Berkshire Hathaway released its annual letter this past weekend. Warren Buffett began the letter with a nice tribute to Charlie Munger.
The tribute may be the first lesson from the letter on humility and the importance of having a great partner, which I urge you to read (find a link at the end). The rest of the lesson from this year’s letter can be found below. Let’s dive in.
Markets and Fundamentals Fluctuate
I can’t remember a period since March 11, 1942 – the date of my first stock purchase – that I have not had a majority of my net worth in equities, U.S.-based equities. And so far, so good. The Dow Jones Industrial Average fell below 100 on that fateful day in 1942 when I “pulled the trigger.” I was down about $5 by the time school was out. Soon, things turned around and now that index hovers around 38,000. America has been a terrific country for investors. All they have needed to do is sit quietly, listening to no one.
It is more than silly, however, to make judgments about Berkshire’s investment value based on “earnings” that incorporate the capricious day-by-day and, yes, even year-by-year movements of the stock market. As Ben Graham taught me, “In the short run the market acts as a voting machine; in the long run it becomes a weighing machine.”
What the market does over days, weeks, and months often diverges from how it performs over decades. The contrast becomes obvious when you zoom out. As Buffett explains, the solution is often best to ignore the short-term swings that cause investors to act against their long-term best interests.
But it’s not just that markets are volatile, fundamentals that drive the market over the long run can be volatile in the short run too. Few companies have consistent steady sales and earnings year after year. And accounting rule changes in recent years can make a company’s earnings swing as wildly as stock prices.
Separating the short-term swings in markets and fundamentals from the long-run trajectory of businesses is more important than ever to investing success.
Simple, But Not Easy
Our goal at Berkshire is simple: We want to own either all or a portion of businesses that enjoy good economics that are fundamental and enduring. Within capitalism, some businesses will flourish for a very long time while others will prove to be sinkholes. It’s harder than you would think to predict which will be the winners and losers. And those who tell you they know the answer are usually either self-delusional or snake-oil salesmen.
At Berkshire, we particularly favor the rare enterprise that can deploy additional capital at high returns in the future. Owning only one of these companies – and simply sitting tight – can deliver wealth almost beyond measure. Even heirs to such a holding can – ugh! – sometimes live a lifetime of leisure.
We also hope these favored businesses are run by able and trustworthy managers, though that is a more difficult judgment to make, however, and Berkshire has had its share of disappointments.
Buffett’s perfect investment is good “enduring” businesses, that can reinvest cash at a high rate for decades, run by capable honest managers. Easy enough?
Not quite. Nothing is assured in business. Today’s big winners are at risk of being tomorrow’s losers. That’s been the fate of businesses throughout history thanks to competition, innovation, and human nature. Companies that get on top, can grow stale and complacent, be out-hustled and out-innovated by the competition, and fall from grace.
That assumes bad management doesn’t inhibit growth from the start. Buffett says assessing management is a difficult part of the process. Are managers saying what you want to hear? Or do they mean it? Are they out to enrich themselves at the expense of you, the shareholder? Or is growing shareholder value their priority?
But if you find a company that checks all three boxes, it’s best to hold on tight.
When you find a truly wonderful business, stick with it. Patience pays, and one wonderful business can offset the many mediocre decisions that are inevitable.
Of course, patience is needed to ride out the obstacles and setbacks — certain to show up in the stock price — that every business faces on the way to greatness. That’s true whether you chase wonderful businesses or are happy owning a basket of wonderful, good, and mediocre businesses over time.
And Avoid Serious Mistakes
One investment rule at Berkshire has not and will not change: Never risk permanent loss of capital. Thanks to the American tailwind and the power of compound interest, the arena in which we operate has been – and will be – rewarding if you make a couple of good decisions during a lifetime and avoid serious mistakes.
Little mistakes are fine. Every investor makes them.
The big mistakes that set your portfolio back years should be avoided as much as possible. The simple reason: serious mistakes interrupt compounding. It’s difficult to get back to even after a major loss. That’s just what the math says.
