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Annual letter out


shalab
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"Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active

trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees

to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of

equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can

happen anytime in markets." [Page 18]

 

This seems to contradict with Buffett's own history of actively investing his entire career & using a bank loan for leverage in his early career.  Thoughts?  Is this a matter of preaching advise to the general public and average investor?

 

I know there have been several threads over the past 10 years on this board and its predecessor MSN board debating the merits of use of leverage (I say this to stress the mere discussion of leverage at this time should not be construed as a contrarian indication, as has been argued on other threads).  I am of the opinion that it is risky, but that risk is mitigated to varying degrees if (a) you are buying earnings power at cheap prices and/or the relevant market in general is cheap, (b) you are young and have high earnings power (and therefore can reasonably expect to continue funding deposits to your investment accounts) and © use of non-recourse leverage (such as mortgage loans for real estate, bank loans, LEAP options, etc).

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I think Buffett talks slightly differently publicly because his words carry so much weight and are then held by others as rules. I mean yes leverage for some very talented investors on some occasions makes sense but for the majority of people it could bankrupt them at some point, so he errors on the side of caution when writing these letters.

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Charlie is definitely publicly tipping Ajit and Greg Abel as the two successor CEO possibilities.  Not that that should come as a surprise, but this is the most explicit naming of a narrowed field we have seen so far.  Leave it to Charlie!

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My favourite part:

 

 

The year 1972 was a turning point for Berkshire (though not without occasional backsliding on my part – remember my 1975 purchase of Waumbec). We had the opportunity then to buy See’s Candy for Blue Chip Stamps, a company in which Charlie, I and Berkshire had major stakes, and which was later merged into Berkshire. See’s was a legendary West Coast manufacturer and retailer of boxed chocolates, then annually earning about $4 million pre-tax while utilizing only $8 million of net tangible assets. Moreover, the company had a huge asset that did not appear on its balance sheet: a broad and durable competitive advantage that gave it significant pricing power. That strength was virtually certain to give See’s major gains in earnings over time. Better yet, these would materialize with only minor amounts of incremental investment. In other words, See’s could be expected to gush cash for decades to come. The family controlling See’s wanted $30 million for the business, and Charlie rightly said it was worth that much. But I didn’t want to pay more than $25 million and wasn’t all that enthusiastic even at that figure. (A price that was three times net tangible assets made me gulp.) My misguided caution could have scuttled a terrific purchase. But, luckily, the sellers decided to take our $25 million bid. To date, See’s has earned $1.9 billion pre-tax, with its growth having required added investment of only $40 million. See’s has thus been able to distribute huge sums that have helped Berkshire buy other businesses that, in turn, have themselves produced large distributable profits. (Envision rabbits breeding.) Additionally, through watching See’s in action, I gained a business education about the value of powerful brands that opened my eyes to many other profitable investments.

 

We need to find more businesses that can grow earnings without significantly more capital injection !

 

:))

 

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"Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active

trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees

to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of

equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can

happen anytime in markets." [Page 18]

 

This seems to contradict with Buffett's own history of actively investing his entire career & using a bank loan for leverage in his early career.  Thoughts?  Is this a matter of preaching advise to the general public and average investor?

 

I know there have been several threads over the past 10 years on this board and its predecessor MSN board debating the merits of use of leverage (I say this to stress the mere discussion of leverage at this time should not be construed as a contrarian indication, as has been argued on other threads).  I am of the opinion that it is risky, but that risk is mitigated to varying degrees if (a) you are buying earnings power at cheap prices and/or the relevant market in general is cheap, (b) you are young and have high earnings power (and therefore can reasonably expect to continue funding deposits to your investment accounts) and © use of non-recourse leverage (such as mortgage loans for real estate, bank loans, LEAP options, etc).

