Key lessons from Warren Buffett and Berkshire Hathaway’s annual letters

Warren Buffett published his now famous annual letter to Berkshire Hathaway’s shareholders on Saturday February 22nd 2020. He’s known to communicate openly both good and bad. Buffett uses a rule when writing his annual letter: write as if his auntie, who doesn’t understand complicated terms, would read it and communicate key business numbers as if he’s the investor who would read the letter.

The compound interest that Buffett achieved for Berkshire Hathaway from 1965 to 2019 is remarkably 20.3%. This is the best record that any investor can achieve for the duration of 54 years.

Lesson 1: Power of retained earning

It’s easier for people to see when the company pays dividends. When companies retain earnings, many factors need to be considered.
Buffett wrote about retained earnings and its importance to the company’s growth many times.
This time, he quoted Edgar Lawrence Smith, the author of the popular book Common Stocks as Long-term Investments, and John Maynard Keynes. Smith planned to argue that bond performs better in deflationary period and stock performs better in the inflationary period. He was in a shock.
Keynes captured Smith’s insights: “I have kept until last what is perhaps Mr. Smith’s most important, and is certainly his most novel, point. Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back into the business. Thus there is an element of compound interest (Keynes’ italics) operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders.”
Rockefellers, Carnegie, and Ford amassed mind-boggling wealth by retaining a huge portion of their earnings to fund growth.
Buffett has followed them to retain all Berkshire Hathaway’s earnings. He reinvested $121 billion in the last decade into the company.

Lesson 2: criteria to acquire businesses

Buffett looks for three things in a business:

  • They must earn good return on the net tangible investment required in their operation
  • They are run by able and honest managers
  • They must be available at sensible prices

Those types of businesses are rare. Down markets often offer more opportunities to own such businesses.

Lesson 3: acquiring good businesses
Tom Murphy gave Buffett an advice: “to achieve a reputation as a good manager, just be sure you buy good businesses.”
Reviewing his record which has losers and winners, Buffett concluded: “Acquisitions are similar to marriage. They start, of course, with a joyful wedding – but then reality tends to diverge from pre-nuptial expectations… I’d have to say it is usually the buyer who encounters unpleasant surprises. It’s easy to get dreamy-eyed during corporate courtships.”
Even though Buffett does not sell losers, they became stagnate and required less and less capital from Berkshire. Capital allocation is one of Buffett’s specialty. He allocated like he invested: more to the winners and less or none to the losers.

Lesson 4: Don’t forecast
as the pundits who opine on forecasting reveal far more about themselves than they reveal about the future.

Lesson 5: 5 factors of Buffett’s optimism on Berkshire’s future.

  • Berkshire’s assets are deployed in extraordinary variety of businesses that on average earn attractive return on invested capital.
  • Berkshire’s positioning of its controlled businesses within a single entity with substantial amount of capital endows it with some important and enduring competitive advantages.
  • Berkshire’s financial affairs will unfailingly be managed in a manner allowing the company to withstand external shocks of an extreme nature.
  • We possess skilled and devoted top managers for whom running Berkshire is far more than simply having a high-paying and/or prestigious job.
  • Berkshire’s directors are constantly focused on both the welfare of owners and the nurturing of a culture that is rare among giant corporations. (A new book called Margin of Trust will be published)

Lesson 6: board of directors

When a CEO wants to make an acquisition, he/she hardly brings in consultants or directors that would likely challenge him/her.
If a director’s income is largely tied with directorship fee, the director is not independent. He/she would not challenge the CEO for the fear of losing their directorship. In addition, CEO often looks at a director’s track record and would more likely bring in directors who have not opposed to CEOs.
At Berkshire, directors got paid a tiny fee compared to their net worth. Berkshire’s directors also buy their own shares instead of being granted.

For the full annual letter, please visit https://berkshirehathaway.com/letters/2019ltr.pdf

Hetty Green – the witch of Walls Street and the world’s richest woman

Hetty Green was born in a rich family. She inherited a large sum from her father. However, unlike other rich daughters, she didn’t like to spend money on luxury. She loved compounding money. From less than $1 million she inherited from her father, she invested in real estates, bonds, and companies. By the time she died at the age of 83, she was the richest woman in America. Her net worth was estimated from $100 million to $200 million (or $2.3 billion to $4.6 billion in 2019).

Hetty Green lived a frugal life. She did what she loved and didn’t care what others thought of her.

The following are stories I collected which are my favorites about Hetty Green.

Hetty thought her servant wasted money shopping for family meals. In fact, she considered her servant a wasteful expense.

