The Berkshire Hathaway Annual Report Letter

fred
March 2nd 2014

On Friday, Berkshire Hathaway published their annual report. I always like to read the shareholder letter that fronts the report. It is available here.

The Gotham Gal and I are not, and have never been, shareholders of Berkshire Hathaway. I guess that is a mistake but we’ve done alright anyway. You don’t have to be a shareholder of Berkshire Hathaway to benefit financially from the brilliance of their managers, Warren Buffet and Charlie Munger. I look up to both of them and have internalized as much of their thinking as I can. Reading the annual shareholder letters is a good way to get inside their heads.

In this year’s letter Warren tells the story of two real estate purchases he made in 1986 and 1993. One is a Nebraska farm and one is piece of NYC real estate in Greenwich Village. Here’s how he ends each story.

The Farm – I still know nothing about farming and recently made just my second visit to the farm.

The NYC Real Estate – I’ve yet to view the property.

But in each case, he went through an analysis of the earning power of the asset, concluded that it was much higher than current performance, and further concluded that it would yield an acceptable return on the purchase price on current performance.

Here is what Warren says about those two investments and the “fundamentals of investing”:

You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”

Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.

If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.

With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.

Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: “You don’t know how easy this game is until you get into that broadcasting booth.”)

My two purchases were made in 1986 and 1993. What the economy, interest rates, or the stock market might do in the years immediately following – 1987 and 1994 – was of no importance to me in making those investments. I can’t remember what the headlines or pundits were saying at the time. Whatever the chatter, corn would keep growing in Nebraska and students would flock to NYU.

I don’t agree with all of those points, particularly the argument against macro thinking. I use macro thinking to find assets that will perform well in the future and avoid assets that will underperform in the future. But the basic idea that what matters most is the asking price of the asset and its future earnings power is something that I totally and completely believe in and I’ve learned that over and over and over from reading these letters over the years.

The Berkshire Hathaway Annual Report Letter is a gift to investors and if you are one, I would encourage you to read them. You can start with this year’s version.