Book Review — Berkshire Hathaway Shareholder Letter 2014
Warren Buffett is considered the most successful investor, but he’s made lots of mistakes too and he never baulks at talking about them.
The 2014 letter, which marked the 50th anniversary of Berkshire Hathaway (NYSE: BRK.A) was full of recanting his losses and mistakes. According to Bill Gates, this letter was one of the best Buffett has written.
Buffett went down memory lane, in the early days of Berkshire when it was still a textile company. He talked about significant mistakes, one that cost him and his partners some billions of dollars, meeting Charlie Munger and how his investment strategy has changed over the years because of Munger as his investment partner.
Some valuable investment lessons from the letter:
1. Avoiding bad investments is just as important as finding the right ones
One of the most quoted lines of Buffett is: Never invest in a business you don’t understand. But the oracle himself made that error in the 1960s.
What is now Berkshire Hathaway, a 500-billion dollar conglomerate, was once a failing textile manufacturing that marked one of the monumental mistakes of Buffett’s career.
He decided to take over Berkshire rather than cashing out on the company and make 50 per cent for the members of his partnership, Buffett Partnership Ltd. The CEO of Berkshire had offered Buffett a premium on the shares of the company, but he refused because the man offered $0.125 less than what was agreed. Instead, he aggressively bought more Berkshire shares and removed the CEO.
However, Buffett admits in the letter that the textile industry was a terrible business he didn’t know anything about at the time. “I found myself with more than 25% of BPL’s capital invested in a terrible business about which I knew very little. I became the dog who caught the car.”
After running Berkshire down, he still went on to buy another textile company, Waumbec Mills, which ended a disaster too.
The lessons learned probably kept him from investing in the technology sector in the late 1990s and early 2000s, given his lack of knowledge of the tech industry. Though that meant he missed out on companies like Amazon and Google.
Nigeria’s government could also apply this lesson too as it continues to invest taxpayers’ monies into the electricity industry without any feasible return.
2. Be willing to learn and unlearn
When a strategy has worked so well for a long time, you tend to fall for the Hot Hand Fallacy; a phenomenon that makes us believe that a person who experiences a successful outcome has a greater chance of success in further attempts. It’s common with gamblers, but also prevalent among investors and businesses.
Buffett used to have an investment approach he called cigar-butt strategy. That is buying a stock way below its book value and at a wide discount from the company’s per-share working capital. It was this strategy that informed buying Berkshire in the first place.
“Buying the stock at that price was like picking up a discarded cigar butt that had one puff remaining in it. Though the stub might be ugly and soggy, the puff would be free. Once that momentary pleasure was enjoyed, however, no more could be expected,” he said, explaining the strategy.
“My cigar-butt strategy worked very well while I was managing small sums. Indeed, the many dozens of free puffs I obtained in the 1950s made that decade by far the best of my life for both relative and absolute investment performance.”
The constant thing in life is change and investors have to learn to adapt their strategies to present economic realities; and because an investment worked out for another investor doesn’t mean you can replicate the return — ask people who invested in bitcoin in December 2017 when the price of one bitcoin peaked at $20, 000.
It took Charlie Munger, Berkshire Hathaway’s current Vice-Chairman, to convince Buffett that it’s a better approach to buy wonderful businesses at fair prices.
“It took Charlie Munger to break my cigar-butt habits and set the course for building a business that could combine huge size with satisfactory profits.”
3. Cash reserves are important to take advantage of unforeseen events.
“Financial staying power requires a company to maintain three strengths under all circumstances: (1) a large and reliable stream of earnings; (2) massive liquid assets and (3) no significant near-term cash requirements.”
While forecasting Berkshire’s fortune for the next 50 years, Buffett remarked that one of the reasons the company was able to play a huge role during the 2008–2009 meltdown was because they had a strong cash reserve. Buffett made over $10 billion in profits for Berkshire after the recession because it acted as the “first-responder” for blue-chip companies like Mars, Goldman Sachs, Bank of America, and Dow Chemical.
Like Buffett says, cash is to a business as oxygen is to an individual. Put another way: cash is to an investor as oil money is to Nigeria’s government.
Read the full shareholder letter here.
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