I am sort of intrigued to know what ideas are conveyed in Warren Buffett's letters and Berkshire AGMs. Starting from 1957 he has written an annual letter. My objective is to note down what the key messages are in each letter & each AGM is. This is my interpretation.
I also do not think a comprehensive editable compilation exists today. I have taken the initiative to compile the letters in a document. Any error can be attributed to me. It is work in progress.
I am not sure how to organize it as hyperlinks are not possible. So far I have covered the following letters:
- 1960 semi-annual 1
- 1960 semi-annual 2
- 1961 semi-annual 1
- 1961 semi-annual 2
- 1962 semi-annual 1
- 1962 semi-annual 2
- 1963 semi-annual 1
- 1963 semi-annual 2
- 1964 semi-annual 1
- 1965 semi-annual 1
- 1965 semi-annual 2
- 1966 semi-annual 1
Though Buffett says this is the second letter I think this is the first which is actually a 'letter'. I don't know if a 1956 letter exists or not but I believe that it would have been an inaugural letter to all the partners. Nevertheless going into what matters most, his ideas.
- When the general market is priced above intrinsic value then there is a greater chance of decline in stock prices. This decline effects all stocks whether they are undervalued or not.
- If the market is overvalued currently think about 5 years down the line with what probability you will look back and say the market was valued to its intrinsic levels.
- Buffett talks about two segregation in his portfolios. First he calls General Issues and the second he calls Work Outs. General Issues are the ones which is a standard equity investment in the business for growth basis fair valuations (I think in these years he was focusing only on undervalued stocks). Work Outs are investments which make profit on specific corporate action. Nowadays we would be calling it special situation investing I believe.
- He believes if the general market were to go higher he would reduce his exposure to General Issues. I think this is something which I have intuitively practiced. Have some barometer of the market valuation and have appropriate chips on the table for the General Issues.
- Buffett says he is not into predicting market movements though I think he is highly cognizant of what levels the indices trade at. His sole focus is finding undervalued securities.
- A great piece of advice he shares is that there is recency bias in a correction especially those who are new in the market. The market correction looks quite deep when in the larger scale of things its very small. And there will be more correction lying ahead from the current valuation levels of the market.
- He doesn't focus on any kind of prediction be it market, economy or businesses. Then I wonder his measure of intrinsic valuation is based on past performances? Is it that Buffett doesn't do forecasting of future cash flows rather more of a reverse cash flow discounting. Just my questions.
- Buffett is ready to take aggressive portfolio bets going all the way up to 20% of allocation on a single idea.
- Great patience to add to a position over months maybe years, I don't know. But he feels a declining or a flat price will work to his advantage. That is great conviction in his ideas.
- Buffett says that there is exuberance in the markets. Any reason is used to justify high valuations.
- He aptly says that the duration of the stay of mercurially tempered people in the market will be as long as profits can be made quickly and effortlessly. I am assuming he thinks that value investing is the only way of making money which I humbly disagree. If the mercurial people are making money by say trend following then so be it. But being a master of one's own domain is what matters and I assume he is the master of masters in his.
- He reiterates that he chooses not to make any kind of forecasts.
- Even if price correction happens which undoubtedly will one day intrinsic value will not be lost.
- In his Work Outs i.e. Special Situation investing of 1957 the price had remained constant and he had build up position in the stock. He discloses the company name a bank. But the key point is that he perhaps holds no position in the stock at the time of writing the 1958 letter. Now here there is some disconnect I have. He was adamant that he was waiting for a value unlock even if that takes years and he gets out of this position because he sees another brighter prospect. It is fair to say one thing and do the same but its quite not justified to say something and do another thing. But the best part is he makes this stance explicitly clear which I like. As I always have felt an investor is only a very long term trader.
- He lays out the reasons for the investment in the bank in 1957 - well managed bank, substantial earnings, selling at a large discount to intrinsic value. In essence the business displayed very strong defensive characteristics at a satisfactory price and there would be value unlocked even if it took 10 years.
- As outlined above Buffett sold his stake in this bank and entered another special situation. He says that he is virtually assured of a better return than the market on this and he wants to allocate to opportunities which have better returns of capital. Fair enough. This new position is even bigger than the earlier holding in the bank he had in 1957.
- He feels as the market is overvalued he will get fewer opportunities to invest in General Issues and would have to now look for more Work Outs. He says he is working to make his own special situations by taking majority positions in companies. And this would lead to an above average performance in a bear market.
- The DJIA made progress but there were more stocks in the red on the NYSE than in green.
