Learning From The Masters | Warren Buffet's 2017 Letter To Shareholders

Knowledge | Investing | Warren Buffet | Berkshire Hathaway

Every year in late February, Berkshire Hathaway releases the now infamous letter to shareholders written by none other than Warren Buffet himself.  Investors, specifically value investors, eagerly await its release because Buffet does something very few other companies/CEOs do: he's open and honest about the performance of the conglomerate and has a knack for simplifying the complex in order to teach.

With 2017's iteration coming out this past weekend, you can find it here, I wanted to share some of my takeaways from this years letter.

Warren starts off the letter, as he does every year, with a table showing per share book value of Berkshire, per share market value and the performance of the S&P 500 with dividends reinvested.  In 2017 the results were 23.0%, 21.9% and 21.8%, respectively.  

Even more impressive is the compounded gains since he took the reins in 1965.  At the end of 2017 Berkshire's book value per share has compounded at 19.1% for 52 years which comes to a staggering 1,088,029% cumulative gain.  Likewise, the market value, or share price, for Berkshire has grown at 20.9% over that same time for a cumulative gain of 2,404,748%.  Compare that to the S&P 500 which grew 9.9% per year for a cumulative gain of 15,508%.  Compound interest is truly an amazing thing.

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.

I don't understand this new GAAP rule at all, but it's going to make things much more difficult going forward when analyzing companies.  The bottom line GAAP net income/EPS numbers, as skewed as they were before, are going to be even less important going forward in order to determine the real earnings power of the business.  

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.

That's the hallmark of investing right there.  While you can still normally find companies that check off most of the boxes it still comes down to the price/valuation to determine whether the investment makes any sense.  I wasn't investing new capital in 2017 but with the bull run that the markets went on during the year finding companies that fit that last requirement was becoming more and more difficult.

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.

HA! Dampened our returns over the years and they still generated twice the return that the S&P 500 delivered.  That last line was one of my favorites of the entire letter.  At times it makes sense to de-risk your portfolio whether by asset allocation or the specific investments or just holding on to more cash rather than investing it at sub-optimal valuations.

Despite our recent drought of acquisitions, Charlie and I believe that from time to time Berkshire will have opportunities to make very large purchases. In the meantime, we will stick with our simple guideline: The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.

Sometimes the best thing you can do is nothing.  

Betting on people can sometimes be more certain than betting on physical assets.

Buffet was speaking about Precision Castparts' CEO Mark Donegan.  Even one of the greatest investors in history realizes that sometimes it's finding the right person and using their expertise more than anything else.

Berkshire’s goal is to substantially increase the earnings of its non-insurance group. For that to happen, we will need to make one or more huge acquisitions. We certainly have the resources to do so. At year end Berkshire held $116.0 billion in cash and U.S. Treasury Bills (whose average maturity was 88 days), up from $86.4 billion at year end 2016. This extraordinary liquidity earns only a pittance and is far beyond the level Charlie and I wish Berkshire to have. Our smiles will broaden when we have redeployed Berkshire’s excess funds into more productive assets.

The reason Buffet wants to increase the non-insurance earnings is because it allows for stability and reduced risk during years where insurance losses mount up such as 2017 with the 3 major hurricanes.  While many insurers suffered huge losses, Berkshire's various other businesses helped to ease the losses Berkshire faced.  Berkshire's GAAP net worth decreased by less than 1% due to the $3B of losses associated with the hurricanes.  

Also, Buffet's cash stock pile continues to grow while he waits for that "fat pitch" rather than swinging at everything.

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. 

As an investor this is how we should treat all of our investments: as part owners.  Once you find a business than meets those criteria from above buy some and hold on for the ride.  

Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure longterm growth in value.

The share price is just that a price that someone is currently willing to buy or sell at.  Use your determination of the strength of the underlying business to guide your buy/sell decisions because Mr. Market can be a truly fickle animal.

In the next 53 years our shares (and others) will experience declines resembling those in the table. No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow. When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt. 

The market will do what it will do whether you like it or not.  All you can do is be prepared with cash during market booms for the eventual bust to come whenever that may be.

Performance comes, performance goes. Fees never falter.

This was in context of the much publicized bet that Buffet had made regarding an investment in the S&P 500 vs a basket of hedge funds.  Well, the final results are in and the S&P 500 beat every single fund of funds over the last 10 years no doubt in part due to the fees.  Keep your investment fees as low as possible because they are a guaranteed drag on your returns.

And – as has been the case since 1776 – whatever its problems of the minute, the American economy was going to move forward.

He didn't specifically mention this but ignore the financial media.  Their job is to get eyeballs which means sensationalizing every little thing that happens.  Remember that the United States of America still has the best economic system and the outlook remains bright over the long term.

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...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.

The longer the time horizon that you have the more exposure to the markets that you should take on.  I whole heartedly agree with that and while history isn't guaranteed to repeat itself it can serve as a pretty good guide.  As the investment period lengthens the outperformance of stocks compared to bonds widens, albeit with wild fluctuations in between.  

There's plenty more pearls of wisdom in this year's letter and I encourage you all to read it as well as previous letters if you haven't yet done so.  The letters have long been one of the best sources for investment knowledge for investors and I have no doubt they will continue to be so.

Have you read this year's letter year?  What else did you find interesting that I didn't cover here?  Are you planning on attending the annual meeting in May?


  1. Thanks for putting this together JC. I am embarrassed to say I have never read one of his letters. But, I always seem to read and enjoy summaries like yours. Tom

    1. Tom,

      I have to admit that I've been fairly lax on reading them as well, but there is always a lot to learn in them. Plus I love his way of breaking things down into their simplest form. And I love some of his non-traditional investments that he explains such as the coffee bean trade and the real estate in NYC. If you ever get a chance to read them I highly recommend them.

      All the best.


Post a Comment