Every year in February, one of the most awaited and finest pieces of investment literature is released – Buffett’s Annual Letter to shareholders.
This year I thought it would be a good idea to pen down just some thoughts/learnings from the letter as well as to draw inferences relevant for the Indian Business milieu. Year after year, the letter commences with Berkshire’s year wise performance since inception along with the corresponding performance of the S&P 500 - the benchmark index. Berkshire’s compounded returns since inception (1965- till date) have been 20.5% against the index which grew at 9.7%. The remarkable aspect about this performance is that, not only has Berkshire comprehensively outperformed the S&P 500, but has managed to do this with phenomenal consistency (i.e. over 53 years) and with such a massive asset base.
As Buffett summarizes his job:
“Our prime goal in the deployment of your capital: to buy ably-managed businesses, in whole or part, that possess favorable and durable economic characteristics. We also need to make these purchases at sensible prices.”
And as regards selecting investments:
“My expectation of more stock purchases is not a market call. Charlie and I have no idea as to how stocks will behave next week or next year. Predictions of that sort have never been a part of our activities. Our thinking, rather, is focused on calculating whether a portion of an attractive business is worth more than its market price.”
Over the years, Berkshire has evolved into a vast conglomerate. The letter discusses the Berkshire conglomerate as vast as a forest with 5 distinct groves or lines of businesses.
These are as follows:
With the first 3 lines of business, what has worked for Berkshire is, buying businesses at a sensible price with a leadership position and sustainable economic moats, and holding them over a long period of time.
From time to time, these managements have repurchased their stocks and consequently, Berkshire stock holding has gone up.
“All of our major holdings enjoy excellent economics, and most use a portion of their retained earnings to repurchase their shares. We very much like that: If Charlie and I think an investee’s stock is underpriced, we rejoice when management employs some of its earnings to increase Berkshire’s ownership percentage.”
In the Indian context as well, India Inc has developed a strong affinity for buybacks with a record INR 49,000 crores in FY18. (This is in part due to the additional 10% dividend distribution tax levied from 2016). However, the point to note here is that repurchases can be value accretive in the long run, when the fundamentals of the business are strong.
The fourth pillar (and most important) of the Berkshire group is Cash and Cash equivalents that Buffett describes as:
“Berkshire held $112 billion at yearend in U.S. Treasury bills and other cash equivalents,and another $20 billion in miscellaneous fixed-income instruments. We consider a portion of that stash to be untouchable, having pledged to always hold at least $20 billion in cash equivalents to guard against external calamities. We have also promised to avoid any activities that could threaten our maintaining that buffer.“
This is particularly relevant in the Indian context, given what happened in October last year. Companies which trade-off excess growth over prudent liquidity tend to far outperform their counterparts, especially in the long run. Berkshire is a prime example of this. Buffett’s words reiterate these prudent and sustainable business practices.
“Berkshire will forever remain a financial fortress. In managing, I will make expensive mistakes of commission and will also miss many opportunities, some of which should have been obvious to me. At times, our stock will tumble as investors flee from equities. But I will never risk getting caught short of cash.”
The last plank of the Berkshire group is the Insurance Business, which has been an engine for Berkshire’s growth over the last 50 odd years. While, Buffett’s often stated “float income” and “underwriting profits” enable him to hold billions of dollars, and “get paid for holding them”.
This is a classic example of a moat that they have successfully created over the years, and one which leads to a virtuous cycle of investment and returns for Berkshire.
One of the cornerstones of running a large and successful business sustainably, is to ensure a robust succession plan. The other important parameter for long-term growth is the ability to get the best leaders to do the job and his conviction to stand by them in trying times.
Berkshire is no exception to the rule, last year itself, Ajit Jain and Greg Abel are elevated as Vice Chairmen to look at the insurance and non-insurance businesses respectively. While Todd Combs and Ted Weschler independently handle the investment fund (collectively managing USD 25 bn)
The letter ends with Buffett ascribing a vast amount of his success in investing over the last 77 years the ‘American tailwind’ and maintains that over the last seven decades America has experienced everything from long period of viral inflation, a 21% prime rate, several controversial and costly wars, the resignation of a president, a pervasive collapse in home values, a paralyzing financial panic and a host of other problems.’
And maintains that over the next 77 years,
‘the major source of our gains will almost certainly be provided by The American Tailwind. We are lucky – gloriously lucky – to have that force at our back.’
I think in this regard, we have our own ‘’Indian Tailwind”. With India marching towards becoming a USD 5 trillion economy by 2025.
The lessons on successful investing in a conducive environment such as ours is amply explained in by Buffett – Invest in the business, not the stock, buying at a reasonable price, and most importantly – Staying invested!
Happy Investing!