Key Points Warren Buffett’s Letter to Shareholders
March 11, 2020
Famed investor Warren Buffett is not only the world’s most famous investor. The 89-year-old Oracle of Omaha also fancies himself a teacher to others. In his annual letters to Berkshire Hathaway Inc’s (NYSE:BRK.A) (NYSE:BRK.B) shareholders, Buffett usually walks readers through the Berkshire’s large and diverse operations, dispersing bits of wisdom regarding the various businesses that the company owns, while sprinkling in nuggets of his investing philosophy along the way.
Buffett’s 2019 letter to shareholder was released on February 22, 2020,
and is another fun and informative read. In this article, we will summarise the
key points of the letter, both to Berkshire’s shareholders and the investing
public in general.
For Berkshire’s shareholders
Succession planning: Succession planning is a hot topic at Berkshire, given the advanced ages of both Warren Buffett and Charlie Munger. Two of the leading candidates to succeed Buffett and Munger are Ajit Jain and Greg Abel. Jain manages the insurance operations at Berkshire, while Abel runs the non-insurance business. In this year’s annual letter, Buffett revealed that Jain and Abel would be joining him and Munger for the Q&A period at the annual shareholders’ meeting in May. While this does not guarantee that either of them will be next in line to run the company, it is a strong endorsement of their value to the company and suggests that both individuals are likely to be with the company for the longer term.
Buffett has also outlined how his shares in Berkshire should be managed after his death. He has instructed the executors of his estate to each year convert a portion of his A shares into B shares and then distribute the B shares to various foundations. Those foundations will be required to deploy their grants promptly. Buffett estimates that it will take 12 to 15 years for the entirety of his Berkshire shares to make it way to the market. Given Buffett’s huge position in Berkshire, this assures that the stock itself will not be negatively impacted on a large scale in the time following his passing.
Stock repurchases: Buffett has in past letters discusses both the sense and nonsense of stock repurchases. He has reiterated that Berkshire will buy back its stock only if a) both he and Munger believe that it is selling for less than it is worth and b) the company, upon completing the repurchase, is left with ample cash. However, as calculations of intrinsic value are far from precise, Berkshire will only be aggressive in repurchasing shares only when the price-to-value discount widens considerably. And he made it clear that Berkshire will not, however, artificially prop up the price of its stock at any level.
Buffett has revealed that though in 2019, the company had spent US$5 billion in repurchasing 1% of the company. Furthermore, he urged shareholders having at least US$20 million in value of A or B shares and an inclination to sell, to contact the company directly. While Buffett does not quote the intrinsic value for Berkshire, the share repurchases and call-to-action for prospective shareholders suggests that both he and Munger still consider Berkshire’s shares to be attractively priced.
Power of retained earnings: Buffett has gone to great lengths in this year’s annual letter to highlight the power of retained earnings and the differentiation of Berkshire from other major corporations, given the huge combination of controlled and non-controlled business that it owns.
On page 5 of the annual letter, he
explains that in controlled companies, the earnings of each business flows
directly into the operating earnings that Berkshire reports. However, in
non-controlled companies (marketable stocks), only the dividends that Berkshire
reports are recorded in the operating earnings. Below is the list of
Berkshire’s 10 largest stock-market holdings of businesses, which is
distinguished between the earnings reported under GAAP accounting (these are
the dividends received by the company from its investees) and Berkshire’s share
of earnings in the investees, which are retained and put to work in the respective
Buffett calls this “non-recognition of earnings” a standout omission and indicates that the retained earnings of Berkshire’s investees are certain to be major importance in the growth of the company’s value over time.
For the general investing public
Deployment of funds: In the deployment of funds, Buffett indicates that he first seeks to invest in the many diverse businesses Berkshire already owns. Reinvestment in productive operational assets will forever be the company’s top priority.
As investors, we could do well to emulate Buffett’s approach. When searching for stock ideas, we should first look inside our portfolio and reinvest in those companies that are producing positive returns. “Adding to winners” should be our main focus rather than hunting for the next investment opportunity.
Investment checklist: When buying new businesses, Buffett checks for three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price. We suggest that you make good use of this investment checklist when evaluating your stock purchases.
Investing mistakes: Investing mistakes are inevitable. Buffett admits that he has made his fair share. Fortunately, he notes that the fallout from many errors has been reduced by a characteristic shared by most business that disappoints. As the years pass on, “poor” businesses stagnate, thereupon entering a state in which their operations require an ever-smaller percentage of Berkshire’s capital. Meanwhile, Berkshire’s “good” businesses often tend to grow and find opportunities for investing additional capital at attractive rates. Because of these contrasting trajectories, the assets employed at Berkshire’s winners gradually become an expanding portion of its total capital.
Whether you are a novice or experienced investor, everyone makes mistakes from time to time. It is easy to get discouraged by your losses, but contrary to conventional wisdom, it is possible still to achieve outstanding gains. And the key is to have a properly diversified portfolio where you “cut your losses short and let your winners run”. Consider this, the most that you can lose from an investment is 100% of your invested capital, but there is no upper limit to the returns that you can earn from another investment, this can be infinite!
Having conviction: On page 10 of the annual letter, Buffett lists Berkshire’s fifteen common stock investments as at year-end based on largest market value.
Buffett goes on to say that he and Munger do not view the US$248 billion detailed above as a collection of stock market wages – dalliances to be terminated because of downgrades by “the Street”, an earnings “miss”, expected Federal Reserve actions, possible political developments, forecasts by economists or whatever else might be the subject du jour.
We should also look upon our investments as ownership of pieces of business. Our conviction in these business purchases should not be easily shaken by everyday noises in the market. Instead, our focus should be on the long-term economics of each business that we own. The key is that the stock market just sets prices, so it exists to serve you, not instruct you.
Berkshire’s annual letters is always an enjoyable experience. There is always plenty
of wisdom to be gleaned from the pages, and the 2019 annual letter is no
different. We hope this simple summary adds value to your investing knowledge
as we embark into the next decade.
An accountant by training, F.I.R.E 2030 is a student of value investing since 2012. She believes that successful investing requires discipline and patience. But with the right knowledge and temperament, ordinary investors can achieve extraordinary results. These articles are her journals on stocks and the investing journey toward financial freedom in 2030.