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Warren Buffett sends an open letter each year to owners in Berkshire Hathaway. Over the last 40 years, these letters have become a regular standard for reading throughout the investment world, providing insight into how Buffett and his colleagues are talking about everything from investment strategy to stock ownership to corporate culture, and more.
Save your money in peacetime so that during the war you can buy more. In 1973, Buffett made in the Washington Post one of his most profitable investments ever.
At the moment, the Post was generally regarded as having a valuation anywhere between $400 million— $500 million— placing it at only $100 million through its stock ticker. To Buffett, that was a warning to purchase. He was able to acquire more than 1.7 million securities for just $10M.
The underlying philosophy here is simple: hang on to your capital when it’s inexpensive, and invest freely when it’s expensive.
The world was still in the midst of a stock market crash that began in January 1973. The slow-motion collapse produced a two-year bear market— the Dow Jones opened at 1020 in 1973 and finished at 616 in 1974. One of Buffett’s big investments, Coca-Cola’s shares plunged from $149.75 to $44.50. Industries whose conditions had not improved were significantly underpriced across the board, according to Buffett’s assessment.
The portfolio of the Washington Post also fell after the sale of Buffett. The Post became technically a loss for Berkshire Hathaway after the end of 1974, slipping from a valuation of $10.6 million to $8 million. Yet Buffett had a belief that the fortunes of the firm would change, so he realized that the stock had been picked up at a great price, despite the fact that it had sunk even more.
In his 2016 letter, Warren Buffett wrote,
“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold”.
“When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons.”
By the time Jeff Bezos purchased the paper in 2013, the 1.7 million share interest of Buffett was worth around $1.01B— a return of over 9,000 percent.
When others are greedy, be fearful and when others are fearful, be greedy.
Following the financial crisis of 2007-2008, few economic dogmas have been hit harder than the theory of efficient markets, or the notion that an asset’s price represents the market’s fair assessment of available information about it.
When it became apparent that managers at some of the world’s largest banks routinely overlooked the risks inherent in the commodities they dealt with, it became difficult to defend the notion that rates were ever really rationally set.
Retail and institutional investors sold massive numbers of assets of weak and strong companies amid the recession. Nevertheless, Buffett went on a personal binge of purchasing, even penning an impassioned New York Times op-ed entitled ‘Buy American’ about the billions he had spent buying up marked-down stock.
On the topic of efficient markets and moral actors, Buffett is mild. In 2017, commenting on the financial crisis, its implications, and its benefits, he said,
‘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.”
Buffett is generally of the opinion that markets are efficient. That’s why he typically warns against bargain-hunting or ‘timing’ your entrance into a market: it’s nearly impossible to try and outsmart the crowd’s consensus that sets prices.
Buffett also suggests that there are world-historic periods in which all that falls out of the window — natural disasters, fires, and other times in which passions seize over and rationalism spills out of the window. He goes on to further say,
“What investors then need instead is an ability to both disregard mob fears or enthusiasm and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period – or even to look foolish – is also essential.”
Buffett argues that savvy investors will continue to look at the fundamental value of firms in unpredictable or turbulent times, finding businesses that can maintain their competitive advantage for a long time, and buying with the mindset of an individual. Obviously, because buyers can do that, they would continue to go in the herd’s opposite direction—to “be fearful when others are greedy and greedy only when others are fearful,” Warren Buffett wrote in his 2004 letter to Shareholders.
The reasoning is simple: if others are scared, prices will fall, but in the short term, prices are likely to remain low. Buffett is optimistic about any company that creates great goods, has good management, and offers great competitive advantages over the long term.
Buffett reportedly made $10B by 2013 by pouring capital into struggling American companies including General Electric, Goldman Sachs, and Bank of America during the financial crisis of 2008.
It is like playing Russian roulette to raise debt.
Managers use leverage to boost profits throughout the business world, from large corporate boardrooms to venture capital departments. Whether it’s a business like Uber raising $1.5B to re-energize its declining development or a venture like ModCloth requiring $20 M to follow the initial growth path, leverage gives businesses a way to raise money without giving up space on their cap table or diluting the current stock.
According to Buffett in his 2018 statement, debt even pushes creditors into a Russian roulette game. So ‘a Russian roulette equation — usually win, occasionally die — may make financial sense for someone who gets a piece of a company’s upside but does not share in its downside. But that strategy would be madness for Berkshire, “ says Warren Buffett.
Because of the incentive structure involved, the venture capital paradigm where the costs of a hundred mistakes can be offset by one major investment achievement is particularly prone to suggest debt usage.
Buffett declared in his 2018 letter that stock prices are currently too big and that Berkshire will continue to invest in shares while hoping for another ‘elephant-sized’ chance.
Equally likely, a market speculator would encourage the use of leverage to maximize returns because they can create investments where they do not have to think about the downside risk. It may make sense for them to do so, because, as Buffett points out, they usually won’t get a ‘bullet’ when they pull the ‘trigger.’ But, for Buffet, who holds so many businesses outright and intends to keep them for the long term, it doesn’t make sense to get an outcome of ‘always living, often losing.’
A company’s risk of failure and a large amount of debt being called back is too great a risk, so Buffett and Berkshire Hathaway share equally with their owners in that danger.
Berkshire uses interest, but primarily through its affiliate railway and service. For these highly asset-laden companies with endless infrastructure and maintenance requirements, leverage makes more sense, and even in an economic downturn, they can produce plenty of cash with Berkshire Hathaway.
Final Thoughts
The biggest lesson from his letters to the shareholder is how Buffett has changed over time. We see him talking about buying a big business at the right price on CNBC. Sure, it’s very necessary, but it’s not how he’s doing 40% a year. What is most important for the small investor in the early years, and how he used Ben Graham’s overall philosophy but tailored it to small shares, risk arbitrage, takeover securities, etc.
The average investor won’t get amazing results when they look at it, say, BNSF and then go out and purchase another railway. If only a couple of million individuals were handled by Buffett, he would do completely different things. Reading the shareholder letters gives you a glimpse back in time to grasp this with incredible depth.
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