- Buffett is skeptical of the levels of stock markets. He says the blue chips have a substantial speculative component in their pricing with a corresponding risk of loss.
- He reflects that there could be other standards of valuations which is evolving but he doesn't think so finally. He is happy to face penalties of over conservatism than face permanent loss of capital. He calls this 'New Era' of investing as a philosophy where trees grow to the skies.
- All his 6 partnerships were in profit and the only operating expense he has is the Nebraska tax of 0.4%. This looks extremely small.
- In 1958 he invested in a Work Out which now is 35% of the portfolio. This investment is itself invested in 30 to 40 other high quality securities.
- Rest of the portfolio is in undervalued and some work out operations. He is confident that his overall portfolio will lead to superior results in bear markets and average results in bull ones.
- In every year so far he has focused on preservation of capital. That is why the emphasis on managing to do well in bear markets. I think the focus of going on at a comfortable compounding rate is the core essence. Beautiful approach.
- The letters now have become 2 in a year. Not sure for long this will continue.
- Buffett reemphasizes that the DJIA couldn't be beaten by even 10% of the stocks a year ago. I think he has been pro Index Investing since eternity. History now makes sense to me on this subject. In 1960 the DJIA declined but more stocks lost than won.
- He is curt in saying that if the partnerships don't perform better than the index i.e. DJIA there is no reason for the partnerships to exist. Like this approach.
- Buffett always has said it is better that his funds hold or lose little value in a declining market that gain disproportionately in an upward market. Love this approach. I find it conservative and cautious too.
- He talks a lot about details of his partnerships. More related to operational issues. These can be avoided.
- The first case study: Sanborn Map
- The investment mentioned in the previous 1959 letter which took 35% of the portfolio value was that in Sanborn Map.
- Sanborn was or is (I wonder) engaged in creating extremely detailed maps of cities. For instance insurance agencies and fire services would know how ducts flow, where are water outlets etc.
- For 3/4 of a century the company operated in a monopolistic environment. Every year they generated profits without much sales efforts. The insurance agencies were afraid that Sanborn would become too powerful so they put executives on its board.
- In 1950s a competitive method of underwriting by these insurance companies came into force, it was called 'carding' (I am unaware what it exactly was). Essentially the company was losing its monopoly and revenues fell.
- But Sanborn being smart in the 1930s began an investment portfolio. There was no capital requirements for Sanborn so it devoted large sums of money for investments.
- Overtime in 1958 the embedded valuation of the maps business was priced negatively in the stock price and all the positive value was because of Sanborn's investments.
- It now had a sales of $2 Mn and an investment portfolio of $7 Mn.
- Buffett talks about the complexity of the deal and how existing shareholders navigated. This is not of importance to me personally.
- After his investment the existing shareholders were essentially rewarded with improved asset value, higher earnings per share and increased dividends.
- This case is more to do with a takeover where Buffett felt he could unlock value for existing shareholders. This serves as a good learning for me but not something from which I can apply in my own investing.
- Buffett says that 6 months or even 1 year is too short a time frame for measuring performance. His personal view is that a 5 year is an appropriate period.
- He reiterates that his fund will under perform in a bull market.
- Very important quote - Our holdings, which I always believe to be on the conservative side compared to general portfolios, tend to grow more conservative as the general market level rises. At all times, I attempt to have a portion of our portfolio in securities as least partially insulated from the behavior of the market, and this portion should increase as the market rises. However appetizing results for even the amateur cook (and perhaps particularly the amateur), we find that more of our portfolio is not on the stove.
- Provisions of combining all the 6 partnerships makes a mention in this letter. Not that there is a learning for me here. He and his wife hold maximum stake in the combined entity, minimum investment is a paltry $25,000.
- Not much investment knowledge in this letter other than the quote above.
- I have lost count of the times Buffett says that he will look good in a down market and bad or average in an up market.
- Despite 1961 being a good year for both the general markets and his fund he holds onto his view above. He actually beats the DJIA by 23% odd!
- This letter marks 5 years of compounding. His fund has a staggering 251% vs 75% of the index.
- He again highlights how tough it is to beat the index. He quotes a result of 32/38 mutual funds losing to DJIA and 6 who were ahead were only by a few percentage points. I think in the Indian context the story is the same. Though we do not have index funds (of such popularity) I think they could be the real deal of the future.
