Buffett’s Annual Letter 2017

At Berkshire what counts most are increases in our normalized per-share earning power. That metric is what Charlie Munger, my long-time partner, and I focus on – and we hope that you do, too.

Acquisitions:
There are four building blocks that add value to Berkshire: (1) sizable stand-alone acquisitions; (2) bolt-on acquisitions that fit with businesses we already own; (3) internal sales growth and margin improvement at our many and varied businesses; and (4) investment earnings from our huge portfolio of stocks and bonds.

Why he didn’t make a big deal in 2017:
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 last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high.

Insane to risk what you have….to obtain what you don’t need:
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.

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.

Bolt-on acquisitions:
I don’t understand manufacturing operations as well as I do the activities of real estate brokers, home builders or truck stops.

Fortunately, I don’t need in this instance to bring knowledge to the table: Mark Donegan, CEO of Precision, is an extraordinary manufacturing executive, and any business in his domain is slated to do well. Betting on people can sometimes be more certain than betting on physical assets.

Insurance:
Property-casualty insurance, a business I do understand and the engine that for 51 years has powered Berkshire’s growth.

Ever since, float has been of great importance to Berkshire. When we invest these funds, all dividends, interest and gains from their deployment belong to Berkshire. (If we experience investment losses, those, of course, are on our tab as well.)

Berkshire’s insurance managers are conservative and careful underwriters, who operate in a culture that has long prioritized those qualities. That disciplined behavior has produced underwriting profits in most years, and in such instances, our cost of float was less than zero. In effect, we got paid then for holding the huge sums tallied in the earlier table.

Prior to 2017, Berkshire had recorded 14 consecutive years of underwriting profits, which totaled $28.3 billion pre-tax. I have regularly told you that I expect Berkshire to attain an underwriting profit in a majority of years, but also to experience losses from time to time. My warning became fact in 2017, as we lost $3.2 billion pre-tax from underwriting.

This is a business in which there are no trade secrets, patents, or locational advantages. What counts are brains and capital. The managers of our various insurance companies supply the brains and Berkshire provides the capital.

Need to make one or more ‘huge acquisitions’:
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 yearend Berkshire held $116.0 billion in cash and U.S. Treasury Bills. 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.

Stock investments are not just ‘ticker symbols’:
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.

“In the short run, the market is a voting machine; in the long run, however, it becomes a weighing machine.”

Market declines:
“There is simply no telling how far stocks can fall in a short period. 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.”

Buffett’s Letter – 2016

Following is the transcript of a CNBC interview with Warren Buffett on CNBC:

– American dynamism my theme for decades
– US always comes back and wins
– I don’t know anyone who can time markets
– People should buy stock consistently over time
– Interest rates act like a gravity on valuation
– We are not in a bubble territory now
– Stocks are cheap with current interest rates
– If interest rates go up a lot (5-7%), that brings stocks down
– Things are always unpredictable in short term
– Investment decisions has something to do with interest rates
– I want my money in companies, not treasuries
– We bought more Apple since 2017 began
– We haven’t bought Apple post-earning report
– I bought more Apple because I liked it
– Apple has a sticky and useful product
– Tim cook has done a terrific job at Apple
– Apple stake now worth about $17B
– Our stakes in airlines “about the same”
– Airline industry had a bad first century
– Airlines need to operate well over 80% capacity
– Charlie is ok with our airline stakes
– Don’t want to own any chemical common stocks
– I don’t mix politics and investment decisions
– I’ll judge President Trump on safety
– I want to see more people benefit from economy
– US economy will improve under any president
– Border tax would be big tax on consumers
– 3G and I agreed on friendly bid for Unilever
– First bid for Unilever got neutral response
– It was apparent quickly Unilever bid unwelcome
– No intention to do hostile Unilever bid
– No “backup deal” following Unilever
– Unilever is a high quality business
– No big deals close for Berkshire
– I can very easily be wrong
– Self-driving cars could cut Geico profits
– We don’t commit to owning stocks “forever”
– No plans to sell Amex or Coke
– Retailing is an area “too tough for me”
– Many department stores disappeared rapidly
– Bezos may be best manager I’ve ever seen
– NYT, WSJ among few papers that can survive
– Wells Fargo’s mistake was failure to act
– Wells Fargo needed to attack issue immediately
– Get it right, get it fast, get it out and get it over
– Index fund will outperform active managers
– Most money wasted on investment advice
– Retained earnings add value over time

Note # 3 – Investment advice for non-professionals

Here are the investing lessons for common investors from Buffett’s Annual Letters.

Note # 3 – Investment advice for non-professionals
The “what” of investing:
American business has done wonderfully over time and will continue to do so. The Dow Jones industrial index advanced from 66 to 11,497, paying a rising stream of dividends.

The goal of the nonprofessional should not be to pick winners – but should rather be to own a cross section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.

The “when” is also important.
The main danger is that the beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur.

The investor to accumulate shares over a long period and never sell when the news is bad and stocks are well off their highs.

Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results.

Buffett’s advice is simple:
– Put 10% of the cash in short-term government bonds and
– 90% in a very low-cost S&P 500 index fund

– From 2014 Buffett’s Annual Letter

Note # 2 – Buffett’s Best Investment

Here are the investing lessons for common investors from Buffett’s Annual Letters.

Note # 2 – Buffett’s Best Investment
Of all the investments he ever made, buying Ben Graham’s bookThe Intelligent Investor” was the best.

Buffett said, the key points were laid out in Chapters 8 and 20. These points guide his investing decisions today.

Chapter 8 talks about Market Fluctuations
– Widely fluctuating stock prices would give you an enormous advantage to buy a wonderful business at a fair price

Chapter 20 talks about Margin of Safety
– How to value a business?
– What’s the right price to buy?

– From 2014 Buffett’s Annual Letter

Note # 1 – Four Filters

Note # 1 – Four Filters
Buffett and Munger look for businesses
1) that they can understand
2) with sustainable competitive advantage
3) operated by able and honest people; and
4) available at a very attractive price

Because of both market conditions and Berkshire’s size, they now substitute ‘an attractive price’ for ‘a very attractive price.’

An experienced analyst can easily go wrong in estimating the attractive price. At Berkshire, they attempt to deal with this problem in two ways.
1) They try to stick to relatively simple and stable businesses. If a business is complex or subject to constant change, it is impossible to predict future cash flows. The most important thing for investors is not how much they know, but rather how realistically they define what they don’t know. An investor needs to do very few things right as long as he or she avoids big mistakes.
2) They insist on a margin of safety in their purchase price. They are not interested in buying a common stock if the calculated value is slightly higher than the market price. In many instances, shares worth x in business value have sold in the market for 1/2x or less.

Sustainable competitive advantage:
They look for consumer monopolies that offer products or services where there is little or no competition. This could be either due to a brand name or patent that makes the product or service unique.

A moat is a sustainable competitive advantage that allows a company to earn good profits over time. They look for companies that have one of the following moats.
a) Low Cost Producer
b) High Switching Costs
c) The Network Effect
d) Intangible Assets (brands or patents)

Able and honest management:
The ability of the management can dramatically affect the equity future earnings.

– From 2010 Buffett’s Annual Letter