While he does admit that the market is often efficient, Buffett believes that inefficiencies exist in the market that can be exploited through careful analysis. “Observing correctly that the market was frequently efficient, they went on to conclude that it was always efficient. In his 2012 letter, Buffett reaffirms these sentiments by saying, “Indeed, disciplined repurchases are the surest way to use funds intelligently. When these two criteria are met, Buffett is a strong proponent of corporate share repurchases. First, the company must have available funds (cash on hand plus sensible borrowing capacity). Buffett does not wish to see this happen, and thus refuses to split Berkshire stock.

In later letters, he sets forth an in-depth example of how much frictional trading costs can eat away at investing returns. In his 1983 letter, he states his distaste for highly active investing, saying, “One of the ironies of the stock market is the emphasis on activity. He shuns the idea that diversification limits risk because often it requires that investors move money away from winning stocks and into companies with which they are unfamiliar. As long as Berkshire’s managers continue to think like owners and manage their companies as if the companies are the only assets that they own, Berkshire shareholders can be confident that these outstanding results are likely to continue. His views on the tone and content of his correspondence are summarized in his 1979 letter, when he explains to his shareholders that he does not “expect a public relations document when our operating managers tell us what is going on, and we don’t feel you should receive such a document.”

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Buffett states that the best place to find true independence-“the willingness to challenge a forceful CEO when something is wrong or foolish”-is among people whose interests are aligned with shareholders. In his mind, the best directors are those who have their interests best aligned with shareholders. If a functional board is in place, and it is dealing with “mediocre or worse” management, it has a responsibility to the absentee shareholder to change that management.

  • As of 2012, Berkshire carried investments per share of $113,786 and non-insurance subsidiary earnings per share of $8,085.
  • These directors are incentivized to stay on the board, which often means choosing not to offend a CEO or fellow directors so that his popularity with management can remain strong and he can continue to collect directors’ fees.
  • In his letters, Buffett often speaks of how investors should respond to fluctuations in market prices.
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  • The answers to these three questions will allow the investor to rank all of his possible investments in different “bushes.” According to Buffett, “Aesop’s investment axiom, thus expanded and converted into dollars, is immutable.

In this case, if stocks are traded based on market price, shareholders of the company with the more overvalued stock will ultimately benefit at the expense of shareholders of the other company (similar to the benefits of trading with an overvalued currency). In his letters, Buffett often speaks of how investors should respond to fluctuations in market prices. Conversely, if a manager cannot create over $1 of market value for every $1 retained, he has a duty to his shareholders to distribute his earnings to them so that they may earn a higher rate of return elsewhere. If a manager is able to employ all of company earnings internally at a high rate of return that will create over $1 of market value for every $1 retained, managers should do so. In fact, if their business experience continues to satisfy us, we welcome lower market prices for stocks we own as an opportunity to acquire even more of a good thing at a competitive price.”

  • Buffett favored return on equity over earnings per share as a yardstick to measure managerial effectiveness.
  • In 1965, Warren Buffett penned his first annual letter to the shareholders of Berkshire Hathaway.
  • As long as Berkshire’s managers continue to think like owners and manage their companies as if the companies are the only assets that they own, Berkshire shareholders can be confident that these outstanding results are likely to continue.
  • In this event, the key question to Buffett is whether he can receive as much intrinsic business value as he gives.

On Market Fluctuations

Buffett encourages “moat-widening” actions from his operating managers and actively seeks to invest in businesses possessing a durable competitive advantage, such as Coca-Cola and Gillette. Much in the same way, a durable competitive advantage can protect a business and its returns on invested capital from the threat of competition and lessen the impact of other outside forces that can cripple average businesses. When he presents financial statements on a pro forma basis, he does so to reveal truth to his shareholders, rather than display the statements as if nothing bad had happened to the company.

Central to Buffett’s thesis on dividend policy is the concept that not all retained earnings are equal.

Retained earnings can be worth considerably more or less than 100 cents on the dollar, and managers should adopt dividend policies that reflect that fact. Buffett contends that the true value of retained earnings lies in how effectively managers can employ them. He openly states that for investments in truly great companies, his favorite holding period is forever. Buffett humorously (but accurately) describes his investment style in his 1990 letter, when he says that “lethargy bordering on sloth remains the cornerstone of our investment style.” The answers to these three questions will allow the investor to rank all of his possible investments in different berkshire hathaway letters to shareholders “bushes.” According to Buffett, “Aesop’s investment axiom, thus expanded and converted into dollars, is immutable.

What readers of these letters gain is far more than a list of rules for successful investing in the market.

