Warren Buffett, also known as the “Oracle of Omaha,” is one of the most successful investors of all time. Buffett manages Berkshire Hathaway, which owns a multitude of businesses, including insurer Geico, battery manufacturer Duracell, and food chain Dairy Queen. Son of a U.S. congressman, he purchased his first stock at age 11 and filed his first tax return at age 13.
He has pledged to give away more than 99 percent of his money and he has donated over $48 billion, primarily to the Gates Foundation and his children’s foundations. In 2010, Buffet and Bill Gates initiated the Giving Pledge, which asks billionaires to pledge to donate at least half of their money to philanthropic organizations.
However, there is more to the Oracle of Omaha than meets the eye. Buffett is also an exceptional writer. He issues an annual letter to Berkshire Hathaway shareholders each year. As predicted, Warren Buffett’s annual shareholder letters are one of the most anticipated events in the financial sector. Not only because he is one of the wealthiest investors in the world, but also because he communicates general financial advice in simple language that anyone can grasp.
These letters are made available on the website of Berkshire Hathaway. You can observe his and his team’s perspectives on the investment strategy, stock ownership, corporate culture, etc. Due to the abundance of Buffett’s annual letters, we have organized them into ten essential lessons in this blog.
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Executives Should Only Eat What They Can Kill
Buffett stated in 1985 that he used a system of incentive compensation at Berkshire Hathaway that rewards managers for their individual contributions throughout the year, regardless of the company’s overall performance. If they did good in an average year, they will reap the rewards. And if their labor was average during a good year, they will not be rewarded. Rewarding outstanding managers for achieving their goals is an industry-wide practice. Contrary to the majority of corporations, Berkshire Hathaway does not utilize the stock price as a performance metric.
In his 1985 annual letter, Warren Buffett stated, “We believe good performance should be rewarded whether Berkshire stock rises, falls, or stays even. Similarly, we think average performance should earn no special rewards even if our stock should soar”.
Buffett also stated that “performance” varies based on the nature of the business: “In some, our managers enjoy tailwinds not of their own making, in others, they fight unavoidable headwinds.”
Therefore, Berkshire Hathaway’s incentive will never be in the form of stock options because he believes that this not only dilutes the shares but also enables executives to increase their wealth at the expense of shareholders by using their knowledge of the company.
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Buy Stock To Own, Not Speculate
It is generally observed that upon purchasing a stock, most investors become price-obsessed. After that, they continually check the stock’s price throughout the day at multiple intervals. Several people find it difficult to resist the desire to check the price multiple times per day. From this perspective, the 1996 annual letter from Warren Buffett made an interesting argument. “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes,” he said.
Buffett maintains, essentially, that instead of worrying about daily changes, you should seek out specific things. For instance, companies that manufacture superior products have substantial competitive advantages and provide consistent future profits. Therefore, “always invest with an owner’s mentality”
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Don’t Ignore The Value Of Intangible Assets
Several businesses have both tangible and intangible assets. Buffett considers intangibles to be of the utmost importance. However, it may surprise you to learn that Buffett did not always believe in the power of intangibles. In his 1983 annual letter, Warren Buffett writes, “I was taught to favor tangible assets and to shun businesses whose value depended largely upon economic goodwill. This bias caused me to make many important business mistakes of omission, although relatively few of commission.”
He acknowledges that he served tangible assets. And he avoided intangible assets such as businesses reliant on goodwill.
The acquisition of “See’s Candy Stores” by Berkshire finally altered his perspective and attitude toward intangibles. When Berkshire acquired See’s Candy in 1972, it had around $2 million in post-tax income and $8 million in net tangible assets. Now, for a retail chain such as See’s Candy Stores, a 25% return on assets significantly exceeded industry standards. Ten years after the acquisition, See’s Candy reported $13 million in post-tax earnings on a $20 million net tangible asset basis in 1982. The return on assets increased from 25% to 65% during the past decade as a result of intangible assets such as the goodwill factor. This substantiates a great phrase by Warren Buffett: “Goodwill is the gift that keeps giving.”
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Be Fearful When Others Are Greedy, And Greedy When Others Are Fearful
Buffett considers the stock market to be typically efficient. In this setting, successfully “timing” one’s entry and exit from the market is nearly difficult. However, Warren Buffett’s annual letters have frequently underlined that phases such as natural disasters, wars, market crashes, and bubbles will continue to occur. In his 2017 annual letter, Warren Buffett stated, “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”.
In other words, Buffett believes that astute investors should regularly evaluate a company’s underlying value. If investors are able to do so, they will naturally tend to go against the herd and generate excess profits. In Buffett’s words, “Be fearful when others are greedy and greedy only when others are fearful”.
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Don’t Invest In Businesses That Are Too Complex To Fully Understand
Buffett favors companies that invest in their own expansion or use corporate money to repurchase shares. Even if it doesn’t pay off in the short term, he is a firm believer that companies that retain a portion of their profits to reinvest in the business increase their worth over time.