A 30% loss requires a 43% gain to break even. If you’re lucky enough to earn a market average return of 10%, it’ll take 3.7 years to recover. A 50% loss needs a 100% return or 7.3 years earning 10% to break even. An 80% loss would take about 17 years to recover. And a lower returns extends your recovery time out further.
Time is your friend when it comes to compounding. Serious mistakes turn time against you.
Gambling Instinct
Though the stock market is massively larger than it was in our early years, today’s active participants are neither more emotionally stable nor better taught than when I was in school. For whatever reasons, markets now exhibit far more casino-like behavior than they did when I was young. The casino now resides in many homes and daily tempts the occupants.
One fact of financial life should never be forgotten. Wall Street – to use the term in its figurative sense – would like its customers to make money, but what truly causes its denizens’ juices to flow is feverish activity. At such times, whatever foolishness can be marketed will be vigorously marketed – not by everyone but always by someone.
A lot has changed about investing since Buffett made his first trade in 1942. Back then, you had to stroll down to your local stockbroker’s office to open an account and place a trade. There was a hefty fee attached to each transaction.
That all changed thanks to technology and financial innovation. Now, you can open a brokerage account or an IRA with a few clicks, deposit money, and be invested in seconds at little to no cost…using only your phone.
Yet, very little has changed. Human nature, with all its foibles, endures.
Trading at your fingertips is a double-edged sword. The elimination of inertia is the last great impediment for Wall Street.
When you can trade with ease through your phones, you’re a notification away from over-trading. Increased activity is their goal. Brokerage apps can exploit human nature to keep you engaged and trading more. They use the same tactics the social media platforms use to keep you scrolling all day.
Of course, social media only adds to the problem. Newsletters and stock tips abound. Anyone can market themselves as an “expert” investor or trader these days. Just highlight the big wins and hide or delete any posts/tips that show losses. It’s a deceptive view of success. It makes trading appear easier than it is. It makes losing appear impossible. That’s not the case, of course, but that’s how they sell subscriptions.
As Buffett alludes to in the letter via his sister Bertie:
She is sensible – very sensible – instinctively knowing that pundits should always be ignored. After all, if she could reliably predict tomorrow’s winners, would she freely share her valuable insights and thereby increase competitive buying? That would be like finding gold and then handing a map to the neighbors showing its location.
Bertie understands the power – for good or bad – of incentives, the weaknesses of humans, the “tells” that can be recognized when observing human behavior. She knows who is “selling” and who can be trusted.
Ignorance of the promotion and tips and behavioral manipulation is a blessing in disguise. Being able to tune it all out is a necessity for investing success these days.
Lesson from Bertie
Bertie – yes that Bertie – spent her early formative years in a middle-class neighborhood in Omaha and, many decades later, emerged as one of the country’s great investors.
You may be thinking that she put all of her money in Berkshire and then simply sat on it. But that’s not true. After starting a family in 1956, Bertie was active financially for 20 years: holding bonds, putting 1⁄3 of her funds in a publicly-held mutual fund and trading stocks with some frequency. Her potential remained unnoticed.
Then, in 1980, when 46, and independent of any urgings from her brother, Bertie decided to make her move. Retaining only the mutual fund and Berkshire, she made no new trades during the next 43 years. During that period, she became very rich, even after making large philanthropic gifts (think nine figures).
Buffett’s sister Bertie plays a prominent role in this year’s letter. His sisters are his muse, the people he pictures when writing the letter each year. Her investing arc is a lesson in itself.
Yes, Berkshire’s performance played a massive role in Bertie becoming rich. She also would have done well enough without it had she chosen bonds and the mutual fund instead.
But the alternative — actively trading in and out stocks — would have left her worse off. Imagine trying to jump in and out of Berkshire and other stocks to improve her results.
Her decision to forego activity for the most boring investment approach ever played a big role in her success.
Source:
2023 Berkshire Shareholder Letter
Related Reading:
Lessons from the 2022 Berkshire Letter
Lessons from the 2021 Berkshire Letter