What I Learned From Warren Buffett’s 2017 Shareholder Letter

When the Oracle of Omaha talks, you must listen!

I’m finally getting to the letter Warren Buffett wrote to his investors last year.

In this post, I’ve highlighted the things I found to be most most profound. I read Buffett’s letters to learn about the way he thinks, and why. Also, occasionally, I think it’s possible to find a great investing idea of your own inside:

1 The ease of margin is always right in front of you. But it’s dangerous. But the leverage screams profits, and bigger earnings. Buffett has done an incredible job never getting caught in the madness of leverage:

“Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need. We held this view 50 years ago when we each ran an investment partnership, funded by a few friends and relatives who trusted us. We also hold it today after a million or so “partners” have joined us at Berkshire.”

2 Being self-sufficient is the ultimate goal. Buffett would always rather be the one who helps someone else than the one who needs help from others:

Charlie and I never will operate Berkshire in a manner that depends on the kindness of strangers — or even that of friends who may be facing liquidity problems of their own. During the 2008–2009 crisis, we liked having Treasury Bills — loads of Treasury Bills — that protected us from having to rely on funding sources such as bank lines or commercial paper.

3 Buffett acquires businesses for a living. That is essentially how he’s done so well — buying undervalued companies, and watching them grow into their true value. On the theme of no debt, he writes this about buyouts:

“At Berkshire, in contrast, we evaluate acquisitions on an all-equity basis, knowing that our taste for overall debt is very low and that to assign a large portion of our debt to any individual business would generally be fallacious.”

4 A subtle note about a massive tax change, and how it will impact certain companies reporting methods:

“The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period… For analytical purposes, Berkshire’s “bottom-line” will be useless.”

5 Here’s why Berkshire Hathaway is one of the only companies to release earnings on a Friday evening. More companies should do this:

“We will attempt to alleviate this problem by continuing our practice of publishing financial reports late on Friday, well after the markets close, or early on Saturday morning. That will allow you maximum time for analysis and give investment professionals the opportunity to deliver informed commentary before markets open on Monday. Nevertheless, I expect considerable confusion among shareholders for whom accounting is a foreign language.”

6 What does Buffett look for when he acquires a new company? Let this quick explanation guide you through his checklist:

“In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price.”

7 Throughout his entire career, Buffett has done a remarkable job never getting caught up in the hype of Wall Street flash or excess. Instead, to this day, he finds ways to point out their flaws:

“Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.”

8 Look who’s quietly becoming one of the nation’s biggest real estate brokers:

“But, year-by-year, the company added brokers and, by the end of 2016, HomeServices was the second-largest brokerage operation in the country — still ranking, though, far behind the leader, Realogy. In 2017, however, HomeServices’ growth exploded. We acquired the industry’s third-largest operator, Long and Foster; number 12, Houlihan Lawrence; and Gloria Nilson. With those purchases we added 12,300 agents, raising our total to 40,950. HomeServices is now close to leading the country in home sales.”

9 Buffett’s biggest holdings are still mostly all American companies:

“Almost 90% of our investments are made in the United States. America’s economic soil remains fertile.”

10 Buffett never forgets who his managers are, and to praise them. I respect that about him. I am sure they are rewarded generously for their work as well:

“Some of the stocks in the table are the responsibility of either Todd Combs or Ted Weschler, who work with me in managing Berkshire’s investments. Each, independently of me, manages more than $12 billion; I usually learn about decisions they have made by looking at monthly portfolio summaries.”

11 Does Warren Buffett believe in media coverage of stocks or technical analysis? The answer is no, and never. He’s long-term, and he does not scare easy:

“Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well. Sometimes the payoffs to us will be modest; occasionally the cash register will ring loudly. And sometimes I will make expensive mistakes. Overall — and over time — we should get decent results. In America, equity investors have the wind at their back.”

12 I am posting this quote only because I think it’s important to remember who Buffett’s mentors were:

“The connection of value-building to retained earnings that I’ve just described will be impossible to detect in the short term. Stocks surge and swoon, seemingly untethered to any year-to-year buildup in their underlying value. Over time, however, Ben Graham’s oft-quoted maxim proves true: “In the short run, the market is a voting machine; in the long run, however, it becomes a weighing machine.”