 

 

This is a great point and a great discussion.  In his personal life, Buffett has taken personal loans before to buy stocks (for instance, in early 1972-3 I believe).  And with Berkshire, he has previously employed leverage in certain ways that most non-obsessed investors would be surprised that Berkshire engages in.  In 1988 or so, I believe, he took advantage of cheap financing to borrow a significant amount of money "just to have it" to strategically deploy - because capital was cheap.  He has done this a number of times with Berkshire; borrow long-term when capital is very cheap and then deploy it during a period of turmoil or something similar.  So, what gives?  Is he a hypocrite, I can hear someone say?  Well - how dare they say that - this man is my hero - of course, he is not a hypocrite.  Its just that leverage and debt are not always ipso facto bad.

 

There are exceedingly few things in business, and dare I say life, that are always bad or always good.  Is a gun good or bad?  Depends on whose hands it is in.  (Maybe the world would be better without any guns, but that is a different discussion.)  A police officer saving the life of someone by shooting a hostage-taker is of course substantially different than the hostage taker with the gun in his hands.  So with that said, there are sensible and wise uses of debt and leverage.  But, on balance, debt and leverage have caused every one of Western Civilization's significant financial calamities.  Additionally, leverage is the singular largest way that smart people lose everything or have some other very adverse business outcome.  Thus, from Buffett's vantage point, society and most of its members do not properly employ debt and would be better off without it.  So in that context, dogmatic rules such as "don't employ debt" are the best general advice he can give to society.

 

There is also a difference between being leveraged and employing leverage.  Being leveraged, to my mind, is either actually or potentially being extended past the point where one could own everything they do without debt and/or does not have the capacity to pay back everything they owe or could owe in the short-run.  Buffett has never put himself (at least this is my belief about him) nor Berkshire in the position where they couldn't pay back what they owe in the very short-run.  They employ leverage when it is cheap so they do not have to sell a liquid asset or to build up their cash pile war chest - but he has never actually been extended past what he could have bought without the leverage.  I'm not really articulating this point well, but I hope this point makes sense.

 

All of this reminds a bit of this interesting thing a wise man once told me.  I was having a beer one time with a very well-known political figure and he said "I've taken the two most likely, by a huge margin, personal scandals that cost politician's their careers completely off the table."  I said, "How's that?"  He responded: "I don't cheat on my wife and I don't drink alcohol.  So there is no chance that there will be a mistress scandal or a drunken video of me out there or a DUI [though I actually think this man had one when he was a very young man, but I think he meant once his political career started he wouldn't have one]."

 

I've thought about that conversation often when politicians inevitably have a scandal that either involves or is facilitated by infidelity and/or alcohol.  If a really drive politician wants to simply remove the largest stumbling blocks from their career it is quite easy: Don't drink and don't cheat.  It's that easy, yet human nature gets in the way.  I think it is similar for investors, institutions, and certain businesses with debt - most of us can't help ourselves, especially when there is a huge industry made up of smart people who are always willing to (read: encouraging) the use of debt.

 

Great points.

 

People take Buffett's comments too literally almost all of the time. When he makes sweeping generalizations he is meaning this for the average person. He is also saying that 99% of the time doing "x" is a bad idea, but not always. He has lots of common sense and most people don't.

 

 

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"Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active

trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees

to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of

equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can

happen anytime in markets." [Page 18]

 

This seems to contradict with Buffett's own history of actively investing his entire career & using a bank loan for leverage in his early career.  Thoughts?  Is this a matter of preaching advise to the general public and average investor?

 

I know there have been several threads over the past 10 years on this board and its predecessor MSN board debating the merits of use of leverage (I say this to stress the mere discussion of leverage at this time should not be construed as a contrarian indication, as has been argued on other threads).  I am of the opinion that it is risky, but that risk is mitigated to varying degrees if (a) you are buying earnings power at cheap prices and/or the relevant market in general is cheap, (b) you are young and have high earnings power (and therefore can reasonably expect to continue funding deposits to your investment accounts) and © use of non-recourse leverage (such as mortgage loans for real estate, bank loans, LEAP options, etc).

