Buffett’s 2014 Letter to Shareholders

buffett

Decades ago, Ben Graham pinpointed the blame for investment failure, using a quote from Shakespeare: “The fault, dear Brutus, is not in our stars, but in ourselves.”

Comments on the Berkshire Hathaway 2014 letter,  Part 1

Note the plug (page 6) for Where Are the Customers’ Yachts by Fred Schwed. That along with the Money Game by Adam Smith will teach you the ways of Wall Street. Also, see:

Intrinsic Value: Buffett reiterates that it is not a precise number for Berkshire nor, in fact for ANY stock.

GEICO delivers savings to its customers because it is a low-cost operation (source of structural competitive advantage).  The company’s low costs create a moat—an enduring one—that competitors are unable to cross.  Note Buffett’s comment on the animated gecko, a LOW-COST spokesperson.

TESCO

Here’s how he explained it:

“In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)

“During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.”

Buffett said the dawdling resulted in an after-tax loss of $444 million by the time Berkshire was no longer a Tesco shareholder. That, he added, is about 0.2% of Berkshire’s net worth. Only three times in 50 years has Berkshire recorded losses from a sale equal to more than 1% of its net worth.

Unfortunately, we don’t learn what exactly caused the loss. How did Buffett miscalculate intrinsic value?    Did management worsen, but if so, then how can an investor sidestep that?   I believe the economics changed as customers had more in-home deliveries and other choices coupled with poor store execution from Tesco.  I was disappointed with this explanation of the Tesco loss, but Buffett would reply that it was only 1/5 of 1%.

Nominal vs. Real Returns

During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196% shown on page 2. Concurrently, the purchasing power of the dollar declined a staggering 87%. That decrease means that it now takes $1 to buy what could be bought for 13 cents in 1965 as measured by the CPI (Flawed or whats wrong with cpi)

I prefer measuring in gold grams, because gold is a store of value and market-based rather than concocted by Federal bureaucrats.DJIA-1900

There is an important message for investors in that disparate performance between stocks and dollars. Think back to our 2011 annual report, in which we defined investing as the transfer to others of purchasing power now with reasoned expectation of receiving more purchasing power–after taxes have been paid on nominal gains—in the future.”   (I wonder why Mr. Buffett makes no mention of the financial repression of ZIRP and NIRP?  It is the elephant in the room because of the devastating effect it has on savers and on calculating discount rates for investment.)

The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities—Treasuries, for example—whose values have been tied to American currency. That was also true in the preceding half century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.  Buffett’s comments are backed up by history as shown here:Triumphand triumph_of_the_optimists

Stock prices will always be far more volatile than cash equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments—far riskier investments. Than widely –diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk.  Though this pedagogic assumption makes for easy teaching, it is dead wrong. Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.

It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing power terms) than leaving funds in cash-equivalents. That is relevant to certain investors-say, investment banks—whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.

For the great majority of investors, however, who can—and should—invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.

Note the multi-decade horizon. Stocks were unchanged from 1964-1981, please see page 79: A Study of Market History through Graham Babson Buffett and Others.  Read what Buffett has to say about stock markets. Some say it is Time to exit because of high valuations for big-cap stocks in the U.S. market. So even if stocks decline for a decade but your holding period is MULTI-Decade, then hold tight.  Tough to do, but history seems to bear his thesis out: valuing-growth-stocks-revisiting-the-nifty-fifty.  I prefer to act like the pig farmer in A Study of Market History (see link above).

If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risk things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon (to panic) are now earning a pittance on sums they had previously expected would finance a pleasant retirement. (The S&P 500 was then below 700; now it is about 2,100.) If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).

spx

Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary to managers and advisors and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. ….Anything can happen anytime in markets. And no advisor, economist, or TV commentator–and definitely not Charlie nor I–can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

A plug for Jack Bogle’s The Little Book of Common Sense Investing.  Basically, Buffett is saying keep it simple, think and hold L O N G – T E R M, avoid high fees and commissions, and don’t use leverage. 

Next, let’s look at Berkshire–Past, Present and Future in Part II

2 responses to “Buffett’s 2014 Letter to Shareholders

  1. Here’s a little curiousity: on 16 Oct 2014, BBC News reported that Buffett sold 245m Tesco shares, taking his holding below 3%. If you had bought on that day, the price was 170.85p. If you had held for 3 months, and sold out, you would have sold for about 219.05p, for a gain of 28%. Not bad.

    Sometimes it pays to take a contrarian position to the greats. News of the accounting scandal was around that time, but unlike Enron, there was little danger that Tesco faced imminent banktruptcy.

    When Buffett bought, Tesco was a disappointment. When he sold, Tesco was a disaster. It’s a good example of why investors are likely to be better off buying into deep value, rather than shallow value.

    My hat goes off to your reader that had a position in Tesco. I’m sure he has done well out of the purchase. Unfortunately, I let the opportunity slip by me completely.

    Thanks for the pricedingold chart – it’s very illuminating.

    “Recall, if you will, the pundits who six years ago bemoaned falling stock prices” Unfortunately, it wasn’t just pundits, but some investing legends. I didn’t note their name at the time, so I can’t name names. Buffett was one of the few who was optimistic.

  2. If you are going to buy a non-franchise, then you gotta buy very cheaply whether that is replacement value, liquidation value, of earnings five years out, because growth won’t help like in See’s Candies.

    I once followed M. Pabrai and when he invested in Exide Batteries saying it was a franchise, I knew that he was in for trouble. Sure enough two years later he sold but below its tangible assets or thereabouts, so I bought–the most marginal seller had sold. I am not knocking Pabrai because he uses volatility for his purchases, but he was buying heavily levered (operationally and sometimes financially) businesses.

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