“Hetty insisted on doing most of the shopping herself, and would return to the house bearing the cheapest flour she could find, and bags of broken cookies that grocers sold cheap. Grocer Patrick J. Keane said she always redeemed her berry boxes for a nickel refund, and asked for—and received—free bones for the family dog.”

“When the Greens first arrived in town, they took pleasure rides in Edward’s barouche, a fancy, four-wheeled carriage with a collapsible top, double seats facing each other inside the carriage, and an outside front seat for the driver, along with a pair of fine horses. Hetty decided the rig was too fancy. She sold the carriage and horses, and paid $10 for an old horse and a modest jump seat wagon, barely large enough to fit the family.”

“Edward’s mother was no match for Hetty’s forceful nature. Anna had no doubt expected to live out her remaining days in genteel comfort and contentment, surrounded by Edward, his bride, and the two grandchildren. Instead, she found herself sharing her suddenly too small home with a loud, opinionated woman who questioned every incidental expense, harangued her beloved maid, and didn’t even bother to make herself presentable. Neighbors on Henry Street were shocked one day to see Hetty on the roof, seated, wearing hoop skirts, hammering away. Why pay workmen for a simple repair job?”

“Merchants reportedly tried to lie low when they saw Hetty Green approaching. She was known to demand the cheapest possible goods and, still, to haggle endlessly over a bill.”

“Hetty Green never thought of anything without evaluating its cost, and never received a bill that she did not question.”

“She seems to have made it a rule of her life to indulge in no personal luxuries. She has been known to walk from her hotel in this city to a social reception through a heavy snowstorm rather than pay for the use of a coach.”

“Although she could have afforded a home as fine as the finest on Millionaire’s Row, she chose instead the teeming, dense borough of Brooklyn, populated by immigrants and, laborers, where nobody dressed up as royalty”

“Nobody ever saw her with a dress which was not severely plain, and seldom has she been noticed when she did not carry an old style and well-worn black satchel. Her appearance would never cause the uninitiated to think that she was anything more extraordinary than an old fashioned woman of moderate means and simple tastes, who was on her way to the corner grocery or the bakery on the block below. Yet, if money is power, this same staid looking person is one of the most powerful human beings in the country.”

“Hetty rarely lost sleep worrying what others thought of her, and yet there was a certain irony in the public’s reaction to her. For all of her faults, she was no snob. She sneered at all forms of pretense, and was unimpressed with titles. She didn’t just mix with the common folk; she lived among them, ate at their restaurants, rode their streetcars and ferries.”

“Hetty lived her life convinced that, as a businesswoman, if not as a woman, she was fundamentally and completely alone. Nobody else would watch out for her interests. She mistrusted all forms of alliances and cabals. Where other investors sought the safety of numbers, the soothing ring of consensus, Hetty felt most comfortable on her own, trusting her own judgment and instincts. She was a free agent in the truest sense of the term.”

The Georgia Central was unwieldy, inefficient, and complacent. The stock languished at $69. In 1886, a group of investors from New York began buying up the stock with the idea of replacing the management and directors. 

The Georgians fought back. 

Hetty got wind of the plan early on and began quietly buying stock at around $70 a share. She had 6,700 shares. She took no side and waited patiently. 

By November, the stock shot up to $100 per share. 

Alexander, the New Yorker, offered Hetty $115 a share. 

Hetty told him that he could have her shares for $125. Alexander declined. 

A few days later he came back accepting her offer with a condition that she waited till the election was over. 

Hetty replied: “If I have to wait for my money, the price is $130.”

Alexander counted with $127.50 and Hetty agreed. 

As her custom, she demanded that Alexander’s group post collateral for the entire amount. 

Despite her reputation as a miser and a hard-nosed dealer, Hetty usually offered rates that were more than fair. Although she could be ruthless when dealing with an enemy, she rarely if ever took the opportunity to kick a borrower when he was down. That was bad business, she always said.

“I’ve found out something about the young man who has been waiting on you at Newport, Sylvia. I find that your young man is very nice and proper, but if it wasn’t for his father, the world wouldn’t know a thing about him. He has never earned a dollar and doesn’t know the value of money. Now Sylvia, I’ve kept my eyes open all these years, and I want to say right here and now, that you shall never marry a society man with my consent. I want to see you happily married and in a home of your own, but I want you to marry a poor young man of good principles, who is making an honest, hard fight for success. I don’t care whether he’s got $100 or not, provided he is made of the right stuff. You will have more money than you’ll ever spend, and it isn’t necessary to look for a young man with money. Now you know my wish, and I hope I won’t hear anything more about your young man at Newport, who knows just about enough to part his hair in the middle and spend his father’s money.”

“Hetty kept to a simple and predictable daily routine. Each morning she awoke early enough to eat a light breakfast in her apartment and make the short walk, rain or shine, to the ferry slip in order to catch the 7 A.M. ferry to Manhattan.