 

 

This is a great point and a great discussion.  In his personal life, Buffett has taken personal loans before to buy stocks (for instance, in early 1972-3 I believe).  And with Berkshire, he has previously employed leverage in certain ways that most non-obsessed investors would be surprised that Berkshire engages in.  In 1988 or so, I believe, he took advantage of cheap financing to borrow a significant amount of money "just to have it" to strategically deploy - because capital was cheap.  He has done this a number of times with Berkshire; borrow long-term when capital is very cheap and then deploy it during a period of turmoil or something similar.  So, what gives?  Is he a hypocrite, I can hear someone say?  Well - how dare they say that - this man is my hero - of course, he is not a hypocrite.  Its just that leverage and debt are not always ipso facto bad.

 

There are exceedingly few things in business, and dare I say life, that are always bad or always good.  Is a gun good or bad?  Depends on whose hands it is in.  (Maybe the world would be better without any guns, but that is a different discussion.)  A police officer saving the life of someone by shooting a hostage-taker is of course substantially different than the hostage taker with the gun in his hands.  So with that said, there are sensible and wise uses of debt and leverage.  But, on balance, debt and leverage have caused every one of Western Civilization's significant financial calamities.  Additionally, leverage is the singular largest way that smart people lose everything or have some other very adverse business outcome.  Thus, from Buffett's vantage point, society and most of its members do not properly employ debt and would be better off without it.  So in that context, dogmatic rules such as "don't employ debt" are the best general advice he can give to society.

 

There is also a difference between being leveraged and employing leverage.  Being leveraged, to my mind, is either actually or potentially being extended past the point where one could own everything they do without debt and/or does not have the capacity to pay back everything they owe or could owe in the short-run.  Buffett has never put himself (at least this is my belief about him) nor Berkshire in the position where they couldn't pay back what they owe in the very short-run.  They employ leverage when it is cheap so they do not have to sell a liquid asset or to build up their cash pile war chest - but he has never actually been extended past what he could have bought without the leverage.  I'm not really articulating this point well, but I hope this point makes sense.

 

All of this reminds a bit of this interesting thing a wise man once told me.  I was having a beer one time with a very well-known political figure and he said "I've taken the two most likely, by a huge margin, personal scandals that cost politician's their careers completely off the table."  I said, "How's that?"  He responded: "I don't cheat on my wife and I don't drink alcohol.  So there is no chance that there will be a mistress scandal or a drunken video of me out there or a DUI [though I actually think this man had one when he was a very young man, but I think he meant once his political career started he wouldn't have one]."

 

I've thought about that conversation often when politicians inevitably have a scandal that either involves or is facilitated by infidelity and/or alcohol.  If a really drive politician wants to simply remove the largest stumbling blocks from their career it is quite easy: Don't drink and don't cheat.  It's that easy, yet human nature gets in the way.  I think it is similar for investors, institutions, and certain businesses with debt - most of us can't help ourselves, especially when there is a huge industry made up of smart people who are always willing to (read: encouraging) the use of debt.

 

Thanks

 

Is the politician from Texas by any chance ?

 

 

 

 

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Guest notorious546
Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.

I'm happy to see this reiterated.

 

Berkshire’s marvelous outcome in insurance was not a natural result. Ordinarily, a casualty insurance business is a producer of mediocre results, even when very well managed. And such results are of little use. Berkshire’s better outcome was so astoundingly large that I believe that Buffett would now fail to recreate it if he returned to a small base while retaining his smarts and regaining his youth.

 

This is a good reminder of how different the previous environment was compared to today's.

 

 

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Charlie is definitely publicly tipping Ajit and Greg Abel as the two successor CEO possibilities.  Not that that should come as a surprise, but this is the most explicit naming of a narrowed field we have seen so far.  Leave it to Charlie!

 

Buffett's section says "Both the board and I believe we now have the right person to succeed me as CEO – a successor ready to

assume the job the day after I die or step down. In certain important respects, this person will do a better

job than I am doing". Makes it sound like there is one person already identified as the CEO!!!

 

Overall a great read, I personally enjoyed Buffett's section a lot more than Charlie's.

