Investing lessons from Warren Buffett’s letter to shareholders

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There is a lot to learn from Warren Buffett. The simplicity of thought and a direct communication style is enviable. These are qualities I try my best to emulate. Believe me, it is easier said than done – institutional imperative pushes us in the opposite direction.

Of course, his legend is built on his underlying investment track record and the tremendous wealth he has generated for his shareholders over 50 years — since 1965. Berkshire Hathaway’s shares have returned 20 percent annually, compared to the 10.2 percent for the benchmark S&P 500.

In cumulative terms, that is a staggering 28,10,526 percent rise versus 23,454 percent for the S&P!

System and discipline

In my opinion, Buffett’s genius (much like his mentor’s i.e., Benjamin Graham) lies in being able to cut through the fluff and think straight.

In his own words: “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

The reason why they are probably the most important lessons is that the nature of investing is such that (i) any long-term active investor will witness many periods (sometimes, years) of underperformance, and (ii) every portfolio will have its share of losers. Both apply to Warren Buffett as well.

Berkshire’s stock performance has lagged the benchmark in numerous years. However, a ‘sound intellectual framework’ focussed on company fundamentals and the discipline to stick to it has meant that the good years, which saw massive outperformance, more than made up for the bad ones.

Buffett has had his share of lemons, too. In fact, as always, in the letter, he openly admits that he made a big mistake on a $37 billion investment in Precision Castparts (PCC). He said, “I paid too much for the company… I was wrong, however, in judging the average amount of future earnings and, consequently, wrong in my calculation of the proper price to pay for the business”

This showed up as a $10 billion write-down in 2020. He also went on to say, “PCC is far from my first error of that sort.” He famously swore off investing in airline stocks in the 1990s and early 2000s, referring to himself as an ‘air-o-holic.’ This addiction seems to have reared its ugly head again because in the throes of the pandemic Berkshire booked a loss on another set of airline stocks in 2020.

Again, for every bad airline investment, Buffett has made famously huge windfalls in the likes of Coca Cola, American Express or Apple. At the end of the day, every investor will make mistakes; the key is to have a sound system in place and remain undeterred.

Owner mindset

Not for the first time, Buffett continues to emphasise that Berkshire’s portfolio is ‘a collection of businesses’ not just tickers on a screen.

The quality of a company’s business is reflected in metrics like growth, both in revenue and retained earnings as well as return on capital, among others.

Of course, the price one pays in relation to these metrics is an important factor, but periodic fluctuations in price should not matter much to a fundamentals-focussed investor.

In the same vein, Buffett highlights Berkshire’s property/casualty insurance operations, BNSF and Berkshire Hathaway Energy, among many other privately owned businesses that don’t have daily stock prices.

Hence, they probably don’t receive as much attention as Berkshire’s investment portfolio of ‘marketable stocks’.

However, it is clear from the letter that Berkshire remains focussed on investing behind and growing these ‘family jewels’.

The same philosophy is behind Berkshire’s practice of regularly buying back stock. Just in 2020, it repurchased shares worth $25 billion. Buffett again chooses to focus his shareholders’ attention on the underlying effect of the action.

“….That action increased your ownership in all of Berkshire’s businesses by 5.2 percent without requiring you to so much as touch your wallet. Following the criteria Charlie and I have long recommended, we made those purchases because we believed they would both enhance the intrinsic value per share for continuing shareholders.”

Conclusion

The title of this piece could easily say ‘life lessons’ rather than just ‘investing lessons’ from the world’s most famous and arguably GOAT (Greatest Of All Time) investor.

Armed with his folksy charm, he is truly an insurmountable icon of the investing world. But the biggest lesson for me remains that even this icon’s investment track record is not perfect – yours won’t be either.

You will miss opportunities and frequently misjudge both the timing and assumptions behind your investments. However, if you have a robust framework and the courage to stick with it, you should fare well.

My co-founders and I started building a product on a similar belief. Human investors are prone to react to market euphoria and panic that leads to irrational and emotional investing. Hence, the idea is to leverage machine learning tools while staying true to fundamental investing principles.

In the process bridging the gap between active and passive investing to deliver alpha over human/active investing, with the consistency of passive investing. Essentially, we hypothesise that ‘AI is the new Warren Buffett’.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.