She was, invariably, among the first to arrive at the bank (where she has her office desk). She ate a small and hurried lunch at any of several nearby restaurants.

In the evening, Hetty was usually among the last to leave the bank. ”

“Waiter, I want the best steak you can give me for thirty cents.”

“We have no thirty-cent steaks, madam.”

“No thirty-cent steaks! Haven’t you something you can warm up for me?”

“No, madam.”

“Well, how much is your tea?”

“Ten cents.”

“Ten cents! Well, it isn’t worth it. How much are your stews?”

“Fifteen cents.”

“Can’t you let me have a stew for less than that? “No, madam.”

“Well, you can bring me some tea, some toast without butter, and a stew.”

“All of her life she had considered herself physically indestructible, and her remarkable constitution generally supported this conceit. She attributed her ability to function into her seventies with the energy and sharpness of someone half her age to her prudent habits—moderation, frugality, and self-denial. Illness and health to Hetty had always carried a moral component—people who were sick were probably overindulging their desires, becoming soft, or else spending money they did not have and driving themselves to an early grave over worry. ”

“One way is to give money and make a big show. That is not my way of doing. I am of the Quaker belief, and although the Quakers are about all dead, I still follow their example. An ordinary gift to be bragged about is not a gift in the eyes of the Lord.”

Warren Buffett series #8 – bought National Indemnity in 15 minutes

National Indemnity purchase in 15 minutes

Warren Buffett is known to make a decision to buy a business in very short period of time. The following is his story of how he bought his first insurance business in less than 15 minutes.

Jack Ringwalt, who ran National Indemnity, for every 15 minutes every year would want to sell the company. A friend of mine and I discussed this phenomenon of Jack being in heat once a year for 15 minutes. I asked my friend if he ever caught Jack in this particular phase to let me know. He called and said “Jack is ready.” I asked him to tell Jack to come over. We made a deal in that 15 minutes zone.

It’s a fascinating story because Jack having made the deal really didn’t want to do it. But he wouldn’t have backed out of a deal. 

He said to me after we’d shaken hands: “I suppose you will want audited financial statements.” If I’d say “Yes”, he would have said “Well, that’s too bad then. We can’t have a deal.” So I said “I wouldn’t dream of looking at audited financial statements. They are the worst kind.” Then Jack said “I suppose you will want me to sell my agencies to you as well.” I said “Jack, I wouldn’t buy those agencies under any circumstances.”

If I’d said yes, he would have said “Well, I wouldn’t be able to do it. We must have misunderstood each other.” So we went through about three or four of these.

Finally, Jack gave up and sold me the business.Jack was an honorable guy. When he came to pick up his money, he was about 10 minutes late because he was looking for a parking meter with a few minutes left on it. 

About me and why this series:
I got a life-changing experience studying Warren Buffett’s annual letters in 2013 after 10 years of speculating, market timing, charting, and forecasting. I started investing in the Vietnamese stock market in 2015 with what I saved from my engineering job. In 2018, I decided to study Warren Buffett’s investing again by going through all of available Berkshire Hathaway’s annual meeting videos. It has been another life-changing experience. Warren Buffett’s teaching is a real germ and yet not many people replicate. Hence, I am committed to share what I learned.

You can subscribe to my blog to follow the series of what Warren Buffett has been teaching in his annual meetings. I attempted to modify but keep as much as possible what he spoke.

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Warren Buffett series #7 – How to calculate intrinsic value of a business

People always want a formula. They go to the Intelligent Investor and think somewhere they are going to find a little formula.
It really doesn’t work that way.

“A bird in hand is worth two in the bush” – Aesop

Aesop was onto something but he didn’t finish it. There are a couple of other questions that go along: “When are you going to get the two in the bush?”, “How certain is it to get the two in the bush?”, “What’s the interest rate?”

If you know interest rate and the timetable, you know investing. You would trade a bird in hand.

You lay out cash today to get more cash in the future.

It’s an investing decision. You have to decide how many birds are in the bush, when they are going to get out, and when you are going to acquire them. 

If the interest rate is 5% and you will get the two birds in five years, two birds in the bush is much better than one bird in hand. That’s roughly 15% compounded annually. If the interest rate is 20%, you would decline to take two birds in the bush five years from now. 

With growth, people associate with a lot more birds in the bush. You still have to decide when you are going to get them. You have to measure that against interest rates. You have to measure that against other bushes.

It’s a value decision: what it is worth, how many birds are in that bush, when you are going to get them, and what interest rate is.

Every year you wait to take a bird out of the bush, you have to take out more birds. If a company doesn’t pay you a dividend this year or next year, it has to be able to pay you more in perpetuity the year after.

