Tag Archives: The Intelligent Investor

Warren Buffett’s 2013 letter to the shareholders of Berkshire Hathaway

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.

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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:

“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.”

Offer Letter for NFM (retrieved from BRK annual report [PDF, 6.5MB])

Offer Letter for NFM (retrieved from BRK 2013 annual report [PDF, 6.5MB])

On certain fundamentals of investing:

  • “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 […]”

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Warren Buffett’s 2012 letter to the shareholders of Berkshire Hathaway: dividends, books and sport

Last Saturday Warren Buffett’s 2012 letter to the shareholders of Berkshire Hathaway [PDF, 155 KB] was released. As always, I strongly encourage you to read it (23 pages).

From this year’s letter, I wanted to comment on 3 things:

  • Lesson on dividends’ policy
  • Books
  • Running

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Dividends’ Policy

In my opinion the great lesson from this letter starts at page 18, when Warren explains the different ways a company has to allocate earnings. He makes a comparison between dividends and what he calls the “sell-off” scenario, where a shareholder can be better off when the company is not paying dividends and instead reinvesting all earnings while the shareholder sells part of his shares to obtain some cash.

See the explanation below (bit long):

“We’ll start by assuming that you and I are the equal owners of a business with $2 million of net worth. The business earns 12% on tangible net worth – $240,000 – and can reasonably expect to earn the same 12% on reinvested earnings. Furthermore, there are outsiders who always wish to buy into our business at 125% of net worth. Therefore, the value of what we each own is now $1.25 million.

You would like to have the two of us shareholders receive one-third of our company’s annual earnings and have two-thirds be reinvested. That plan, you feel, will nicely balance your needs for both current income and capital growth. So you suggest that we pay out $80,000 of current earnings and retain $160,000 to increase the future earnings of the business. In the first year, your dividend would be $40,000, and as earnings grew and the onethird payout was maintained, so too would your dividend. In total, dividends and stock value would increase 8% each year (12% earned on net worth less 4% of net worth paid out).

After ten years our company would have a net worth of $4,317,850 (the original $2 million compounded at 8%) and your dividend in the upcoming year would be $86,357. Each of us would have shares worth $2,698,656 (125% of our half of the company’s net worth). And we would live happily ever after – with dividends and the value of our stock continuing to grow at 8% annually.

There is an alternative approach, however, that would leave us even happier. Under this scenario, we would leave all earnings in the company and each sell 3.2% of our shares annually. Since the shares would be sold at 125% of book value, this approach would produce the same $40,000 of cash initially, a sum that would grow annually. Call this option the “sell-off” approach.

Under this “sell-off” scenario, the net worth of our company increases to $6,211,696 after ten years ($2 million compounded at 12%). Because we would be selling shares each year, our percentage ownership would have declined, and, after ten years, we would each own 36.12% of the business. Even so, your share of the net worth of the company at that time would be $2,243,540. And, remember, every dollar of net worth attributable to each of us can be sold for $1.25. Therefore, the market value of your remaining shares would be $2,804,425, about 4% greater than the value of your shares if we had followed the dividend approach.

Moreover, your annual cash receipts from the sell-off policy would now be running 4% more than you would have received under the dividend scenario. Voila! – you would have both more cash to spend annually and more capital value.”

As always, I believe that the best way is to make (play with) the numbers yourself, so you get to understand it once and for all. I paste here the numbers for those not being number-crunchers:

Buffett's sell-off case vs. dividends.

Buffett’s sell-off case vs. dividends.

Books

Over 2 years ago, I read Buffett’s biography “The Snowball: Warren Buffett and the Business of Life“, by Alice Schroeder (of which I wrote a post); it seems that I will have to get the newest one by Carol Loomis, “Tap Dancing to Work: Warren Buffett on Practically Everything“.

