Lessons from Warren Buffett’s Annual Letter to Shareholders

Last week, Warren Buffett’s letter to his shareholders was available online.  His letters are always a great read, and they provide insight into his views on investments.  This post will be dedicated to some of the wisdom and humorous quips an investor can glean from his letter.

“Today, I would rather prep for a colonoscopy than issue Berkshire shares.”

Warren Buffet, 2016 letter to shareholders, page 4

Buffett’s reason to not issue shares is a result of past experience.  The examples he cites in the letter include buying Dexter shoe and General Re by issuing Berkshire shares.  Dexter shoe is the most painful decision as Buffett notes that the company’s stock promptly went to zero.  The shares he issued to purchase the company gave the Dexter sellers $6 Billion in Berkshire shares by the end of the year.

The lesson that Warren takes from this experience is to purchase his investments in all cash.  More importantly, for an investor reading his letter it identifies that one of the best investors in the world has a long memory of his mistakes.  The Dexter fiasco happened in 1993 and he is mentioning it in his 2016 letter to shareholders as a lesson learned.

“To recap Berkshire’s own repurchase policy: I am authorized to buy large amounts of Berkshire shares at 120% or less of book value because our Board has concluded that purchases at that level clearly bring an instant and material benefit to continuing shareholders. By our estimate, a 120%-of-book price is a significant discount to Berkshire’s intrinsic value, a spread that is appropriate because calculations of intrinsic value can’t be precise.”

Letter, pg 7

After a rant against companies that repurchase their shares at an inflated price, Warren identifies Berkshire’s repurchase policy-120% of book value.  His preceding words identified that too many boards today repurchase shares of their stock with no hard numbers on which price is an appropriate price to pay.  This is ridiculous, because price would be the first thing management would consider if looking at an acquisition.

This line of thought provides two lessons that an investor can use-watch your managements and set the appropriate price in hard numbers.  Watch the management of the companies that you purchase and make sure that they are making rational decisions.  They should not be following the crowd to simply buy back shares if the company stock price is inflated.  This would be wasting shareholder funds on a poor endeavor.  Having a hard test for their numbers is a great way to find the value of a company in the market.

“Over the years, I’ve often been asked for investment advice, and in the process of answering I’ve learned a good deal about human behavior. My regular recommendation has been a low-cost S&P 500 index fund. To their credit, my friends who possess only modest means have usually followed my suggestion.”

“I believe, however, that none of the mega-rich individuals, institutions or pension funds has followed that same advice when I’ve given it to them. Instead, these investors politely thank me for my thoughts and depart to listen to the siren song of a high-fee manager or, in the case of many institutions, to seek out another breed of hyper-helper called a consultant.”

Letter, pages 24-25

Warren identifies the best advice he can for investing-use low fee vehicles that match the market.  In my opinion, this is the simplest way to go with investing.  Match the market through a low cost index fund.  If you are not interested in looking at specific positions and digging deep – then purchase an index fund that attempts to match the S&P 500 and call it good.  Correction, if you are over 10 years from needing the money, purchase an index fund that matches the S&P 400 and call it good.  My reason is that the S&P 400 typically outperforms the S&P 500 but it will be more volatile than the S&P 500.  You can read more in the post below.

Investment Plans, Part 3: ETF example

In conclusion, Warren Buffett’s letters are great for anyone aspiring to be a successful investor.  If you would like to read his whole letter in its entirety you can find it here.  I leave you with my personal favorite quote from his letter, it is an adage he used when talking about how Wall Street managers separate their customers from money:

“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.”

-Letter, pg 25