Required Reading: Warren Buffett Wisdom in the Annual Letter

Warren Buffett’s annual letter just came out on March 1st. Read it here.

Disclosure: I own Berkshire Hathaway and have idolized Warren Buffett for years. Be prepared for a Warren Buffett lovefest. Also, if you want to go with Mrs. 1500 and I to see Buffett in the flesh in May, read on!

What is the annual letter and why should you care?
Warren Buffett is one of the greatest investors of all time. If you can consistently his performance, I’d like to hire you as my personal investment adviser.

His annual letter is where he not only discusses the status of Berkshire Hathaway, but also talks about the state of the economy in general. It’s filled with all kinds of interesting tidbits and wisdom. I highly suggest you have a look. It’s not that long and parts of it will send chills down your spine (well, maybe if you’re a Warren Buffett geek like me).

What is Berkshire Hathaway?
Before I discuss the letter, a little background information about Berkshire Hathaway (BH) is in order. BH is a holding company. A holding company doesn’t produce any goods or services itself, but owns other companies in part or whole. You may be surprised at some of the companies owned by BH: Dairy Queen, Brooks, Borsheim’s and Geico are all wholly owned under the BH umbrella. Additionally, BH owns shares of companies including Coke and IBM.

The Letter
The letter is a great read. Print it out and sit down with a highlighter. Read it a couple times. You may want to have a computer near to look up some of the technical stuff. I guarantee that you’ll learn something.

Here are the parts of the letter that I found especially interesting:

Compounded Annual Gain – 1965-2012: 19.7%,  9.4%

The 19.7% number is Warren Buffett’s annual percentage gain from 1965 to 2012. The 9.4% number is the S&P 500’s annual gain. He doubled it! INCREDIBLE!

When the partnership I ran took control of Berkshire in 1965, I could never have dreamed that a year in which we had a gain of $24.1 billion would be subpar, in terms of the comparison we present on the facing page.

But subpar it was. For the ninth time in 48 years, Berkshire’s percentage increase in book value was less than the S&P’s percentage gain (a calculation that includes dividends as well as price appreciation). In eight of those nine years, it should be noted, the S&P had a gain of 15% or more. We do better when the wind is in our face.

In 2012, Buffett didn’t beat the S&P 500. The S&P returned 16.0% while Buffett earned 14.4%. However, he has beaten it in 39 out of 48 years. This is spectacular performance.

He also states that he does better ‘when the wind is in our face.’ So, Buffett does better when the markets are underperforming.

Unless the U.S. economy tanks – which we don’t expect – our powerhouse five should again deliver higher earnings in 2013. The five outstanding CEOs who run them will see to that.

One theme throughout the letter is Buffett’s incredible optimism for the US economy. If Buffett is optimistic, you should be too.

Todd Combs and Ted Weschler, our new investment managers, have proved to be smart, models of integrity, helpful to Berkshire in many ways beyond portfolio management, and a perfect cultural fit. We hit the jackpot with these two. In 2012 each outperformed the S&P 500 by double-digit margins. They left me in the dust as well.

As a BH shareholder, one concern I have is Buffett’s age. At 82, he is no spring chicken. What will become of BH when he passes on? If you have the same concerns, the letter is sprinkled with praise for the folks around Buffett. This makes me feel a lot better about the long term success of my investment. Also, this seems to be a common theme with Buffett in general; surround yourself with smart people of high integrity they’ll get the job done.

I also like his humility. If he has not done something well or someone is doing a better job, he calls himself out.

Berkshire’s “Big Four” investments – American Express, Coca-Cola, IBM and Wells Fargo – all had good years. Our ownership interest in each of these companies increased during the year.

The four companies possess marvelous businesses and are run by managers who are both talented and shareholder-oriented. At Berkshire we much prefer owning a non-controlling but substantial portion of a wonderful business to owning 100% of a so-so business.

I always love to learn about what successful people invest in. So, here is your answer for Buffett. Again, these are companies that Buffett owns stock in, but does not own outright like Geico.

