The Berkshire Hathaway annual letter was released this past weekend. It was one of Warren Buffett’s shortest letters to date.
But it wasn’t without a few lessons. As usual, Buffett scattered several lessons and reminders for investors throughout. The lessons were just briefer than normal. Let’s dive in.
Buy Businesses, Not Pieces of Paper
Whatever our form of ownership, our goal is to have meaningful investments in businesses with both durable economic advantages and a first-class CEO. Please note particularly that we own stocks based upon our expectations about their long-term business performance and not because we view them as vehicles for timely market moves. That point is crucial: Charlie and I are not stock-pickers; we are business-pickers.
Buffett makes two important points. He’s not trying to profit off of short-term swings in the market. He knows market timing is a fool’s errand.
Instead, he wants quality businesses run by quality people that will grow over time. It’s a simple combination that isn’t easy to find but that’s the goal.
But the keyword is business-pickers. Every stock is tied to a business and the business’s performance ultimately determines how the stock performs in the long run.
Said another way, the long-term prospects of a business don’t change nearly as much as its stock price. That’s because investors over and under-react to the news which causes stock prices to swing above and below what the business is often worth.
This is true whether you own individual stocks or index funds. The only difference between the two is the number of businesses you own. So keep that in mind whenever the market gets wild or makes you feel uneasy.
I make many mistakes… One advantage of our common-stock segment is that — on occasion — it becomes easy to buy pieces of wonderful businesses at wonderful prices. That shooting-fish-in-a-barrel experience is very rare in negotiated transactions and never occurs en masse. It is also far easier to exit from a mistake when it has been made in the marketable arena.
The ease with which investors can jump in and out of stocks is often cited as a disadvantage…for good reason. Enough studies have shown that the amount one trades is inversely related to the returns earned. Overtrading should be avoided.
That said, the ability to quickly unwind a mistaken investment is an advantage. Except, it’s an advantage that Buffett doesn’t always have. When he makes mistakes he’s often stuck with an entire business that he has to sell or eventually shut down.
Average investors don’t have that problem. Dealing with mistakes can be tough. But if you catch mistakes early enough, it’s easier to part ways with those shares than what Buffett has to do. Just sell it and move on.
Our final path to value creation is to repurchase Berkshire shares… When the price/value equation is right, this path is the easiest and most certain way for us to increase your wealth. (Alongside the accretion of value to continuing shareholders, a couple of other parties gain: Repurchases are modestly beneficial to the seller of the repurchased shares and to society as well.)
Years ago, Jim O’Shaughnessy came up with a metric called shareholder yield. He combined dividend yield with buyback yield to see how it would perform. Turns out, stocks with a high shareholder yield did remarkably well. And it still does today.
In fact, stocks with a high buyback yield perform fairly well on their own too. But when you test stocks with a high buyback yield (or shareholder yield) in combination with a low value metric, like P/E for example, you see an extra boost in performance.
The reason why this happens boils down to basic math. Dividing a company’s earnings by a shrinking number of outstanding shares naturally increases earnings per share. If the multiple paid for those earnings per share remains the same, then the price of the stock should rise. But if the multiple should also rise, due to it being “undervalued,” then the stock price gets an added boost from the rising multiple and higher earnings per share.
Thus undervalued companies that are net buyers of their shares tend to, on average, outperform.
Learning Through Teaching
Teaching, like writing, has helped me develop and clarify my own thoughts. Charlie calls this phenomenon the orangutan effect: If you sit down with an orangutan and carefully explain to it one of your cherished ideas, you may leave behind a puzzled primate, but will yourself exit thinking more clearly.
The best way to learn a topic is to teach it to someone else. Writing certainly helps solidify thoughts and prove how well you understand a subject.
But teaching, done well, can make a complex topic simple to understand. It’s probably no coincidence that some of the best investors, who happen to be great communicators, spent time teaching their craft.
Sleep Well at Night Portfolio
People who are comfortable with their investments will, on average, achieve better results than those who are motivated by ever-changing headlines, chatter and promises.
The sleep-well-at-night portfolio should be everyone’s goal.
Unfortunately, we live in a world where the volume of news and information seems to accelerate every year in an effort to elicit clicks and engagement. That means headlines and opinions are optimized to trigger emotions. Which can impact decisions made on your portfolio.
The sooner investors realize that there is always something to worry about, then the sooner they can detach their portfolio from the hectic news cycle. The reality is that practically all of it is a distraction because it has little to no long-term impact on the businesses you own.
That said, your portfolio should be built with the “worst of times” in mind. Knowing that your portfolio can handle those periods should offer immediate comfort.
2021 Berkshire Shareholder Letter (pdf)