Warren Buffett’s annual letter to Berkshire-Hathaway (BRK.B) shareholders is on my must-read list, and I suggest adding it to yours as well. The letter always provides investing insights on Buffett’s folksy but outspoken manner. This year’s letter included special commentary from both Buffett and his partner Charlie Munger.
One of the most interesting pieces was Buffett’s discussion of his mistakes. Right off the bat in his reflection of 50 years as CEO, he described his decision not to sell his stake in Berkshire Hathaway (then just a textile manufacturer) as “a monumentally stupid decision.” Buffett bought shares on the cheap and when his investment thesis played out, Buffett refused to sell at a profit. Rather, he did the exact opposite and bought more shares. Buffett ended up owning a troubled company that he admittedly didn’t know much about. He described himself as having become “the dog who caught the car.”
Another mistake Buffett admitted was buying Waumbec Mills on the belief that “synergies” would result in a profitable investment. Cost savings have been a continuous argument from corporate executives as to why shareholders should support their acquisition decisions. Often, however, synergies don’t come to fruition. Or as Buffett put it, “I’ve never heard ‘dis-synergies’ mentioned, though I’ve witnessed plenty of these once deals have closed.”
Mergers and other types of corporate restructuring were a big a topic in this year’s letter. Berkshire Hathaway is a conglomerate set up to pool the excess cash thrown off by each holding to fund potentially profitable endeavors. The unique structure of the company and the talents of Buffett and Munger allow capital to be deployed in a manner that is tax-friendly and without transaction costs. It is a characteristic Buffett routinely touts in his shareholder letters.
In discussing mergers, the Oracle of Omaha brought up the topic of creative accounting. He particularly focused on companies issuing shares to grow their businesses, stating, “We have never invested in companies that are hell-bent on issuing shares. That behavior is one of the surest indicators of a promotion-minded management, weak accounting, a stock that is overpriced and–all too often–outright dishonesty.”
Buffett also used Jimmy Ling, who made a habit of acquiring and divesting companies in the 1960s and 1970s, as an example as to why investors should be weary of CEOs who use creative business strategies. “Periodically, financial markets will become divorced from reality–you can count on that. More Jimmy Lings will appear. They will look and sound authoritative. The press will hang on their every word. Bankers will fight for their business. What they are saying will recently have ‘worked.’ Their early followers will be feeling very clever. Our suggestion: Whatever their line, never forget that 2+2 will always equal 4. And when someone tells you how old-fashioned that math is—zip up your wallet, take a vacation and come back in a few years to buy stocks at cheap prices.”
Buffett and Munger were also critical of the environment that encourages various corporate restructurings. Buffett wrote, “Investment bankers, being paid as they are for action, constantly urge acquirers to pay 20% to 50% premiums over market price for publicly-held businesses. The bankers tell the buyer that the premium is justified for ‘control value’ and for the wonderful things that are going to happen once the acquirer’s CEO takes charge. (What acquisition-hungry manager will challenge that assertion?)…A few years later, bankers–bearing straight faces–again appear and just as earnestly urge spinning off the earlier acquisition in order to ‘unlock shareholder value.’”
Munger says the culture of resistance to such deals is what has helped Berkshire’s success: “Berkshire, by design, had methodological advantages to supplement its better opportunities. It never had the equivalent of a ‘department of acquisitions’ under pressure to buy. And it never relied on advice from ‘helpers’ sure to be prejudiced in favor of transactions.”
Perhaps the biggest reason many of us read the Berkshire shareholder letters in their entirety is that there are often good nuggets of advice intermingled with the commentary that could be missed if one were to simply scan the monologue. This year’s letter was no different, with Buffett cautioning on page 34 that “A sound investment can morph into a rash speculation if it is bought at an elevated price.” This is a quote you would do well to look at every time before you place an order to buy an investment.
I want to personally invite you to our 2015 Investor Conference, which will be held this November in Las Vegas. This conference regularly sells out. If you can attend, you will be treated to many great presentations. Among the speakers at this year’s conference are Jack Ablin of BMO, Larry Swedroe of the Bam Alliance and Christine Benz of Morningstar. I hope to see you there!
The Week Ahead
Just two S&P 500 companies will report earnings next week: Urban Outfitters (URBN) on Monday and Dollar General (DG) on Thursday.
The first economic reports of note will be the January Job Openings and Labor Turnover Survey (JOLTS) and January wholesale trade, on Tuesday. Thursday will feature February retail sales, February import and export prices and January business inventories. The February Producer Price Index and the preliminary March University of Michigan consumer sentiment survey will be released on Friday.
Cleveland Federal Reserve Bank President Loretta Mester will speak publicly on Monday.
The Treasury Department will auction $24 billion of three-year notes on Tuesday, $21 billion of 10-year notes on Wednesday and $13 billion of 30-year bonds on Thursday.About The Author - Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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