I Read Warren Buffett's Annual Letter To Shareholders So You Don't Have To
On February 25th, Warren Buffett released his annual letter to shareholders of Berkshire Hathaway stock. As usual, his letter contains pearls of wisdom regarding investing and the financial services industry. In case you missed the letter, I've compiled the best quotes below with commentary from yours truly.
Berkshire Hathaway's Performance
Buffett: "Berkshire’s gain in net worth during 2016 was $27.5 billion, which increased the per-share book value of both our Class A and Class B stock by 10.7%. Over the last 52 years (that is, since present management took over), per-share book value has grown from $19 to $172,108, a rate of 19% compounded annually." *
* All per-share figures used in this report apply to Berkshire’s A shares. Figures for the B shares are 1/1500th of those shown for A.
Me: Impressive. Most impressive.
Beating the Market
Buffett: "There are, of course, some skilled individuals who are highly likely to outperform the S&P over long stretches. In my lifetime, though, I’ve identified – early on – only ten or so professionals that I expected would accomplish this feat.
There are no doubt many hundreds of people – perhaps thousands – whom I have never met and whose abilities would equal those of the people I’ve identified. The job, after all, is not impossible. The problem simply is that the great majority of managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well. Bill Ruane – a truly wonderful human being and a man whom I identified 60 years ago as almost certain to deliver superior investment returns over the long haul – said it well: “In investment management, the progression is from the innovators to the imitators to the swarming incompetents.”
Further complicating the search for the rare high-fee manager who is worth his or her pay is the fact that some investment professionals, just as some amateurs, will be lucky over short periods. If 1,000 managers make a market prediction at the beginning of a year, it’s very likely that the calls of at least one will be correct for nine consecutive years. Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet. But there would remain a difference: The lucky monkey would not find people standing in line to invest with him."
Me: Ouch. Comparing asset managers to monkeys is harsh, but Buffett isn't wrong. Study after study suggests it's nearly impossible for anyone to consistently beat the market. Of course, that hasn't stopped anyone from trying.
The Challenges That Come With Managing Money
Buffett: "Finally, there are three connected realities that cause investing success to breed failure. First, a good record quickly attracts a torrent of money. Second, huge sums invariably act as an anchor on investment performance: What is easy with millions, struggles with billions (sob!). Third, most managers will nevertheless seek new money because of their personal equation – namely, the more funds they have under management, the more their fees.
These three points are hardly new ground for me: In January 1966, when I was managing $44 million, I wrote my limited partners: “I feel substantially greater size is more likely to harm future results than to help them. This might not be true for my own personal results, but it is likely to be true for your results. Therefore, . . . I intend to admit no additional partners to BPL. I have notified Susie that if we have any more children, it is up to her to find some other partnership for them.”
The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds."
Me: Buffett makes two important points here:
First, the more money an asset manager has to work with, the more difficult it is to find worthwhile investments. For example, managers of the American Funds Growth Fund of America mutual fund, which was founded in 1973, saw huge inflows for many years because investors were attracted by its solid track record. Unfortunately, managers had an increasingly difficult time putting all that cash to good use. The fund, which currently has assets of ~$74 billion, has seen net outflows for almost every year since 2008. The consistent outflows can be attributed to better-informed investors, the increasing popularity of index funds, and an extremely long bull market.
The second point Buffett makes is that many asset managers have a heads-I-win, tails-I-win business model. I'm looking at you, hedge fund managers. It's not unusual for them to follow a "2 and 20" model, which means a 2% annual fixed fee, payable even when losses are huge, and 20% of any profits. That's a great deal...if you're a hedge fund manager. Of course, even hedge fund managers are feeling pinched by, once again, better-informed investors and the rising popularity of index funds. See this recent story from the Wall Street Journal about Tudor Investment Corp.
Buffett: "As the subject of repurchases has come to a boil, some people have come close to calling them un-American – characterizing them as corporate misdeeds that divert funds needed for productive endeavors. That simply isn’t the case: Both American corporations and private investors are today awash in funds looking to be sensibly deployed. I’m not aware of any enticing project that in recent years has died for lack of capital. (Call us if you have a candidate.)"
Me: Companies occasionally buy their own stock. For example, from September 2013 through 2015, Apple repurchased 760 million shares. Fortune magazine states the benefit - and pitfall - of this practice better than I can:
"When a company buys its own stock, it reduces the overall number of shares outstanding. That raises earnings-per-share, and all other things being equal, the stock price, making shareholders richer. Put simply, the folks who own Apple get a bigger share of the Apple pie, courtesy of the constantly shrinking count of shares outstanding. But buybacks fail to enrich investors if management overpays for their shares."
Buffett again: "My suggestion: Before even discussing repurchases, a CEO and his or her Board should stand, join hands and in unison declare, 'What is smart at one price is stupid at another.'"
Me again: Translation: Share repurchases aren't bad, as long as the price is right.
Listening / Reading / Watching
Here's what has my attention right now:
Mediation and Interest-Based Negotiation Skills Training. Last week I spent four days in training to help couples going through a divorce. My goal is to add the role of financial neutral to the list of services I provide.
Homo Deus: A Brief History of Tomorrow by Yuval Noah Harari. Here's another book that continues my obsession with trying to determine which trends, businesses, and technology will have the biggest impact on humanity.
From the publisher: "Over the past century, humankind has managed to do the impossible and rein in famine, plague, and war. This may seem hard to accept, but as Harari explains in his trademark style - thorough yet riveting - famine, plague, and war have been transformed from incomprehensible and uncontrollable forces of nature into manageable challenges. For the first time ever, more people die from eating too much than from eating too little; more people die from old age than from infectious diseases; and more people commit suicide than are killed by soldiers, terrorists, and criminals put together. The average American is 1,000 times more likely to die from binging at McDonald's than from being blown up by Al Qaeda.
What then will replace famine, plague, and war at the top of the human agenda? As the self-made gods of planet Earth, what destinies will we set ourselves, and which quests will we undertake? Homo Deus explores the projects, dreams, and nightmares that will shape the 21st century - from overcoming death to creating artificial life. It asks the fundamental questions: Where do we go from here? And how will we protect this fragile world from our own destructive powers? This is the next stage of evolution. This is Homo Deus."
Legion on FX. I'm a sucker for science fiction, especially smart science fiction. Is the main character crazy, or gifted with special abilities? What's the creepy organization trying to track him down? What the heck is that yellow-eyed thing in his visions?? Good stuff. Honorable mention goes to The Expanse on the SyFy Channel.