- Buffett again explains his methodologies which is divided into three types of investments
- Generals - Buying undervalued securities
- Work Outs - Where he can unlock some value with some corporate action
- Controls - Where Buffett can have a say in running the operations of the company
- On Generals he says they have large positions of 5% to 10% of their assets and they have major positions in 5 to 6 securities. Then there is a long tail of 15 odd stocks. This is a good way to visualize his portfolio. Personally for me as a retail investor Generals is what we are looking for and this gives a good idea of portfolio size.
- Buffett is not worried about timing the market. He says he is good at entering but not that good in selling. He doesn't want to haggle over nickels. This is an important lesson for us - we must not be stuck to a number of our valuation of a company.
- He is confident the generals will outperform the index. I guess this stems from the fact that he has bought at a fair or under valuation.
- The second case study so far is presented: Dempster Mill Manufacturing Company
- Buffett bought Dempster Mill Manufacturing Company as an undervalued security 5 years ago but later obtained a majority control with 70% holding.
- This is a company which manufactures farm implements and water systems. It has $9 million worth of operations in 1961.
- Buffett feels the company deserves a higher valuation. He holds 21% of the fund value in this company.
- In a raging bull market control situations is a method to insulate the partnership from the markets as per Buffett.
- Buffett makes a very important point when he says few years ago people were buying bonds and that those bonds have led to severe depreciation of capital. Now he says people are buying blue-chip shares not knowing that this too is not conservative which the public has assumed to be. He feel people are speculating and justifying higher multiples. This is so true today in the Indian market scenario of mid 2019. All the money is flowing into a handful of stocks which are essentially the bluest of the blue chip stocks. People are thinking they are safe havens. This might turn out to be a major pain point in the future.
- An important quote - You will not be right simply because a large number of people momentarily agree with you. You will not be right simply because important people agree with you. In many quarters the simultaneous occurrence of the two above factors is enough to make a course of action meet the test of conservatism. You will be right, over the course of many transactions, if your hypotheses are correct, your facts are correct, and your reasoning is correct. True conservatism is only possible through knowledge and reason.
- Buffett then lets out two very important quantitative numbers about his fund management approach
- Stop loss equivalent: They have never realized a net loss of 0.5% of 1% of total assets of the fund.
- Win ratio equivalent: Total dollars realized from a win to a loss is 100 to 1.
- In my understanding the win ratio is brilliant. Stop loss is a good metric here. I personally am more open with a broader stop loss but I have a lot of endowment bias. A major area of improvement.
- Another brilliant idea he puts forward as a prediction. He says that anyone thinking he will beat the index handsomely will face disappointment. He is focusing more on the number of years in the market than the annual growth rate. He makes this explicit. Buffett says there will be years of +25% and then -25% and it could happen number of times in any order but his focus is to add on the years with some positive growths. Beautiful prediction indeed.
- Buffett continues to add that in a bad year for the Dow he hopes he would have not such a bad year. And over time this cushioning effect would lead him to beat the index by 10% odd.
- This letter has some core ideas - time in market is critical, focus on long term rather very long term, protect capital like a fanatic, cut your losers, run your winners, save your portfolio in a down market and always be humble. This is a very good letter indeed.
- Buffett talks about him not losing as much as the index in the bad years and appearing average in good years. This time he gives a numerical target. He says that for every 1% drop in the Dow he should lose only 1/2%. That is an ambitious target. Roughly his fund should have 0.5 portfolio beta?
- He does perform fabulously well. DJIA is down 21.7% but his partnership is down only 7.5%.
- 6 month or even a year is too short a time frame to judge investor performance he says again.
- Buffett says that the Dow is no pushover. Whenever people will beat the Dow it will most likely be a poorer performance than a superior one he says. This is true today too seeing most active fund managers failing to beat the marquee index.
- Not much content in terms of investment knowledge in this letter. I think there should be only letter a year.
- Lot of details on operational aspects of the partnership are mentioned. These semi-annual letters in my opinion are not timely, some are written in July and some the next year in January. I can overlook this for the sheer quality of ideas which Warren Buffett shares.
- The Dow was down this year till the time the letter was written. Buffett's investment in Dempster has been paying off with prompt sale of its assets. I think in the early years Buffett focused a lot on such opportunities wherein he could buy a company cheap strip its assets of and sell them at fair value and make money. Dempster is just one case.
- Though the index was in red the partnership was in green with close to 22.3% point advantage. 40% of its overall gain was because of only Dempster.
- Buffett importantly highlights that such results are distinctly abnormal and will recur infrequently, if at all.