There is another book that I should read, according to the following passage in the letter:

“Above all, dividend policy should always be clear, consistent and rational. A capricious policy will confuse owners and drive away would-be investors. Phil Fisher put it wonderfully 54 years ago in Chapter 7 of his Common Stocks and Uncommon Profits, a book that ranks behind only The Intelligent Investor and the 1940 edition of Security Analysis in the all-time-best list for the serious investor. Phil explained that you can successfully run a restaurant that serves hamburgers or, alternatively, one that features Chinese food. But you can’t switch capriciously between the two and retain the fans of either.”

I’ve got all three books in the shelf since 5 years ago, it’s a shame that I have not yet read or gone through the first one!

Running

I found one final surprising and hilarious passage at the end of the letter embedded in the information related to the shareholders meeting:

“On Sunday at 8 a.m., we will initiate the “Berkshire 5K,” a race starting at the CenturyLink. Full details for participating will be included in the Visitor’s Guide that you will receive with your credentials for the meeting. We will have plenty of categories for competition, including one for the media. (It will be fun to report on their performance.) Regretfully, I will forego running; someone has to man the starting gun.

I should warn you that we have a lot of home-grown talent. Ted Weschler has run the marathon in 3:01. Jim Weber, Brooks’ dynamic CEO, is another speedster with a 3:31 best. Todd Combs specializes in the triathlon, but has been clocked at 22 minutes in the 5K.
That, however, is just the beginning: Our directors are also fleet of foot (that is, some of our directors are).

Steve Burke has run an amazing 2:39 Boston marathon. (It’s a family thing; his wife, Gretchen, finished the New York marathon in 3:25.) Charlotte Guyman’s best is 3:37, and Sue Decker crossed the tape in New York in 3:36. Charlie did not return his questionnaire.”

I would have loved to take part in that race. I will probably do so in some other year :-).

Final confession

Luca and I went a couple of years ago to Berkshire Shareholder meeting. This year’s meeting will take place on May 4th.

This year, Luca and I will get married on May 11th, but one of the dates we considered was April 27th, and one of the drivers behind it was to be able to attend 2013 BRK meeting during the honeymoon…

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Woodstock for Capitalists

Right now, while this is being published and if everything is going as planned, Luca and I are in Omaha, Nebraska. By now we should be already registered to attend tomorrow the annual shareholders meeting of Berkshire Hathaway, company famous for its CEO and Chairman, Warren Buffett.

While studying an MBA at EOI business school in Seville some 5 years ago, I developed a special interest in investing. I started reading some books and this led me to the bible of them all, Benjamin Graham’s “Intelligent Investor”, which I have referred to in this blog a number of times.

Warren Buffett, of World fame, was one of Graham’s disciples. He started very early setting up small businesses and investing in stocks. Decades later, he is known as the “oracle of Omaha” and considered to be on of the best investors ever.

About 2 years ago, Luca and I decided to invest in Berkshire Hathaway, mainly to acquire the right to attend this weekend’s party (you may call us freaks, right). Sure, we have arranged a nice holiday trip around it passing by Montreal, DC, Chicago and even Des Moines (!). But the end of this trip, was attending the shareholders’ meeting (others travel to attend a concert of U2!).

If you want to grasp what the experience may feel like, start by reading one of his letters to the shareholders of BRK, e.g. this year’s letter [PDF]. It’s 26 pages, ok, but it won’t take you more than 1 or 2 hours, and who knows, it may change your view of saving, investing, managing businesses, doing you a great favour. Apart from that, you’ll have a great fun reading it, as it is a very entertaining and humorous piece.

Finally, a positive note from an extract of the letter to reflect on, in today’s times:

“Don’t let that reality spook you. Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective.”

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My investment fund

After two years of investing for fun, I was troubled because neither the ING internet banking tool nor Google Finance enabled me to correctly monitor the profitability of our investments.

  • Google Finance shows each new addition of capital as an increase of assets (price) in the same way as if a particular stock had increased its market price. So after a year our portfolio showed an increase of 97%… but most of it was due to new additions of capital.
  • While with ING, each time we added some cash it lowered the profitability as it went directly to the denominator of the equation (the same happens with Google Finance “gain”).

