The 2017 annual report for Berkshire Hathaway is available and, as usual, it’s chock-full of wisdom. The information written in the first few pages is priceless. Investors of all backgrounds and ages can benefit from the words of Warren Buffett. As the world’s greatest investor, there are 85.3 billion reasons to believe Mr. Buffett knows what he’s talking about; his guidance is timeless.
Here are a few nuggets I mined from the pages of this year’s annual report.
He and his partner, Mr. Charlie Munger, don’t use leverage to enhance returns. They shun debt because they don’t want to put their current assets at risk. If you need proof of how leverage can destroy a company look no further than Toys R. Us. After 70 years in business this storied franchise is shutting its doors forever due to a mountain of debt. Using margin to try and increase your returns is just as foolish. Leverage looks good when the market is rising but it will become a nightmare during a declining one.
Mr. Buffett doesn’t “depend on the kindness of strangers” to help him grow his business. Meaning he doesn’t rely on bankers or money lenders to fuel his growth. Berkshire invests in Treasury Bills for safety, liquidity and opportunities. Their T-Bills helped them during the financial crisis of 2008-2009 and it gives them a cushion to “withstand economic discontinuities, including such extremes as extended market closures.” T-Bills aren’t sexy, and bonds are boring. Owning boring bonds while stocks are falling is comforting. If you’re concerned about the recent stock market volatility, add T-Bills and bonds to your portfolio.
Investors want to know what tomorrow will bring, they want a crystal ball, so they can position their portfolio accordingly. No one knows what will happen in the future, including Mr. Buffett. When discussing the probability of a mega-catastrophe in the U.S. he says, “No one, of course, knows the correct probability.” When talking about market declines he adds: “No one can tell you when these (declines) will happen. The light can at any time go from green to red without pausing at yellow.”
He views stocks as a “businesses, not as ticker symbols.” He doesn’t buy stocks “based on their ‘chart’ patterns, the ‘target’ prices of analysts or the opinions of media pundits.” He adds: “In America, equity investors have the wind at their back.” He also expects to own companies “indefinitely.”
Berkshire likes to acquire entire companies with a market cap in the “$5-$20 billion range” that are easy and simple to understand with “consistent earning power.” If a company meets the criteria set forth by Mr. Buffett and Mr. Munger they can give “a very fast answer – customarily within five minutes – as to whether we’re interested.”
During the last 53 years the share price of Berkshire Hathaway has appreciated significantly but they “have suffered four truly major dips.” The drops in the price of the stock are listed below. If you panicked and sold your shares during one of these drops, you would’ve missed extraordinary long-term returns from Berkshire.
March 1973 – January 1975 the price of Berkshire stock fell 59.1%.
October 2, 1987 – October 27, 1987 the stock fell 37.1%.
June 19, 1998 – March 10, 2000 it fell 48.9%.
September 19, 2008 – March 5, 2009 it fell 50.7%.
The best part of this year’s annual report is when Mr. Buffett recaps his bet with Protégé Partners. In December of 2007, he bet Protégé that an unmanaged S&P 500 index fund would outperform five funds-of-funds. These five funds “owned interests in more than 200 hedge funds.” The funds-of-funds could trade their hedge funds and add “new ‘stars’ while exiting their positions in ones whose managers had lost their touch.” The active fund managers could trade as often as they wished while the index fund was left alone, a pure buy and hold strategy. He recommends to “stick with big, ‘easy’ decisions and eschew activity.”
The hedge fund managers in the bet were receiving “fixed fees averaging a staggering 2.5% of assets.” As he says, “Performance comes, performance goes. Fees never falter.”
How did this bet turnout? Mr. Buffett’s index bet trounced Protégé Partners, their funds-of-funds and the 200 hedge funds. In fact, one of the funds was liquidated before the ten-year bet was over. The average annual return for the Protégé team was 2.9% while the S&P 500 index returned 8.5%! He said the returns these “helpers” generated was “really dismal.” All the king’s horses, and all the king’s men…
He does mention that the risks of owning stocks is higher than owning short term bonds but over time they “become progressively less risky than bonds.” He adds, “As has been the case since 1776 – whatever its problems of the minute, the American economy was going to move forward.”
As the market swoons, Mr. Buffett likes a “depressed market” because it gives him the opportunity to buy companies at reduced prices. When the market falls, he and his team go shopping: “So when the market plummets – as it will from time to time – neither panic nor mourn.”
The infinite wisdom of Mr. Buffett carries on and we’d be wise to follow his counsel. Here is a recap of his guidance:
- Avoid leverage and debt.
- Buy bonds and T-Bills for safety, liquidity, emergencies and opportunities.
- It’s impossible to know the future so invest your assets based on your financial goals.
- Buy businesses and not ticker symbols. Valuation and earnings matter.
- Focus on simple investments that are easy to understand.
- When, not if, stocks fall use it as an opportunity to add quality companies to your investment portfolio. Buying the dips has worked well for the past few hundred years and it will probably continue to do so going forward.
- Buy low-cost index funds and hold them forever. A buy and hold strategy is a great way to create generational wealth.
- Fees matter, so make sure they’re low. A fee audit can help you identify the fees you’re paying.
- Indefinitely is a long time so don’t worry about the short-term moves in the stock market. Your financial goals are more important than short-term volatility.
Last, Mr. Buffett references Rudyard Kipling’s, If, in this year’s annual report so here’s a link to the poem:
IF you can keep your head when all about you are losing theirs… ~ Rudyard Kipling
Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX. For more information please visit www.parrottwealth.com.
Note: Past performance is not a guarantee of future returns. Your returns may differ than those posted in this blog and investments aren’t guaranteed.