- Again he reemphasizes that in a good year for Dow he will look bad by saying 'If the Dow had continued to soar, we would have been low man on the totem pole.'
- He ends the letter reiterating that such superior performance to the Dow will be very limited.
- Buffett likes clarity. Supreme clarity. He even proposes axioms for his investors in this letter.
- He says his performance needs to be bench marked against the index Dow in this case. If he does better than the Dow they will be pleased if not he 'deserves tomatoes'.
- 5 year test for performance is what is preferable to him. 3 years is minimum.
- Reiterates he is not in the business of predicting stock market.
- He makes 3 promises to his investors
- Investments will be based on value and not popularity
- Risk of permanent capital loss will be minimized though there will be quotational losses. This he will achieve by having a margin of safety in his investments.
- He has skin in the game because his family's networth is invested in this fund.
- He makes an 'unscientific' opinion by saying that 10% alpha over Dow over a 10 year period is the maximum one can achieve.
- One of the greatest point he makes again: Dow is no pushover as an index of investment achievement.
- Buffett gives an anecdote on 'The Joys of Compounding' (reminds me of the book by this name by Gautam Baid a professional fund manager). He gives an example of compounding over centuries at 4%. Then puts is his typical humorous fashion as 'Such fanciful geometric progressions illustrate the value of either living a long time, or compounding your money at a decent rate. I have nothing particularly helpful to say on the former point.'
- Just like the previous years in 1961 he lays out his 3 types of portfolios
- Generals - Consisting of undervalues securities. Here he has large positions as a percentage to portfolio 5% to 10%. These investments sometimes work out fast and sometimes takes years. He holds 10-15 stocks in this category. Buffett is willing to leave something on the table and is not going after the last nickel in these investments. He makes an important point 'The generals tend to behave market-wise very much in sympathy with the Dow. Just because something is cheap does not mean it is not going to go down'.
- Workouts - These are special situations in which certain corporate situations will unlock value. Not something which I am interested in personally. This is his second largest category. He could have 5 to 10 positions in this category.
- Controls - These are where Buffett will take control of the company by being a major stockholder. He will unlock value by steering the workings of the company. Again something which I am not interested in. Sometimes a General ends up becoming a Control type of situation.
- Buffett goes back to the Dempster example. He says when control of a company is gained the value of the assets of the company becomes all important and not the market quotation of a 'piece of paper' (share certificate).
- In this case he gives the actual workings of how to apply appropriate discounts to the assets of the company.
- Cash @ 100%
- Accounts receivables @ 85%
- Inventory @ 60%
- Prepaid Expenses @ 25%
- Recoverable income tax @ 100%
- This is the cornerstone of our investment philosophy: “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. The better sales will be the frosting on the cake.”
- Conscious, perhaps overly conscious, of inflation, many people now feel that they are behaving in a conservative manner by buying blue chip securities almost regardless of price-earnings ratios, dividend yields, etc.
- There is nothing at all conservative, in my opinion, about speculating as to just how high a multiplier a greedy and capricious public will put on earnings.
- You wont be right simply because a large number of people momentarily agree with you. You wont be right simply because important people agree with you. In many quarters the simultaneous occurrence of the two above factors is enough two make a course of action meet the test of conservatism.
- You will be right, over the course of many transactions, if your hypotheses are correct, your facts are correct, and your reasoning is correct. True conservatism is only possible through knowledge and reason.
- He again says that in down markets is what will separate men from the boys.
- Buffett says that compounding at a moderate pace is important but more important is the length.
- His core focus is to pile on advantages to the Dow and continue doing so for as long as possible.
- This letter in my opinion does not have many new points. Buffett repeats his views on how his fund would do better in a declining market vs a rising market where it would lag the index. He talks about how index is a strong competitor. And so on.
- One thing I realized in this letter was that he is also shorting stocks when he talks about his net investment positions in Generals.
- Buffett makes a very important statement - Investment decisions should be made on the basis of the most probable compounding of after-tax net worth with minimum risk.
- This semi-annual letter again is very short outlining operational tasks for partners. Therefor not of much use in terms of learning.
- Buffett says that a 'moderate' annual edge over the Dow should be satisfactory. He says this because his fund is 13% odd above Dow's return in 1963.
- Mr Buffett re-emphasizes the point on maintaining an edge over the index. He says if we can maintain this edge over a long period of time the results will be satisfactory both financially as well as philosophically.