While a great manager is a tremendous asset to a company, when the company’s success is tied to his/her presence, any competitive advantage created simply cannot be durable by nature. As a long term investor, the durability of a competitive advantage is a key concern to Buffett. Buffett’s attitude on management, while simple, has produced outstanding results at many of Berkshire’s subsidiary companies. Early on, readers see that Buffett is very candid in his communication with his shareholders and that he does not shy away from discussing both his triumphs and failures. If these two criteria are satisfied, Buffett feels that his managers are doing their jobs and will praise them for it in the annual letter. Indeed, it is not uncommon for Berkshire’s managers to work well into old age simply because of their love for their business.

Buffett relates this point nicely in his 1977 letter, when he states that he finds “nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. For example, a stock that has dropped very sharply compared to the market-as had the Washington Post when we bought it in 1973-becomes ‘riskier’ at the lower price than it was at a higher price.” Over the years, Buffett goes on to explain that as a net buyer of stocks, the best thing that can happen is for stock prices to drop, as articulated in his 1977 letter when he states that “we ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. When Mr. Market offers high prices, the investor can take advantage by selling to him at a price above intrinsic value, and when he offers low prices, the investor can take advantage by buying from him at prices below intrinsic value. In this chapter, Graham characterizes the market as a manic-depressive who comes each day to offer prices at which he will buy from and sell to the investor, whichever one the investor chooses. Occasionally, Buffett will choose to include special topics in his letters on whatever topic he feels that his shareholders should be aware.

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Buffett has two criteria that must be met for share repurchases to become advisable for a business. Making Berkshire stock more tradable would inevitably lead to more trading, and more trading would lead to fewer long-term investors. He views a stock-for-stock transaction to be a case in which both companies are making a partial sale of themselves. Buffett only contemplates issuing additional shares of stock as part of an acquisition (and even in this instance, only grudgingly).

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Additionally, in Buffett’s early letters, readers are able to see firsthand how he operates as a manager of a small company himself. The combination of employing capital at high rates of return and operating with little or no leverage allows the long-term investor to feel reasonably confident about the underlying economics of the business. After all, even a dormant savings account will produce steadily rising interest earnings each year because of compounding.” On top of employing capital at high rates of return, Buffett requires that companies operate from a position of low leverage. Buffett favored return on equity over earnings per share as a yardstick to measure managerial effectiveness. Buffett is a proponent of purchasing extraordinary companies at fair prices, rather than average companies at bargain prices. In fact, for a number of years, at the end of each letter he would place an advertisement for possible acquisition candidates from his shareholders.

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There have been a few times in the past when on a very short-term basis I have felt it would have been advantageous to be smaller but substantially more times when the converse was true. I now feel that we are much closer to the point where increased size may prove disadvantageous. This was due to the partly fortuitous development of several investments that were just the right size for us — big enough to be significant and small enough to handle. In 1965, Buffett sent a letter to what was then the Buffett Investment fund which held Berkshire Hathaway as one of a series of positions. Sign up for our Newsletter below and receive a consolidated PDF of The Buffett Bible and learn with us!

By viewing market prices as quotes from a manic-depressive business partner, the investor is now put in a position of power over market prices rather than enslaved by them (a far-too-common occurrence). Readers of these letters are provided with an invaluable understanding of how to view markets and companies, which is exceedingly beneficial for passive investors and professionals alike. Readers gain a framework for how to view risk, markets, and investing, as well as an understanding of how truly great businesses should operate. Some argue that share repurchases serve as a means for managers to artificially boost per share earnings, but the fact of the matter is that as long as Buffett’s conditions are met, repurchases provide shareholders with a very real economic benefit with little to no downside. In his 1983 letter, Buffett makes exactly this point, saying, “Were we to split the stock or take other actions focusing on stock price rather than business value, we would attract an entering class of buyers inferior to the exiting class of sellers.”

These “special topics” provide the most valuable insight available in the letters, and will be the focus of this brief hereafter. Berkshire has averaged a book value growth rate of 19.7% compounded annually from $19 per share in 1965 to $114,214 per share in 2012. Each letter typically begins with the change in book value over the course of the year.

When this happens, directors who are not content with the quality of management or fear that management is becoming too greedy can go directly to the owner and report their dissatisfaction. In his 1993 letter, Buffett lays out the three “boardroom situations” in great detail. He goes on to state that he is actually grateful to the academics professing the Efficient Market Hypothesis as gospel, saying, “In any sort of a contest – financial, mental, or physical – it’s an enormous advantage to have opponents who have been taught that it’s useless to even try.” Speaking on a 63-year record built at Graham-Newman Corp., Buffett Partnership, and Berkshire Hathaway during which he averaged an unleveraged annual return of over 20%, he states that his experiences provide a fair test.

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