Investing without great intelligence

Each year, Warren Buffett (the third richest man in the world) writes a letter to the shareholders of Berkshire Hathaway. Usually, it is a recap of the preceding year for the company, an invitation to the yearly stockholder meeting, and some insight into the mind of the world’s greatest investor. I always look forward to reading his advice.

The letter (PDF), which is always released late Friday evening or Saturday morning so as to not influence irrational trading on the market, was released today. The whole thing is worth reading if you’re interested in long-term investing. (That’s the investing I prefer as well.) Below are some of my favorite parts of the 2017 letter:

Each year, Mr. Buffett gives the numbers up front, plain and clear but this year is a little different:

The format of that opening paragraph has been standard for 30 years. But 2017 was far from standard: A large portion of our gain did not come from anything we accomplished at Berkshire.

The $65 billion gain is nonetheless real – rest assured of that. But only $36 billion came from Berkshire’s operations. The remaining $29 billion was delivered to us in December when Congress rewrote the U.S. Tax Code.

He also talks about a new accounting rule that will affect how reports are done in the future. One of the best tips I can give parents, church leaders, bosses or coaches is to give experienced foresight to those who learn from you. It not only allows the learners to prepare but also increases their trust in you:

I must first tell you about a new accounting rule – a generally accepted accounting principle (GAAP) – that in future quarterly and annual reports will severely distort Berkshire’s net income figures and very often mislead commentators and investors.

It reminds me of a talk I recently heard of a father who would talk to his son each year and tell him things that he might expect in his life for that year. After a warning, he’d encourage that “when these things happen—or anything else that troubles you—I want you to come and talk to me, and I’ll help you get through them. And then I’ll tell you what comes next.”

Before reporting on the acquisitions from last year, Warren explained the simple approach to adding value to the company:

There are four building blocks that add value to Berkshire: (1) sizable stand-alone acquisitions; (2) bolt-on acquisitions that fit with businesses we already own; (3) internal sales growth and margin improvement at our many and varied businesses; and (4) investment earnings from our huge portfolio of stocks and bonds.

And in 2017, there were not many acquisitions made by Berkshire. He explained what they look for in purchasing a company:

In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price.

I love that when the rest of the world is buying, he’s staying true to the founding rules:

That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.

Why are the prices so high? Money is cheap and this:

Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase.

Even though Berkshire stayed mostly on the sidelines, the multi-billion dollar train moves on just fine:

Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need.

And:

The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.

That doesn’t mean they won’t buy when the time is right:

…we will need to make one or more huge acquisitions. We certainly have the resources to do so. At yearend Berkshire held $116.0 billion in cash and U.S. Treasury Bills (whose average maturity was 88 days), up from $86.4 billion at yearend 2016. This extraordinary liquidity earns only a pittance and is far beyond the level Charlie and I wish Berkshire to have. Our smiles will broaden when we have redeployed Berkshire’s excess funds into more productive assets.

He also gives another overview of his victorious ten-year bet on index funds. And assures the rest of us that it’s still the right approach, especially to avoid fees:

Performance comes, performance goes. Fees never falter.

And when others hesitate, you move:

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 such as alpha and beta.

and

And – as has been the case since 1776 – whatever its problems of the minute, the American economy was going to move forward.

I highly recommend the whole letter as it’s full of financial and other advice.