Tuesday, April 22, 2014

Buffett: 2014 Take-Aways

Buffett:  Ignore the bark of daily stock prices, he recommends
Each year Warren Buffett's Letter to Shareholders is a remarkable feat. His discussions of business lines, operations and performance are conventional. But Buffett, as Berkshire Hathaway CEO, intersperses passages about profitability with stories and lessons for investors of all types and ages.

Each year you wonder how is it possible for Buffett to top himself. What more enlightenment about long-term investing could he possibly share with shareholders and even investor novices?

Each year, nonetheless, he picks a couple of business topics, sometimes controversial, sometimes complex. He wrestles with the topic, explains it in simple terms, ties it to real business experiences (often his own past success stories) and  offers a special lesson for long-term investors. His audience includes long-term investors.  He seems to have little time, tolerance or patience for short-term traders. 

This year after reviewing Berkshire Hathaway's activities in railroads to insurance companies , Buffett told a couple of stories--one about a Nebraska farm and another about a retail store near NYU--investments he made a long time ago.

In both cases, he boasted about having almost no involvement in either one. He has never bothered to visit the farm and the store (maybe once or a forgotten second time), but both have been successful, thriving investments, based on simple principles. Buffett sums up:  Corn will always grow on his Nebraska farm. Students will always be around and about NYU and will always need a place to buy clothes, snacks, supplies and groceries.

Buffett abhors the fears and panics induced by daily stock-market volatility. For years, he has encouraged investors to avoid staring at daily stock prices and indices. He has advised investors that the best times to buy stocks is when markets have plunged. Yet he knows, no matter his wisdom and his experiences, investors will still watch market upswings and downturns, still be swayed by pundits on CNBC, still be influenced by Wall Street Journal headlines, and still be tempted to follow the masses when determining when to buy and when to sell.

In this year's letter, he offers a story about his Nebraska farm to explain why investors should shut off their ears and eyes to daily stock-market emotions.  Consider the scenario (his shared experience) where, he says, your Nebraska farm is well-managed. It produces corn consistently year after year and distributes produce widely, resulting in stable profits annually, because people eat corn and will continue to do so. Now imagine if a man (or groups of men) stands at the boundary at a fence and barks and screams prices for which he will offer to buy your farm—every day, all day long, non-stop. Imagine, as well, the man's fluctuating offering prices—surprisingly high offers, inexplicably low offers. Prices and prices, echoing across your cornfield.

What an annoyance that can be, Buffett suggests. The man screaming numbers at your gate interferes with the day-to-day requirements of running a thriving business. When it’s time to sell the farm, you’ll know. It just so happens that Buffett hasn't bothered to sell. He still owns his farm, still reaps the benefits of increased cash earnings each year,  and boasts that, except for reviewing operating performance, he never needs to be involved or be present.  He says the annoying, barking man is like the annoyance of stock-market tickers that get in the way of operating a business or presiding over an investment.

Inevitably, in a Buffett letter to the public, some themes repeat themselves. He doesn’t necessarily forget what he wrote in years gone by, but he seems to want to emphasize some points, perhaps points that weren't digested thoroughly in previous shareholder messages. For example, he refers once again to his invaluable security-analysis tool book, Graham & Dodd’s Security Analysis, the comprehensive investment-management text he absorbed while in business school at Columbia many moons ago.

Buffet once again devotes passages to explain the insurance business, seeming to want to convince readers and investors how an apparently aged, dull industry can lead to promising investments if companies do the following: (a) Manage expenses carefully, (b) be realistic and conservative about expected losses, and (c) price premiums carefully.  And once again, he rallies and cheers for his company’s ownership in the popular insurance company Geico, a company in which he has had a stake for decades.

Buffet and his troops have always been shrewd risk managers, preparing for difficult times or exploiting difficult times to find investment bargains. This year, he mentions in passing “liquidity risk management” at Berkshire, discussing briefly a company policy to maintain billions in cash reserves and minimize short-term debt to avert the risks of rising interest rates, to be ready to pounce on any opportunity, and to not be caught off guard in managing liabilities and other debt. Berkshire doesn’t despise or avoid debt; it just prefers it long term.

What else is on Buffett’s mind in 2014?

He tosses out a phrase “circle of competence” to instruct investment analysts to forecast operating earnings based on what they know and what they can grasp.

He mentions some of his favorite blue-chip stocks, investments anybody can step up to purchase, not merely significant investment vehicles like his company. American Express, Coca-Cola, IBM, and Wells Fargo are current favorites, and he explains why: Growing revenues, stable and sustainable profits, managed risks, global operations, and reliable products and services.

“We much prefer owning a non-controlling, but substantial portion of a wonderful company to owning 100 percent of a so-so- business,” he writes. “It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone.”

So what are other take-aways from Buffett’s 2014 finance lecture. His lessons are straightforward, easy to digest, sometimes hard to accept how simple they are. Some lessons are principles to abide by when managing companies and investment portfolios.

1. He reminds all that you don’t need to be an expert to achieve satisfactory returns.

2. Keep things simple, he says. “Don’t swing for the fences.”

3. In assessing the value of companies, focus on future production, recommending that historical numbers should be shunted aside (although a peek at history of performance may tell a story about the competence of management or the potential for assets to generate profit).

4. Focus on the “playing field” (operations, products, costs, industry dynamics), he writes, and not “the scoreboard” (stock prices, stock indices, technical market analysis, market momentum).

The vagaries and emotions of stock markets enveloped his mind this year. He reminds readers how much they enjoy their Saturdays and Sundays without paying attention to stock prices and advises them to enjoy their weekdays, too, by ignoring the crawl of market prices on CNBC or the wails and headlines about market trends from business journalists.

Tracy Williams

See also:

CFN:  The Word from Buffett, 2013
CFN:  Merger Mania, Boom Times Ahead? 2013
CFN:  Shareholder Letters at Financial Institutions, 2010
CFN:  Jamie Dimon's Shareholder Letter, 2011

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