Extracts from Warren Buffet's
2017 Letter to shareholders:
Pure Wisdom............read on.................
·
The
accounting for businesses requires that the carrying value of “losers” be
written down when their failures become apparent. “Winners,” conversely, are
never revalued upwards.
·
As
is the case in marriage, business acquisitions often deliver surprises after
the “I do’s”.
·
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.
·
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.
·
“Money
is always there, but the pockets change.”
·
It’s
our market system – an economic traffic cop ably directing capital, brains and
labor – that has created America’s abundance.
·
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.
·
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.
·
“What
is smart at one price is stupid at another.”
·
When
Ajit entered Berkshire’s office on a Saturday in 1986, he did not have a day’s
experience in the insurance business. Nevertheless, Mike Goldberg, then our
manager of insurance, handed him the keys to our small and struggling
reinsurance business. With that move, Mike achieved sainthood: Since then, Ajit
has created tens of billions of value for Berkshire shareholders. If there were
ever to be another Ajit and you could swap me for him, don’t hesitate. Make the
trade!
·
At
bottom, a sound insurance operation needs to adhere to four disciplines. It
must (1) understand all exposures that might cause a policy to incur losses;
(2) conservatively assess the likelihood of any exposure actually causing a
loss and the probable cost if it does; (3) set a premium that, on average, will
deliver a profit after both prospective loss costs and operating expenses are
covered; and (4) be willing to walk away if the appropriate premium can’t be
obtained. Many insurers pass the first three tests and flunk the fourth. They
simply can’t turn their back on business that is being eagerly written by their
competitors. That old line, “The other guy is doing it, so we must as well,”
spells trouble in any business, but in none more so than insurance.
·
A
few, however – these are serious blunders I made in my job of capital
allocation – produce very poor returns. In most cases, I was wrong when I
originally sized up the economic characteristics of these companies or the
industries in which they operate, and we are now paying the price for my
misjudgments. In a couple of instances, I stumbled in assessing either the
fidelity or ability of incumbent managers or ones I later put in place. I will
commit more errors; you can count on that. Fortunately, Charlie – never bashful
– is around to say “no” to my worst ideas.
·
A
business with terrific economics can be a bad investment if it is bought at too
high a price. We have paid substantial premiums to net tangible assets for most
of our businesses, a cost that is reflected in the large figure we show on our
balance sheet for goodwill and other intangibles. Overall, however, we are
getting a decent return on the capital we have deployed in this sector.
·
Charlie
and I want managements, in their commentary, to describe unusual items – good
or bad – that affect the GAAP numbers. After all, the reason we look at these
numbers of the past is to make estimates of the future. But a management that
regularly attempts to wave away very real costs by highlighting “adjusted
per-share earnings” makes us nervous. That’s because bad behavior is
contagious: CEOs who overtly look for ways to report high numbers tend to
foster a culture in which subordinates strive to be “helpful” as well. Goals
like that can lead, for example, to insurers underestimating their loss
reserves, a practice that has destroyed many industry participants.
·
Charlie
and I cringe when we hear analysts talk admiringly about managements who always
“make the numbers.” In truth, business is too unpredictable for the numbers
always to be met. Inevitably, surprises occur. When they do, a CEO whose focus
is centered on Wall Street will be tempted to make up the numbers.
·
We
have never, however, singled out restructuring charges and told you to ignore
them in estimating our normal earning power. If there were to be some truly
major expenses in a single year, I would, of course, mention it in my
commentary. But, to tell owners year after year, “Don’t count this,” when
management is simply making business adjustments that are necessary, is
misleading. And too many analysts and journalists fall for this baloney.
·
During
the accounting nonsense that flourished during the 1960s, the story was told of
a CEO who, as his company revved up to go public, asked prospective auditors,
“What is two plus two?” The answer that won the assignment, of course, was,
“What number do you have in mind?”
·
The
underlying hedge-fund managers in our bet received payments from their limited
partners that likely averaged a bit under the prevailing hedge-fund standard of
“2 and 20,” meaning a 2% annual fixed fee, payable even when losses are huge,
and 20% of profits with no clawback (if good years were followed by bad ones).
Under this lopsided arrangement, a hedge fund operator’s ability to simply pile
up assets under management has made many of these managers extraordinarily
rich, even as their investments have performed poorly.
·
“In
investment management, the progression is from the innovators to the imitators
to the swarming incompetents.”
·
When
trillions of dollars are managed by Wall Streeters charging high fees, it will
usually be the managers who reap outsized profits, not the clients. Both large
and small investors should stick with low-cost index funds.
·
The
wealthy are accustomed to feeling that it is their lot in life to get the best
food, schooling, entertainment, housing, plastic surgery, sports ticket, you
name it. Their money, they feel, should buy them something superior compared to
what the masses receive. In many aspects of life, indeed, wealth does command
top-grade products or services. For that reason, the financial “elites” –
wealthy individuals, pension funds, college endowments and the like – have
great trouble meekly signing up for a financial product or service that is
available as well to people investing only a few thousand dollars. This
reluctance of the rich normally prevails even though the product at issue is
–on an expectancy basis – clearly the best choice. My calculation, admittedly
very rough, is that the search by the elite for superior investment advice has
caused it, in aggregate, to waste more than $100 billion over the past decade.
Figure it out: Even a 1% fee on a few trillion dollars adds up. Of course, not
every investor who put money in hedge funds ten years ago lagged S&P
returns. But I believe my calculation of the aggregate shortfall is
conservative
·
Much
of the financial damage befell pension funds for public employees. Many of
these funds are woefully underfunded, in part because they have suffered a
double whammy: poor investment performance accompanied by huge fees. The
resulting shortfalls in their assets will for decades have to be made up by
local taxpayers.
·
Human
behavior won’t change. Wealthy individuals, pension funds, endowments and the
like will continue to feel they deserve something “extra” in investment advice.
Those advisors who cleverly play to this expectation will get very rich. This
year the magic potion may be hedge funds, next year something else. The likely
result from this parade of promises is predicted in an adage: “When a person
with money meets a person with experience, the one with experience ends up with
the money and the one with money leaves with experience.”
·
Long
ago, a brother-in-law of mine, Homer Rogers, was a commission agent working in
the Omaha stockyards. I asked him how he induced a farmer or rancher to hire
him to handle the sale of their hogs or cattle to the buyers from the big four
packers (Swift, Cudahy, Wilson and Armour). After all, hogs were hogs and the
buyers were experts who knew to the penny how much any animal was worth. How
then, I asked Homer, could any sales agent get a better result than any other?
Homer gave me a pitying look and said: “Warren, it’s not how you sell ‘em, it’s
how you tell ‘em.” What worked in the stockyards continues to work in Wall
Street.
