Buffett unpacked

Each year during the last week of February, Warren Buffett releases the annual report and shareholder letter of his company, Berkshire Hathaway (BRKB).

For many owners of Berkshire’s stock, it is a chance to marvel at the wisdom of the legendary investor.

In my opinion,  the annual letter to shareholders is required reading for participants in the investment industry.  As such, let me share some observations after digesting this year’s letter.


Big 3

First off, where do the the bulk of Berkshire’s investment gains in current holdings come from?

The answer, in terms of absolute performance and market value, is primarily in three holdings: Coke (KO), American Express (AXP), and Wells Fargo (WFC).  

Secondly, Mr. Buffett remarked on his experiences with acquisitions and how he made mistakes by using stock in acquiring a few companies which subsequently performed poorly.

Cash Rules

In my opinion, cash is now probably the preferred currency in ongoing purchases of additional companies.  

As an individual investor, it is a reminder to pay close attention to the deal structure of companies you own when they make acquisitions.

Cash is the most conservative approach, but probably not the most tax efficient.

Quality Matters

Third, when you look at the operating earnings of the non-insurance and utility businesses that Berkshire owns, the clear emphasis is business quality.

Coke and American Express are prime examples of high quality businesses that produced massive gains because of later growth.  

The common characteristic is for the company to take operating profits and reinvest that capital back in the business at high rates of return, fueling profit expansion in future years.  

Financial Engineering

Fourth, Mr. Buffett makes positive remarks about companies buying back their own stock, which is contrary to what some investment analysts believe.  

Buffett also gave his opinion about why passive investing (through indexes) is probably the best way to invest for most people.  

Essentially, professional investors, mainly hedge funds, cannot beat indexes because of the high fees they charge.  


Finally, I would note Buffett has changed his tune over the years on this subject.  

As he was growing his business empire, Buffett routinely made the observation on how beating the S&P 500 by small or large amounts over a long period of time could make a dramatic difference in how much wealth is accumulated.

I guess it is a case of do as I say, not as I do, which is understandable.  

In my opinion, Buffett’s position has changed a great deal so it is probably better for him to be more conservative in how he advises the general public.  

Photo Credit: DonkeyHotey via Flickr Creative Commons