Warren Buffett’s Letter To Shareholders - Investment Mistakes, Conglomerates And Treating Shareholders As Partners
It’s among the most awaited annual events for the global investing community - Warren Buffett’s annual letter to shareholders of Berkshire Hathaway. Technically, it’s an account of how the company fared in the year gone by. But written in a simple, conversational style, it is often populated with Buffett’s views on the economy, business, finance, markets and life.
The 2020 letter, published today on the company’s website, is no different. It presents Buffett’s views on conglomerates, the genesis of his partnership with Charlie Munger, a close to $11-billion dollar investment mistake, share repurchases (buybacks) and some caustic views on Wall street.
In others words, vintage Buffett.
Buffett’s Billion Dollar Mistake
Berkshire Hathaway took an $11 billion write down in 2020, almost all of which was on account of one investment Buffett made in 2016. The purchase of Precision Castparts, for which Buffett says he paid “too much”.
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.
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.
In 2020, Berkshire Hathaway spent $24.7 billion to repurchase its shares. Buffett explained how Charlie Munger and he view repurchases.
In no way do we think that Berkshire shares should be repurchased at simply any price. I emphasize that point because American CEOs have an embarrassing record of devoting more company funds to repurchases when prices have risen than when they have tanked. Our approach is exactly the reverse.
Berkshire’s investment in Apple vividly illustrates the power of repurchases. We began buying Apple stock late in 2016 and by early July 2018, owned slightly more than one billion Apple shares (split-adjusted). Saying that, I’m referencing the investment held in Berkshire’s general account and am excluding a very small and separately-managed holding of Apple shares that was subsequently sold. 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.
This agreeable dynamic continues. Berkshire has repurchased more shares since yearend and is likely to further reduce its share count in the future. Apple has publicly stated an intention to repurchase its shares as well. As these reductions occur, Berkshire shareholders will not only own a greater interest in our insurance group and in BNSF and BHE, but will also find their indirect ownership of Apple increasing as well.
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.
And as a sultry Mae West assured us: “Too much of a good thing can be . . . wonderful.”
Berkshire Not A Prototype Conglomerate
Prototype conglomerates, that limit themselves to buying entire businesses, run into two critical challenges. The best of entrepreneurs are rarely willing to sell out. That leaves mediocre businesses on the table, for which conglomerates often pay staggering control premiums.
Buffett writes that Berkshire wants to own all or part of a diverse group of businesses with good economic characteristics and good managers. Whether Berkshire controls these businesses, however, is unimportant to Charlie Munger and him. A “non-controlling portion of a wonderful business is more profitable, more enjoyable and far less work than struggling with 100% of a marginal enterprise, he says.
Over time, conglomerates have generally limited themselves to buying businesses in their entirety. That strategy, however, came with two major problems. One was unsolvable: Most of the truly great businesses had no interest in having anyone take them over. Consequently, deal-hungry conglomerateurs had to focus on so-so companies that lacked important and durable competitive strengths. That was not a great pond in which to fish.
Beyond that, as conglomerateurs dipped into this universe of mediocre businesses, they often found themselves required to pay staggering “control” premiums to snare their quarry. Aspiring conglomerateurs knew the answer to this “overpayment” problem: They simply needed to manufacture a vastly overvalued stock of their own that could be used as a “currency” for pricey acquisitions. (“I’ll pay you $10,000 for your dog by giving you two of my $5,000 cats.”)
Often, the tools for fostering the overvaluation of a conglomerate’s stock involved promotional techniques and “imaginative” accounting maneuvers that were, at best, deceptive and that sometimes crossed the line into fraud. When these tricks were “successful,” the conglomerate pushed its own stock to, say, 3x its business value in order to offer the target 2x its value.
Investing illusions can continue for a surprisingly long time. Wall Street loves the fees that deal-making generates, and the press loves the stories that colorful promoters provide. At a point, also, the soaring price of a promoted stock can itself become the “proof” that an illusion is reality.
Eventually, of course, the party ends, and many business “emperors” are found to have no clothes. Financial history is replete with the names of famous conglomerateurs who were initially lionized as business geniuses by journalists, analysts and investment bankers, but whose creations ended up as business junkyards.
Conglomerates earned their terrible reputation.
Buffett On American Politics?
In what seems like a guarded comment on recent political events in the U.S., Buffett says progress on creating “a more perfect union” has been slow and discouraging.
Despite some severe interruptions, our country’s economic progress has been breathtaking.
Beyond that, we retain our constitutional aspiration of becoming “a more perfect union.” Progress on that front has been slow, uneven and often discouraging. We have, however, moved forward and will continue to do so.
Our unwavering conclusion: Never bet against America.
The Secret To A Long Life?
In recounting the start of his partnership with Charlie Munger, Buffett also discusses the many individual shareholders of Berkshire Hathaway who have held on to their shares for decades. He writes about Stan Truhlsen, an 100-year old Omaha ophthalmologist who invested with Buffett in 1959 and remains a Berkshire shareholder. Prompting Buffett to quip on Berkshire ownership and longevity of life.
Two of Stan’s comrades from Emdee are now in their high-90s and continue to hold Berkshire shares. This group’s startling durability – along with the fact that Charlie and I are 97 and 90, respectively – serves up an interesting question: Could it be that Berkshire ownership fosters longevity?
Treating Shareholders As Partners
In expressing his gratitude and fondness for shareholders like Stan, Buffett also comments on clarity in business purpose, shareholders as business partners and Wall Street versus monkeys.
Berkshire’s unusual and valued family of individual shareholders may add to your understanding of our reluctance to court Wall Street analysts and institutional investors. We already have the investors we want and don’t think that they, on balance, would be upgraded by replacements.
There are only so many seats – that is, shares outstanding – available for Berkshire ownership. And we very much like the people already occupying them.
Of course, some turnover in “partners” will occur. Charlie and I hope, however, that it will be minimal. Who, after all, seeks rapid turnover in friends, neighbors or marriage?
In 1958, Phil Fisher wrote a superb book on investing. In it, he analogized running a public company to managing a restaurant. If you are seeking diners, he said, you can attract a clientele and prosper featuring either hamburgers served with a Coke or a French cuisine accompanied by exotic wines. But you must not, Fisher warned, capriciously switch from one to the other: Your message to potential customers must be consistent with what they will find upon entering your premises.
The tens of millions of other investors and speculators in the United States and elsewhere have a wide variety of equity choices to fit their tastes. They will find CEOs and market gurus with enticing ideas. If they want price targets, managed earnings and “stories,” they will not lack suitors. “Technicians” will confidently instruct them as to what some wiggles on a chart portend for a stock’s next move. The calls for action will never stop.
Many of those investors, I should add, will do quite well. After all, ownership of stocks is very much a “positive-sum” game. Indeed, 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 minimization of transactions and fees. Still, investors must never forget that their expenses are Wall Street’s income. And, unlike my monkey, Wall Streeters do not work for peanuts.
When seats open up at Berkshire – and we hope they are few – we want them to be occupied by newcomers who understand and desire what we offer. After decades of management, Charlie and I remain unable to promise results. We can and do, however, pledge to treat you as partners.
And so, too, will our successors
This year’s annual shareholder meeting will also be a virtual one, streamed live on Yahoo, but from Los Angeles not Omaha. Munger will join Buffett as he has in past years save the last one. And, it’s likely, See’s peanut brittle and fudge, along with Coca-Cola, will provide the two veteran investors “nourishment”, as Buffett puts it.