If you buy a company for $500 billion and purchase 10% of that company and want to get a 10 percent return, $50 billion of cash has to come out of that company year after year. If they delay one year of dividend, $55 billion of cash has to come out. To do that, they have to make $80 billion pretax. There are not many companies that earn $80 billion pretax. So it requires a rather extraordinary change in profitability to give you enough birds out of that particular bush to make it worthwhile to give up the one you have in your hand.

People always want a formula. They go to the Intelligent Investor and think somewhere they are going to find a little formula.

It really doesn’t work that way. What you do is to look at all cash a business will produce between now and judgement day and discount it back at a rate that’s appropriate (intrinsic value), and then buy it a lot cheaper than that (margin of safety). You really want to look for things you can understand and where you can see out for a good many years as to the cash that can be generated from the business. If you can buy it at a cheap enough price compared to that cash, it doesn’t make any difference what the name attached to the cash is.

The intrinsic value calculation should already factor in the fact that certain businesses are going to earn less in the future than now. It’s that their intrinsic value goes down. 

Intrinsic value is very important and very fuzzy. We do our best to work with the kind of businesses where we think we have the highest possibilities where our predictions are of a fairly highly probable nature. That leaves out all kind of companies. It’s something like the natural gas pipeline. The chance of big surprises in a pipeline should be relatively small. It doesn’t mean they are zero but they are relatively small.

Let’s assume that you have a pipeline which either the supply of gas is going to run down or there are competitive pipelines that may be trying to take away your contracts that you wrote 10 years ago and expire in two years and you will have to cut the price. Two years from now when you have to cut the price, the intrinsic value hasn’t gone down from today if you properly calculate it today and build in the fact that profit margins in the future will be lower than today.

You build in the prediction of decline in the future operating years. You don’t want to wait till you get there to anticipate it. That’s part of predicting in business. Lots of businesses’ earning go down. They are going to go down. You have to analyze businesses and some businesses are going to be subjected to enormous competitive pressures that are not extant today.

We made a mistake with Dexter Shoes which was earning $40 million pretax. We assumed the future would look as good as the past. That’s part of the game to figure out what those future cash flows are likely to be. When you can’t come up with reasonable estimates, you move onto the next one.

About me and why this series:
I got a life-changing experience studying Warren Buffett’s annual letters in 2013 after 10 years of speculating, market timing, charting, and forecasting. I started investing in the Vietnamese stock market in 2015 with what I saved from my engineering job. In 2018, I decided to study Warren Buffett’s investing again by going through all of available Berkshire Hathaway’s annual meeting videos. It has been another life-changing experience. Warren Buffett’s teaching is a real germ and yet not many people replicate. Hence, I am committed to share what I learned.

You can subscribe to my blog to follow the series of what Warren Buffett has been teaching in his annual meetings. I attempted to modify but keep as much as possible what he spoke.

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Warren Buffett series #6 – Advice to start investing

You can’t look around for people to agree with you. You can’t look around for people to even know what you are talking about. You have to think for yourself.

Advice to start investing:

Start young.

The big thing about investing is that we started building this little snowball on top of a very long hill. We started at a very early age rolling the snowball down.

The nature of the compound interest is that it behaves like a snowball of sticky snow. The trick is to have a very long hill.

If I am to start out today with $10,000, I would do exactly the same way. I would start going right through companies. I would focus on smaller companies because that would be working with smaller sums and there’s more chance that something is overlooked in that area. 

You have to buy businesses or a little piece of businesses called stocks and buy them at an attractive price. You can’t expect anybody else to do it for you. You’ve got to know what you know and what you don’t know.

Within the arena of what you know, you have to pursue it very vigorously and act on it when you find it. 

You can’t look around for people to agree with you. You can’t look around for people to even know what you are talking about. You have to think for yourself. 

The hard part of the process is the first $100,000. The people who get there quickly are helped if they are passionate about being rational, very eager, and opportunistic, and steadily underspent their income grossly.

About me and why this series:
I got a life-changing experience studying Warren Buffett’s annual letters in 2013 after 10 years of speculating, market timing, charting, and forecasting. I started investing in the Vietnamese stock market in 2015 with what I saved from my engineering job. In 2018, I decided to study Warren Buffett’s investing again by going through all of available Berkshire Hathaway’s annual meeting videos. It has been another life-changing experience. Warren Buffett’s teaching is a real germ and yet not many people replicate. Hence, I am committed to share what I learned.

You can subscribe to my blog to follow the series of what Warren Buffett has been teaching in his annual meetings. I attempted to modify but keep as much as possible what he spoke.

Enter your email to subscribe to notifications from this site

Join 4,661 other followers