13 The next time you go for margin, or leverage, remember this table. Also remember how he’s managed to hold through this all:

“This table offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.”

14 Buffett quoting Rudyard Kipling is everything. I also find it interesting how he inserts this into his letter. Between the repeated mentions of margin, debt, and a Kipling poem, I am starting to believe that maybe, Buffett is sending a subtle message to tread carefully in a market that continues to boom higher since the Financial Crisis:

“When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt. That’s the time to heed these lines from Kipling’s If: “If you can keep your head when all about you are losing theirs . . . If you can wait and not be tired by waiting . . . If you can think — and not make thoughts your aim . . . If you can trust yourself when all men doubt you… Yours is the Earth and everything that’s in it.”

15 Here’s the bet that should have everyone, even you as the start-up investor, questioning the “big names” on Wall Street:

“American investors pay staggering sums annually to advisors, often incurring several layers of consequential costs. In the aggregate, do these investors get their money’s worth? Indeed, again in the aggregate, do investors get anything for their outlays? Protégé Partners, my counterparty to the bet, picked five “funds-of-funds” that it expected to overperform the S&P 500. That was not a small sample. Those five funds-of-funds in turn owned interests in more than 200 hedge funds. Essentially, Protégé, an advisory firm that knew its way around Wall Street, selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund. This assemblage was an elite crew, loaded with brains, adrenaline and confidence. The managers of the five funds-of-funds possessed a further advantage: They could — and did — rearrange their portfolios of hedge funds during the ten years, investing with new “stars” while exiting their positions in hedge funds whose managers had lost their touch.”

16 Who won the bet between Buffett, and Protege Partners? It was not close:

17 If you read enough letters from Buffett, you start to see how he’s a wizard fighting against Wall Street lingo, classical academic thinking, and mob psychology. It’s a reminder to always think independently:

“Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period — or even to look foolish — is also essential.”

18 This next section was pure gold for me. Yes, he is a long-term investor, but it’s clear that in words of Keynes, when the facts change he changes his mind:

“By November 2012, our bonds — now with about five years to go before they matured — were selling for 95.7% of their face value. At that price, their annual yield to maturity was less than 1%. Or, to be precise, .88%. Given that pathetic return, our bonds had become a dumb — a really dumb — investment compared to American equities. Over time, the S&P 500 — which mirrors a huge cross-section of American business, appropriately weighted by market value — has earned far more than 10% annually on shareholders’ equity (net worth). In November 2012, as we were considering all this, the cash return from dividends on the S&P 500 was 2 1⁄2% annually, about triple the yield on our U.S. Treasury bond. These dividend payments were almost certain to grow. Beyond that, huge sums were being retained by the companies comprising the 500. These businesses would use their retained earnings to expand their operations and, frequently, to repurchase their shares as well. Either course would, over time, substantially increase earnings-per-share. And — as has been the case since 1776 — whatever its problems of the minute, the American economy was going to move forward. Presented late in 2012 with the extraordinary valuation mismatch between bonds and equities, Protégé and I agreed to sell the bonds we had bought five years earlier and use the proceeds to buy 11,200 Berkshire “B” shares. The result: Girls Inc. of Omaha found itself receiving $2,222,279 last month rather than the $1 million it had originally hoped for.”

19 If Buffett were to define the word investing to you, or to you anyone, in the simplest amount of words possible, it might go like this:

Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date. “Risk” is the possibility that this objective won’t be attained.

20 It seems, at times, that people love to simplify risk. But it is generally not that simple. You might here someone say that you should have a portfolio of 60/40 stocks vs. bonds. But that entirely ignores what that ratio is actually made up of:

“I want to quickly acknowledge that in any upcoming day, week or even year, stocks will be riskier — far riskier — than short-term U.S. bonds. As an investor’s investment horizon lengthens, however, a diversified portfolio of U.S. equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates. It is a terrible mistake for investors with long-term horizons — among them, pension funds, college endowments and savings-minded individuals — to measure their investment “risk” by their portfolio’s ratio of bonds to stocks. Often, high-grade bonds in an investment portfolio increase its risk.”

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