Warren Buffett published his annual letter to investors over the weekend. The publication of this letter has become a significant event in the investment calendar.
In the annual correspondence, the CEO of Berkshire Hathaway usually provides his thoughts on the current state of the market and offers advice for readers on the topic of investing.
Here are my top five takeaways from the annual letter.
The power of share repurchases
In 2018, Berkshire Hathaway changed its share repurchase policy. Previously, the conglomerate was allowed to repurchase stock when it traded below 1.2 times book value.
Today, the group will buy back shares when it believes the stock is trading at an appropriate discount to Buffett’s conservative estimate of intrinsic value.
It seems the stock was trading at a significant discount to this value last year. Throughout the year, Berkshire spent $25 billion repurchasing its own shares.
In his letter, Warren Buffett highlighted the benefits of repurchases to investors, using Apple as an example he said:
“Berkshire’s investment in Apple vividly illustrates the power of repurchases. We began buying Apple stock late in 2016…When we finished our purchases in mid-2018, Berkshire’s general account owned 5.2% of Apple. Our cost for that stake was $36 billion. Since then, we have both enjoyed regular dividends, averaging about $775 million annually, and have also – in 2020 – pocketed an additional $11 billion by selling a small portion of our position. Despite that sale – voila! – Berkshire now owns 5.4% of Apple. That increase was costless to us, coming about because Apple has continuously repurchased its shares, thereby substantially shrinking the number it now has outstanding.
But that’s far from all of the good news. Because we also repurchased Berkshire shares during the 21⁄2 years, you now indirectly own a full 10% more of Apple’s assets and future earnings than you did in July 2018.”
The CEO of Berkshire went on to summarize:
“The math of repurchases grinds away slowly, but can be powerful over time. The process offers a simple way for investors to own an ever-expanding portion of exceptional businesses.”
There will be mistakes
Throughout his career, Buffett has made many mistakes. Some of these have cost Berkshire’s shareholders billions of dollars.
Unfortunately, mistakes are just part of the investing process. Every investor will make them. Buffett covered his latest big mistake in his 2020 letter:
“The final component in our GAAP figure – that ugly $11 billion write-down – is almost entirely the quantification of a mistake I made in 2016. That year, Berkshire purchased Precision Castparts (“PCC”), and I paid too much for the company. No one misled me in any way – I was simply too optimistic about PCC’s normalized profit potential.
Last year, my miscalculation was laid bare by adverse developments throughout the aerospace industry, PCC’s most important source of customers. In purchasing PCC, Berkshire bought a fine company – the best in its business. Mark Donegan, PCC’s CEO, is a passionate manager who consistently pours the same energy into the business that he did before we purchased it.
We are lucky to have him running things. I believe I was right in concluding that PCC would, over time, earn good returns on the net tangible assets deployed in its operations. I was wrong, however, in judging the average amount of future earnings and, consequently, wrong in my calculation of the proper price to pay for the business. PCC is far from my first error of that sort. But it’s a big one.”
Every investor will make mistakes. Admitting your mistakes and understanding why you made them is the hard part.
Buffett knows this all too well, which is why he’s happy to discuss past mistakes. This quality is incredibly rare, and all investor can learn from his lead here.
Warren Buffett: Long term investing is incredibly powerful
Warren Buffett has always advocated the power of long-term investing. He didn’t deviate from this view in his 2020 letter.
The CEO of Berkshire explained that all assets could create wealth; the challenging part is holding on long enough to generate a return:
“A patient and level-headed monkey, who constructs a portfolio by throwing 50 darts at a board listing all of the S&P 500, will – over time – enjoy dividends and capital gains, just as long as it never gets tempted to make changes in its original “selections.”
“Productive assets such as farms, real estate and, yes, business ownership produce wealth – lots of it. Most owners of such properties will be rewarded. All that’s required is the passage of time, an inner calm, ample diversification and a minimisation of transactions and fees.”
Bonds are bad news for the future
Productive assets will create wealth, but bonds are not an attractive asset at current levels, as Buffett explained:
“And bonds are not the place to be these days. Can you believe that the income recently available from a 10-year U.S. Treasury bond – the yield was 0.93% at yearend – had fallen 94% from the 15.8% yield available in September 1981? In certain large and important countries, such as Germany and Japan, investors earn a negative return on trillions of dollars of sovereign debt. Fixed-income investors worldwide – whether pension funds, insurance companies or retirees – face a bleak future.”
Some investors have tried to improve bond returns by taking on additional risk, but that is not the answer, Warren Buffett explained.
Taking on more risk in search of higher returns can backfire, especially in today’s interest rate environment, where interest rates rarely compensate investors for the additional risk assumed.
Warren Buffett: Managers matter
Warren Buffett devoted most of the space in his letter this year to businesses that form part of Berkshire. These companies, which included National Indemnity, Nebraska Furniture Mart, Clayton Homes and Pilot Travel centres, were all started on a shoestring by driven individuals.
In the decades after their founding, they went from strength to strength, and in the cases of Clayton Homes and Pilot Travel centres became billion-dollar businesses.
National Indemnity has exceeded even it’s founder’s wildest expectations. Today the firm is “the only company in the world,” which can “insure certain giant risks,” according to Buffett’s letter.
What linked all of these companies? They were all managed throughout their first few decades of life by driven individuals who knew and understood what they did best. They focused on these strengths and becoming the best they could be in their respective industries. That’s why management always matters. You can’t have a great company without a great manager.