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Warren Buffett's Annual Letter 2014 |
Warren Buffett is such a tease - first publishing an exerpt from his annual letter to shareholders, before publishing the full letter. Since I love reading Buffett, and got some responses from my writeup on the exerpt of his letter, I decided to do another writeup looking at his full letter (click through the link to read it). Most of the original material was in the exerpt, here's what I found interesting in the remaining bit of the report:
The first thing I note is that the last 5 years have been a disaster for Buffett's record - the per-share book value of Berkshire has underperformed the S&P 500 by 22%. However, over the last 7 years Berkshire has outperformed the S&P 500, and it's fairer to look over that period as it more resembles a complete market cycle than the last 5.
"Serious investors should understand the disparate nature of intangible assets: Some truly deplete over time while others in no way lose value. With software, for example, amortization charges are very real expenses. Charges against other intangibles such as the amortization of customer relationships, however, arise through purchase-accounting rules and are clearly not real costs. GAAP accounting draws no distinction between the two types of charges. Both, that is, are recorded as expenses...Eventually, of course, the non-real charges disappear when the assets to which they’re related become fully amortized. But this usually takes 15 years....Every dime of depreciation expense we report, however, is a real cost. And that’s true at almost all other companies as well."
"Intrinsic value is an estimate rather than
a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are
revised."
"Last year, for example, BNSF’s interest coverage was 9:1. (Our definition of coverage is pre-tax earnings/interest, not EBITDA/interest, a commonly-used measure we view as seriously flawed.)"
"At MidAmerican, meanwhile, two factors ensure the company’s ability to service its debt under all circumstances. The first is common to all utilities: recession-resistant earnings, which result from these companies exclusively offering an essential service. The second is enjoyed by few other utilities: a great diversity of earnings streams, which shield us from being seriously harmed by any single regulatory body."
This point drives home my feelings about rail's cost advantage over road : "BNSF, like all railroads, also moves its cargo in an extraordinarily fuel-efficient and environmentally friendly way, carrying a ton of freight about 500 miles on a single gallon of diesel fuel. Trucks taking on the same job guzzle about four times as much fuel."
"When I was first introduced to GEICO in January 1951, I was blown away by the huge cost advantage the company enjoyed compared to the expenses borne by the giants of the industry. That operational efficiency continues today and is an all-important asset. No one likes to buy auto insurance. But almost everyone likes to drive. The insurance needed is a major expenditure for most families. Savings matter to them – and only a low-cost operation can deliver these. GEICO’s cost advantage is the factor that has enabled the company to gobble up market share year after year. Its low costs create a moat – an enduring one – that competitors are unable to cross. Meanwhile, our little gecko continues to tell Americans how GEICO can save them important money. With our latest reduction in operating costs, his story has become even more compelling."
Nobody has had a bigger influence on my investing style than Warren Buffett - I religiously listen to what he has to say. The major deviation in our styles is that I don't think he puts anywhere near as much weight as I place on director trades. Speaking of director trades, there were a spate of director sales on the JSE today - here's the ones I think were meaningful : Famous Brands, Super Group (btw, yesterday SPG reported that Allan Gray have built a 20% stake in the company) and BSI Steel. I'm sitting on quite a bit of cash in my portfolio at the moment, and seeing all these director sales is not encouraging me to invest.
Back to Buffett: Here's an excerpt from his annual letter published in Fortune Magazine (click to read - I've summarised some points below, but it's far better to read the original).
He starts off by speaking about 2 property investments he made:
A farm near Oamaha. He calculated a normalised return for the farm of 10%, and thought that productivity would improve over time and crop prices would go higher. The investment therefore had no downside and only upside (he did recognise that there would be the occasional bad crop and prices would sometimes disappoint, but as Buffett says - so what).
A property next to New York University. The yield was also 10%, and would increase when several vacant stores were rented out. The largest tenant had a very low rent, and his rent would increase when the lease expired in 9 years time.
Key takes:
Focus on what assets will produce going into the future, and first decide whether you can estimate an earnings range 5 years out or more. If you can then buy the stock if it is trading "at a reasonable price in relation to the bottom boundary of your estimate". If you cannot estimate future earnings, which is usually the case, then move on.
"Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important."
The goal of nonprofessionals should be "to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal."
A danger is that a beginner starts investing at a time of "extreme exhuberance".
This isn't from this year's letter, but I thought I'd reproduce some thoughts I've jotted down in previous years on competitive moats, as they are pertinent to the ability to estimate future earnings ranges:
Holding assets that can't easily be duplicated. "Railroads are an asset that can't be duplicated. Move vital goods in an environmentally friendly way. Much better business than it was five or ten years ago."
Being the lowest-cost producer (with features that make it tough for other companies to duplicate): "At Geico it's very reasonable to expect profitable underwriting and growing float for as far as the eye can see. This is possible because Geico is the low-cost producer. Has real advantages that make it tough for other companies to duplicate". GEICO uses a direct to consumer sales model, using money saved from not paying agents to run television commercials.
Being deeply embedded in the processes of other companies: "The chances of being way wrong in IBM are probably less than being way wrong in Google or Apple -- at least for us. Apple makes brilliant products, I just don't know how to value it".
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