Lessons from Buffett and Our Market Thoughts

Warren Buffett’s Berkshire Hathaway Inc.’s Annual Shareholders Letter was released last Saturday morning.

As broad US stock market indices continue to reach new highs this week, Buffett’s thoughts and actions are important.

Much of what follows is Warren’s writing, quoted from his Annual Letter. These thoughts are important today and will be vital lessons in the years and decades to come.

Reading these highlights and following his wisdom will help you to be more disciplined, financially successful and a better investor.

  • Berkshire Hathaway is a very different company than it was in 1970s through the early part of this century. Berkshire grew in those years based on Buffett’s investing in stocks of many large US companies and the vast insurance companies and the huge float (cash) they generate.
  • Over the past decade, he has focused more on buying large companies outright, as well as making many opportunistic investments, particularly during times of crisis, such as during the financial meltdown of 2008-09.

What are the lessons from this year’s Buffett Annual Letter which impact you and your financial life?

The future, fear and costs:

After citing that the DJIA has grown over his lifetime from 66 to 11,497 by 12/31/1999, he stated how the growth continued through the end of 2016 to 19,763, another increase of 72%. (Today, the DJIA is above 21,000.) He then wrote about the future:
  • “American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that.  Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.”
  • “Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics -that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media…”
  • “During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.”

Even Buffett can’t always beat the benchmark

Warren Buffett is clearly recognized as being one of the top investors of our lifetimes, as he has built an extraordinary conglomerate of companies and stock holdings. In this year’s letter, he did not discuss his stock sales and new purchases. However, his actions provide more lessons.

As smart as Buffett is, he makes mistakes and not every stock he buys becomes a home run. During 2016, Buffett sold the 63.5 million shares of Wal-Mart that was owned at 12/31/15.  He accumulated $4 billion in Wal-Mart between 2005-2012, during which time the stock far underperformed the S&P 500, Buffett’s benchmark. In a CNBC interview this Monday, he said that it is just too hard for large retailers to compete against Amazon.

As I wrote about last year, Lessons from Warren Buffett which can help you, Buffett’s top 5 stock holdings as of December 31, 2015 have under-performed the S&P 500 over the past 5-10 years. He may have done great with these stocks since he bought them decades ago, but they have not performed as well in the last 5-10 years.

This shows how difficult it is to succeed over the long term in selecting and holding individual stocks. Even for an “expert,” it is very difficult to vastly outperform the stock market, let alone even matching the index.

Buffett clearly recommends others should use an investment philosophy which is consistent with our firm’s investment approach. He clearly states: “Both large and small investors should stick with low-cost index funds.”

This is further evidence of why we feel so strongly about our investment philosophy of utilizing broadly diversified mutual funds on a global basis, which are similar to indexes/ benchmarks with extremely low costs. We are confident that our investment strategy is the best way to capture the long-term expected returns of the world’s stock markets with the greatest chance for success. As even Warren Buffett has recently shown, trying to pick a group of individual stocks just isn’t the best approach.

He writes at length about why hedge funds and alternative investments, with very high fees, are terrible long-term investments. If these investments interest you at all, read pages 21-24 of this year’s Annual Letter, here. They will be of much less interest to you after you read about Warren’s 10 year $1 million charitable bet, which he clearly will win.

Stock Purchases in 2016-17 market: Apple and airlines

Even though the market is at all time highs, and has been for months, Buffett and one of his associates purchased 61 million shares of Apple in late 2016 for $6.7 billion. And before Apple announced their earnings on January 31, 2017, Buffett has purchased an additional 76 million shares of Apple during January, 2017.

Berkshire’s Apple purchases were in the range of $110-121 per share. They stopped buying when the share price rose to $130-140/share range, where it is now. Buffett has made a huge gain already, but he could have purchased Apple shares for much cheaper many times in the past, and anytime prior to 2015. He may do well in the long-term with Apple’s stock, but he clearly should have been an Apple buyer years ago, if he bought shares in the last few months.