I like what he says about owning a non-controlling part of these businesses. Buffett recognizes that all 4 of these companies are very well run, so he is happy to let them do their thing; no need to interfere.

There was a lot of hand-wringing last year among CEOs who cried “uncertainty” when faced with capital allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash). At Berkshire, we didn’t share their fears, instead spending a record $9.8 billion on plant and equipment in 2012, about 88% of it in the United States. That’s 19% more than we spent in 2011, our previous high. Charlie (Munger) and I love investing large sums in worthwhile projects, whatever the pundits are saying. We instead heed the words from Gary Allan’s new country song, “Every Storm Runs Out of Rain.”

I love his bravado. No fear for Buffett. I also like that he is investing heavily in the United States. Many are terrified about a rising China, not Buffett.

We will keep our foot to the floor and will almost certainly set still another record for capital expenditures in 2013. Opportunities abound in America.

Again, I love the optimism.

American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor. (The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions. And don’t forget that shareholders received substantial dividends throughout the century as well.)

Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.

If you’re an investor and this doesn’t inspire you, nothing will.

I also love how he trashes the market timers. Buffet doesn’t jump in and out of holdings. He buys solid companies and sticks with them for a long, long time.

A century hence, BNSF and MidAmerican Energy will continue to play major roles in the American economy. Insurance, moreover, will always be essential for both businesses and individuals – and no company brings greater resources to that arena than Berkshire. As we view these and other strengths, Charlie and I like your company’s prospects.

One of Buffett’s core investment philosophies is to invest in companies with ‘strong moats’ that therefore, have tremendous staying power. In the quote above, Buffett is saying that he expects two of his holdings, BNSF and MidAmerican to still be around in 100 years.

I don’t know much about energy, but railroads (BNSF) aver very expensive to start. Laying a mile of track costs millions. Locomotives also cost millions. Right of way has to be secured, etc. In short, no-one is going to take down BNSF any time soon. Buffett realized this and that is why he now owns it. Do you think Apple or Google will be around in 100 years?

Our managers must think today of what the country will need far down the road. Energy and transportation projects can take many years to come to fruition; a growing country simply can’t afford to get behind the curve.

We have been doing our part to make sure that doesn’t happen.

Unlike almost every analyst out there, Buffett thinks very long term. Many of the things he is working on probably won’t even pay off until he is long gone. In my opinion, people would be a lot better off if they thought like Buffett instead of trying to turn a quick buck.

The Annual Meeting
Did you know that Berkshire Hathaway has an annual meeting in May in Omaha every year? If you’re a shareholder, you can attend and see Buffett and Charlie Munger grilled for hours on the status of the business. This meeting may sound a bit dry, but I think it actually sounds like great fun. Here are some quotes from the letter:

The doors will open at 7 a.m., and at 7:30 we will have our second International Newspaper Tossing Challenge. The target will be the porch of a Clayton Home, precisely 35 feet from the throwing line. Last year I successfully fought off all challengers.

Challenge Buffett to tossing newspapers, awesome!

At 8:30, a new Berkshire movie will be shown. An hour later, we will start the question-and-answer period, which (with a break for lunch at the CenturyLink’s stands) will last until 3:30. After a short recess, Charlie and I will convene the annual meeting at 3:45. If you decide to leave during the day’s question periods, please do so while Charlie is talking.

This part sounds really cool. I’d love to hear what Warren and Charlie have to say.

On Sunday, in the mall outside of Borsheims, a blindfolded Patrick Wolff, twice U.S. chess champion, will take on all comers – who will have their eyes wide open – in groups of six.

No way I’m taking on this guy, but it sure would be fun to watch.

Want to go with me?
Mrs. 1500 and I have decided that we’re going to attend this year. It happens the weekend of May 4th. I get 4 tickets and my 3 and 6 year are going to sit this one out. That leaves me with two extras. If you want to go, drop me a line here or email at: mr1500 at 1500days dot com.

See you in Omaha!