I discussed this with Luca, read a little bit and then I found out that the best way would be to treat ourselves as a mutual open-ended fund (fondo de inversión). I had to define a net asset value per share (valor liquidativo de la participación) at the beginning of the period and then treat each addition of capital as an issue of new shares to ourselves.

After spending sometime digging in the files and emails of the past two years, reading a bit about how to treat these values, etc., from now on we can readily compare at any moment our “J&L investment fund” with any other fund, stock or index. So did I…

If we had a commercial mutual fund we would announce ourselves with something like:

  • In the year 2010 the gains of the fund were +22.8% compared to
    • S&P 500 ~ +13% (target index)
    • Dow Jones ~ +11%
    • NASDAQ ~ +17%
    • IBEX 35 ~ -17%
    • Euro Stoxx 50 ~ -10%
  • The gains of the fund since its creation in January 2009 have been +86.6%, with a compounded annual gain of +37.6%.

Not bad.

Nevertheless, if we compare it to the leading Spanish value investing fund managers from Bestinver, in 2010:

  • Bestinfond ~ +19%;
  • Bestinver Internacional ~ +26%;
  • Bestinver Bolsa ~ +5%

Since January 2009 both Bestinfond and Bestinver Internacional have fared better than “J&L”, though not Bestinver Bolsa.

Today, now that is already defined, the net asset value per share is 57.19€… however “J&L fund” is not yet that open-ended: it’s open to our own additions to the fund but not to third-party capital… maybe in a couple of years we go and set up an investment club or fund :-).

After reading Ben Graham’s book “Intelligent Investor” I wanted to give it a try with investing, this is why I invest in stocks myself, but, clearly, if you are tempted to follow third-party advice, rumours, tips, etc., you’ll be better off just investing in a low-cost index fund (a strategy described by Burton G. Malkiel’s book “A Random Walk Down Wall Street”) or take a look at the above-mentioned value investing managers.

NOTE: “J&L fund” numbers are pre-tax of capital gains, include dividends (after-tax) and are net of transaction costs & commissions.

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The Snowball, Warren Buffett bio (book review)

Last Christmas, my brother gave me “The Snowball: Warren Buffett and the Business of Life“, by Alice Schroeder. He completely hit on the spot, though I only started reading it during last August holidays (Luca also started reading it to the point that she ended up buying her own Kindle version of it!).

The book is a thorough review of Buffett’s life, including relationships with family & friends and investment decisions. I had previously read other books about Buffett, but they were merely about his investment “strategy” so to say, nothing compared to this one. To complete the book, the author made over 250 interviews, so you can imagine the many insights contained in it.

There are many lessons or just ideas that can be taken from this book. Let me just point the few I can recall at the moment of writing this post:

  • The Inner Scorecard: the idea of acting and valuing yourself according to what you care about and not according to what others’ deem important.
  • The concept of margin of safety: from Benjamin Graham (recommended reading “The Intelligent Investor“).
  • Circle of competence: the idea of looking for simple business that have an enduring competitive advantage (technology companies are not that simple).
  • Cigar butts: companies which are worth more “death than alive” (looking for cheap price to book).
  • Snowball: the idea that compounding interest acts as a snowball falling down the hill, the sooner you start the larger the ball will be down the road (thinking about retirement here).
  • The story of the genie: or that you should invest in your own health as your body is the only one you are going to be given in this life.
  • The Ovarian lottery and the idea that philanthropy achieves more if exercised now and trying to maximize its impact.

Throughout the book you get to learn about many great entrepreneurial characters (e.g. Rose Blumkin, Bill Gates); about the workings of the board of directors of some companies (e.g. Coca Cola, Berkshire Hathaway); about some of the most impressive falls in corporate history (e.g. Solomon Brothers, Long Term Capital Management); about several depressions, recessions and crisis; and above all you learn about what were the thoughts and calculations behind some of Buffett’s investments decisions since the early 1940’s to date.

I definitely recommend this book (700+ pgs.).

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