Additionally, Berkshire purchased billions of dollars of 4 major US airline stocks during 2016. He has said for two decades that airlines are terrible investments. He wrote in 2007 that they are the “worst sort of business.” This shows that we all need to be flexible, that times and thought processes should change based on what is going on in the world now, not just what occurred in the past. Airlines are now profitable and producing free cash flow.

Buffett’s Apple and airline purchases shows that he feels it still makes sense to continue purchasing stocks in the current stock market, as long as he feels he is buying at a reasonable price and the companies have good long-term prospects.

Do not be afraid of downturns, be prepared
  • Buffet wrote: “Charlie (Munger) and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. 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. And that we will do.”
  • “The lesson for us is that we must be prepared and expect that there will be significant down periods in the markets. They will happen. They are buying opportunities or a time to just wait out the down cycle. They are not times to sell or panic.”
Focus on the long term positive progress, not on negative talk
  • Buffett repeated his message from last year, of the importance of long term focus and the dynamism of the US economy.
  • He wrote: “Our efforts to materially increase the normalized earnings of Berkshire will be aided – as they have been throughout our managerial tenure – by America’s economic dynamism. One word sums up our country’s achievements: miraculous. From a standing start 240 years ago – a span of time less than triple my days on earth – Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers.”
  • “You need not be an economist to understand how well our system has worked. Just look around you. See the 75 million owner-occupied homes, the bountiful farmland, the 260 million vehicles, the hyper-productive factories, the great medical centers, the talent-filled universities, you name it – they all represent a net gain for Americans from the barren lands, primitive structures and meager output of 1776. Starting from scratch, America has amassed wealth totaling $90 trillion…. This economic creation will deliver increasing wealth to our progeny far into the future. Yes, the build-up of wealth will be interrupted for short periods from time to time. It will not, however, be stopped. I’ll repeat what I’ve both said in the past and expect to say in future years: Babies born in America today are the luckiest crop in history.”

Huge investments in wind energy and railroad infrastructure:

  • Berkshire owns BNSF, a huge railroad company, and Berkshire Hathaway Energy (BHE), a large multi-state energy company. Buffett and the executives of these two companies are so confident about the long-term future and their ability to generate reasonable returns that they invested $8.9 billion in plant and equipment in 2016. They know society will need transportation and energy.
  • Buffett cites the investments these companies have made in “planet-friendly technology.” He wrote: “In wind generation, no state comes close to rivaling Iowa, where last year the megawatt-hours we generated (from BHE) from wind equaled 55% of all megawatt-hours sold to our Iowa retail customers. New wind projects that are underway will take that figure to 89% by 2020.
  • “Bargain-basement electric rates carry second-order benefits with them. Iowa has attracted large high-tech installations, both because of its low prices for electricity (which data centers use in huge quantities) and because most tech CEOs are enthusiastic about using renewable energy. When it comes to wind energy, Iowa is the Saudi Arabia of America.”
  • “BNSF, like other Class I railroads, uses only a single gallon of diesel fuel to move a ton of freight almost 500 miles. Those economics make railroads four times as fuel-efficient as trucks! Furthermore, railroads alleviate highway congestion – and the taxpayer-funded maintenance expenditures that come with heavier traffic – in a major way.”

If you have read this far, we appreciate it. I have read every one of Buffett’s Annual Letter for decades and continue to find each year’s filled with many nuggetts of valuable advice.

We hope that you find this and each week’s essays valuable and informative.

Disclosure: Brad Wasserman, author of this blog post, owns a small number of Berkshire Hathaway shares, which were purchased years ago to enable me to attend the Berkshire annual meeting. All my other stock investments are in DFA mutual funds, as we recommend to our clients.

Source: Berkshire Hathaway 2017 Annual Letter, released February 25, 2017. See berkshirehathaway.com.
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