth of our investees; (4) repurchasing Berkshire shares when they are available at a meaningful discount from intrinsic value; and (5) making an occasional large acquisition. We will also try to maximize results for you by rarely, if ever, issuing Berkshire shares.”
On the keys of insurance business:
“[…] a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively assess the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained.
[…] That old line, “The other guy is doing it, so we must as well,” spells trouble in any business, but in none more so than insurance.”
On the different views to be taken of certain intangible assets amortization no matter what accounting rules say about them:
“[…] serious investors should understand the disparate nature of intangible assets: Some truly deplete over time while others in no way lose value. With software, for example, amortization charges are very real expenses. Charges against other intangibles such as the amortization of customer relationships, however, arise through purchase-accounting rules and are clearly not real costs. GAAP accounting draws no distinction between the two types of charges. Both, that is, are recorded as expenses when earnings are calculated – even though from an investor’s viewpoint they could not be more different.
[…] Every dime of depreciation expense we report, however, is a real cost. And that’s true at almost all other companies as well. When Wall Streeters tout EBITDA as a valuation guide, button your wallet.”
On simplicity of some transactions and trust:
On certain fundamentals of investing:
“I think back to August 30, 1983 – my birthday – when I went to see Mrs. B (Rose Blumkin), carrying a 1 1⁄4-page purchase proposal for NFM that I had drafted. (It’s reproduced on pages 114 – 115.) Mrs. B accepted my offer without changing a word, and we completed the deal without the involvement of investment bankers or lawyers (an experience that can only be described as heavenly). Though the company’s financial statements were unaudited, I had no worries. Mrs. B simply told me what was what, and her word was good enough for me.
[…] Aspiring business managers should look hard at the plain, but rare, attributes that produced Mrs. B’s incredible success. Students from 40 universities visit me every year, and I have them start the day with a visit to NFM. If they absorb Mrs. B’s lessons, they need none from me.”
- “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. When promised quick profits, respond with a quick “no.”
- 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. […] omniscience isn’t necessary; you only need to understand the actions you undertake.
- If you instead focus on the prospective price change of a contemplated purchase, you are speculating. […]
- […] 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. […]
- Forming macro opinions or listening to the macro or market predictions of others is a waste of time. […]”
A sound investing strategy:
“[…] The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.
[…] My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) […]”
His best investment ever:
“[…] I learned most of the thoughts in this investment discussion from Ben’s book The Intelligent Investor, […]
[…] For me, the key points were laid out in what later editions labeled Chapters 8 and 20. […]
I can’t remember what I paid for that first copy of The Intelligent Investor. Whatever the cost, it would
underscore the truth of Ben’s adage: Price is what you pay, value is what you get. Of all the investments I ever
made, buying Ben’s book was the best […]”