- Views on diversification: I've never gone overboard for Noah's ideas on diversification either. I slightly differ on this. I feel a certain level of diversification is absolutely necessary when the definite edge is not known. There is a probability associated to every trade and if that is low there is no point betting the house on it. That is being plain stupid. Mr Buffett being a genius in this domain would know his odds very well in such trades.
- He reiterates all that he has said on his 3 classes of investing strategies - the generals, the workouts, the controls.
- Skin in the game is extremely essential in money management I believe. Mr Buffett Says - I can't promise results but I can promise a common destiny
- He adds a new case study - The Texas National Petroleum which is a workout situation. Key pointers are that he doesn't go by rumours even if they later turn out to be true. Second he is looking for a definite result in this part of his portfolio.
- He also says that using leverage is perfectly fine in workouts but is dangerous for the generals. I agree with him.
- The second case is something which he has mentioned earlier - Dempster Mill. The emphasis is on capital allocation done by the new manager. Mr Buffett loves good capital allocators.
- Mr Buffett again says that for an investment vehicle like his partnership returns have to be looked at over a minimum period of 3 years
- The point on performing comparatively better in declining markets over beating the index handsomely in a bullish market again finds mention in the letter
- He says that his aim is to achieve a long term advantage of 10% over the Dow. In my opinion this is a very tough target to achieve for fund managers
- Mr Buffett again compares his returns to those of 2 largest open ended mutual funds and another 2 close ended funds. He has a good take on the performance of mutual funds. Quoting below:
- Last year I mentioned that the performance of these companies in some ways resembles the activity of a duck sitting on a pond. When the water (the market) rises, the duck rises; when if falls, back goes the duck. The water level was virtually unchanged during the first half of 1965. The ducks, as you can see from the table, are still sitting on the pond.
- Utilizing a somewhat more restrained lexicon, James H. Lorie, director of the University of Chicago’s Center for Research in Security Prices was quoted in the May 25, 1965, WALL STREET JOURNAL as saying: “There is no evidence that mutual funds select stocks better than by the random method.”
- This is a one pager letter and not much content in it other than operational items.
- One comment by Mr Buffett to note is : Our margin over the Dow is well above average, and even those Neanderthal partners who utilize such crude yardsticks as net profit would find performance satisfactory.
- Mr Buffett reiterates that his goal is to have a 10% point advantage over the index (Dow)
- Forecasting is prone to a lot fallibility
- He says that those who expect very superior results (like those in in the previous year) are perhaps day dreaming by attending weekly meetings of Halley's Comet Observation Club
- 'Dow is no pushover as an index of investment achievement' - Buffett
- Anyone engaged in money management should have a clear standard of measurement be it on returns, time periods and so on. This should also be clear to all stakeholders
- By setting up yardsticks of performance upfront a money manager cannot blame external or other circumstances. There will certainly be loss years but that is not to be criticized, losing to the index in the appropriate time frame is to be criticized
- I think this is the first letter in which he says that increasing the size of the fund will be disadvantageous
- Buffett disclosed that he has bought a company called Berkshire Hathaway, an ailing textile company in 1962. He purchased enough stock to take a controlling stake in the company
- He says 'Berkshire is a delight to own.' Also adds 'While a Berkshire is hardly going to be as profitable as a Xerox, Fairchild Camera or National Video in a hypertensed market, it is a very comfort able sort of thing to own'
- Buffett on diversification - We diversify substantially less than most investment operations. We might invest up to 40% of our net worth in a single security under conditions coupling an extremely high probability that our facts and reasoning are correct with a very low probability that anything could drastically change the underlying value of the investment
- I like to call this as maximizing the probability of returns with least chance of going bust
- He talks about payoffs in an investment and the probability of achieving that payoff. It is akin to having an edge, win ratio and trade payoffs. He is essentially position sizing intuitively basis this. Excellent as expected from Buffett
- Noah school of investing - Brilliant example on the case against diversification. He outlines, as we know, that having a lot of stocks will lead to lesser variance over the years and not so with a concentrated portfolio
- Thus we must concentrate our investments, have margin of safety in investing and be ready for a lot of variance
- He says - Interestingly enough, the literature of investment management is virtually devoid of relative to deductive calculation of optimal diversification. All texts counsel "adequate" diversification, but the ones who quantify "adequate" virtually never explain how they arrive at their conclusion. Hence, for our summation on overdiversification, we turn to that eminent academician Billy Rose, who says, "You've got a harem of seventy girls; you don't get to know any of them very well.”
- Buffett again shares that almost all of his and his close family's networth is invested with this partnership
- This letter in my opinion is an excellent take on concentration vs diversification