 

 

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That to me is an amazing feat and an incredible reminder to us "traders" about avoiding losses:

 

"We sold Tesco shares throughout the year and are now out of the position. (The company, we should

mention, has hired new management, and we wish them well.) Our after-tax loss from this investment was $444 million, about 1/5 of 1% of Berkshire’s net worth. In the past 50 years, we have only once realized an investment loss that at the time of sale cost us 2% of our net worth. Twice, we experienced 1% losses. All three of these losses occurred in the 1974-1975 period, when we sold stocks that were very cheap in order to buy others we believed to be even cheaper."

 

You can argue that Berkshire`s net worth keeps on increasing and that if he holds on to losers long enough that he can minimize the impact from their eventual sale vs Berkshire new net worth, but for the math to work out you need a fantastic ability to avoid the number of losers and/or avoid their losses being large and/or everything else being great. 

 

Cardboard

 

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Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.

I'm happy to see this reiterated.

 

Berkshire’s marvelous outcome in insurance was not a natural result. Ordinarily, a casualty insurance business is a producer of mediocre results, even when very well managed. And such results are of little use. Berkshire’s better outcome was so astoundingly large that I believe that Buffett would now fail to recreate it if he returned to a small base while retaining his smarts and regaining his youth.

 

This is a good reminder of how different the previous environment was compared to today's.

 

 

Yes but also remember that when he was running smaller sums in his partnership days, he employed the Benjamin Graham cigar butt approach in the 50s and thats when he had his greatest returns, until size became a barrier to that. For us small fry(most of us on this board), if you read between the lines, he is saying if you are sufficiently skilled the cigar butt approach is your best bet. Now thats a pretty big caveat, but nonetheless a distinction worth making.

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Anyone else get the impression after reading these letters that Ajit Jain is the name as the next CEO? He mentions that Todd and Ted will manage the investment portfolio and have a lot of latitude. He also mentioned that the CEO role will be separated from a non-executive chairman position that will be filled by his son to safeguard the culture and to be decisive on any board recommendations..

I did not see any mention of Matt Rose, and he semi skewered the performance of BNSF in this letter. Which for his usual standards of lavishing praise was pretty harsh. 

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I did not see any mention of Matt Rose, and he semi skewered the performance of BNSF in this letter. Which for his usual standards of lavishing praise was pretty harsh.

 

Great point.  I thought this was really interesting too.  Like you said he semi-skewered him and then specifically did not mention anything about the management of BNSF, which by implication is somewhat of an indictment since he singled out the heads of the all the other "Powerhouse 5" I believe for praise.  And since in the past it has seemed that Buffett not praising management of one of the very large subsidiaries is almost like criticism.

 

At face value, it does seem like BNSF dropped the ball.  But, my paranoid thought is that Buffett is justifying to regulators and captives shippers why he is going to spend $6 billion this year on a cost plus business. 

 

It is unlike him to single out a business like this when it has been such a great performer unless they have years of trouble.  Plus, Buffett is saying that BNSF needs to spend a much higher portion of revenue than other rails, including its primary competitor.  The first thing regulators are going to ask is: "Why?..."  The answer to regulators has to be that it is because BNSF is losing competitive ground rather than BNSF wants to gain competitive ground and Berkshire loves spending as much as possible on this cost plus business.

 

Plus, note that Matt Rose is no longer CEO (and hasn't been) and Carl Ice is. 

 

But, that is the paranoid response.  The simple explanation is that Union Pac. ate BNSF's lunch.

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NBL,

 

I certainly read it as either Ajit Jain or Greg Abel. But, Buffett specifically said in this letter that (1) the next CEO is not likely to retire at 65, (2) Berkshire will operate best if its CEOs average well over ten years (Jain can serve into his early 80s, thus easily satisfy this wish of Buffett) (3) Warren raised the possibility of him stepping down (for the first time in his letters I believe), and (4) We know Buffett talks to Jain daily. Due to these reasons, I still think there is a good chance that the next CEO will be Ajit Jain.

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