In order to attract Buffett’s investment, a company must be basic and frequently unattractive. He avoids investing in businesses he does not comprehend. When Berkshire Hathaway revealed in 2016 that it would acquire a $1 billion investment in Apple, many investors were shocked. In his 1986 annual letter, Warren Buffett stated, “if there’s a lot of technology, we won’t understand it.” In contrast, this does not imply that Buffett was technologically rigid. Before investing in a company/sector, he desires a comprehensive understanding of its development potential, competitive edge, and the sustainability of that advantage.
While he and his business partner Charlie Munger encourage change in the form of new ideas, new products, and creative methods on a personal level, they are more cautious on a professional level. “As investors, however, our reaction to a fermenting industry is much like our attitude toward space exploration: We applaud the endeavor but prefer to skip the ride.”
Moreover, they prefer to invest in companies that manufacture products that people need, which may not be exciting, cutting-edge investments, but are assured to provide returns for decades.
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Never Invest Just Because You Think A Company Is Cheap
Who doesn’t enjoy a good deal? Warren Buffett, as a student of Benjamin Graham’s, was destined to adopt the “buy low” strategy. That, however, was not the case. And Warren Buffett learned a valuable lesson as a result of a string of disastrous acquisitions and investments in his early investing career. In 1979, Warren Buffett’s annual letter detailed some of his investing blunders. He is referring to Berkshire’s purchase of Waumbec Mills, which was made at a lower price than the company’s operating capital. Although it appeared to be a fantastic deal, Berkshire Hathaway’s acquisition proved to be a blunder.
The reason for this is that no matter how hard the company tried to turn the struggling business around, it was unable to get traction. Furthermore, the textile industry had just entered a downward spiral. This event taught Buffett the value of a return on capital and the importance of maintaining an economic moat.
In his 2014 annual letter, Warren Buffett stated: “At Berkshire, we prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business. It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone”
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Embrace The Virtue Of Sloth
Buffett, like a sloth, only acts when forced to. His 1996 letter to investors advised them to buy a few dependable stocks and hold onto them rather than trying to buy and sell in sync with the market. Even if you’re just buying shares, the same rationale applies. He also encourages investors to rely on their own business judgment rather than sophisticated financial instruments or the recommendations of investment bankers who have their own agendas. And once you’ve invested in a company, only time will tell if you made a good decision:
In other words, for retail investors, the real action is in inaction.
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Never Use Borrowed Money To Buy Stocks
As a prudent investor, Buffett cautions anyone — especially regular people — from incurring debt to invest in the stock market. Market swings might bankrupt consumers if the market falls suddenly. But it doesn’t imply he’s completely opposed to borrowing money. Buffett does encourage borrowing money when it is inexpensive in order to put the money to good use.
With Buffett and Berkshire Hathaway’s risk tolerance and structure in mind, Berkshire largely employs debt with its asset-laden railroad and utility operations, which generate plenty of cash even during a downturn.
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Time Is The Friend Of The Wonderful Business, The Enemy Of The Mediocre
Buffett frequently states that purchasing Berkshire Hathaway, the textile company, was his biggest investment error. There is some truth to this story. After all, he had invested in a subpar, declining, capital-intensive enterprise. If he had invested in insurance firms, he could have earned an additional $200 billion over the next 45 years. This time and return compounding are best described in Warren Buffett’s 1989 annual letter. He stated, “Time is a friend to great businesses and an enemy to average ones.”
To be more specific, Buffett asserts that holding a corporation that does not generate value will undoubtedly harm an investor in the long run. They provide subpar returns and deprive the investor of superior investment alternatives.
Therefore, instead of purchasing inferior businesses and hoping for their value to increase, Buffett recommends seeking out superior businesses. Those that can not only generate a healthy return but also reinvest capital at similarly strong returns. Consequently, they become compounding machines. These organizations represent the Holy Grail of investing. Rather than always searching for fresh flowers to pick, it is in your best interest to plant the correct seeds and observe their growth.
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Corporate Culture
Buffett lives modestly despite being one of the wealthiest persons in the United States. And he believes that a CEO who is frugal (and does not push for excessive salary) would foster a culture of employees who are frugal with investor capital.
Winston Churchill once quipped, ‘You shape your houses and then they shape you.’ That wisdom applies to businesses as well, ” he wrote in 2010. “Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce imperious behavior… As long as Charlie and I treat your money as if it were our own, Berkshire’s managers are likely to be careful with it as well.”
Buffett’s hiring practices contribute to Berkshire Hathaway’s exemplary corporate culture. He has reminded shareholders in a number of letters that he searches for managers who are usually independently rich and do not need to work. Then, Buffett develops the optimal work atmosphere for them, guaranteeing that they enjoy their employment and that they cannot be tempted away. Therefore, if your job entails hiring, ensure that your next job posting describes not only what you seek in an employee, but also why someone would want to work for you – and stay with you.
Conclusion
Even Buffett, at the end of the day, has committed errors. However, due to his concentration on consistent, long-term progress, he always makes up for it in time. Therefore, even if you’re fresh to the game, don’t be disheartened by the market’s constant fluctuations. Buffett discourages new investors from examining their holdings daily for just this reason.
Instead make sure you:
- Take a long-term perspective and prioritize long-term plans such as retirement.
- Focus on growth that is moderate and steady.
- Only invest what you can afford.
If you follow this counsel, you may one day be imparting your own nuggets of wisdom to your shareholders’ adoration.
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