Berkshire Hathaway’s Annual Shareholder Letter: A Tutorial in Investing Par Excellence

Every year at the end of February, tens if not hundreds of thousands of people – and not just shareholders — eagerly await with anticipation the release of Warren Buffett’s letter to Berkshire Hathaway (NYSE: BRK-A, BRK-B) shareholders. Around two months later each year, thousands of Berkshire shareholders (35,000 last year) make the pilgrimage to Omaha, Nebraska for the “Woodstock of capitalism,” also known as the Berkshire Hathaway annual meeting.

In fact, some people buy a single share of Berkshire stock for the sole purpose of gaining admission to the annual meeting. If you’re thinking of attending on May 1^st and want to stay at the Hilton Omaha, which is the only hotel with a sky-bridge connection to the Qwest Center where the meeting is taking place, you’re out of luck. The Hilton is already sold out.

Most Annual Reports are Junk

Huh? You might be thinking. Don’t most people throw the annual reports of the companies in which they’re invested in the trash without even opening them? Aren’t the annual reports of the vast majority of public companies incredibly boring documents full of incomprehensible numbers, obscure footnotes, and a shareholder letter from a smiling CEO that says everything is great even when it clearly isn’t?

Yes, most annual reports are virtually worthless, as are most annual meetings.  For example, Slate Magazine has called annual reports a waste of paper that should be abolished and last year’s annual meeting of Telephone & Data Systems (NYSE: TDS) did not allow any shareholder questions. It’s no surprise that TDS’ stock has underperformed the S&P 500 over the past year by more than 20 percentage points.

Berkshire is Different

But Berkshire’s annual report and shareholders meeting are both quite unusual, some would say unique. What is it about Berkshire that elicits such strong public fascination and shareholder loyalty?

Amazing Wealth Generation

I see two main reasons. First, Berkshire shareholders have enjoyed tremendous returns over the past 45 years, 434,057% to be exact (20.3% compounded annually) or 80 times what an investor would have earned in an S&P 500 index fund.  Even this amazing out-performance is understated since it is based on the change in book value per share, not the change in market price per share.  Based on share price, Berkshire shareholders have gained 801,516% (22% compounded annually). The powers of long-term compounding are pretty amazing when you realize that just a couple of extra points of performance per year result in almost a doubling of wealth. In any event, you’ve got to admire a company that understates its stock-price performance by almost half.  Makes you trust the CEO. Nothing succeeds like success in creating popularity and Berkshire has succeeded like no other.

Unparalleled Investment Education

The second reason for Berkshire’s popularity is the incredibly valuable investment wisdom and education provided both in the annual report and at the annual meeting. Many people believe that reading Buffett’s annual reports is a far better education in value investing than you could possibly get by going to business school and earning an M.B.A. (and a lot cheaper too).  The same goes for the SIX HOURS of Q&A Buffett provides at the annual meeting. There are a lot of rich, successful investors, but most keep their investment strategy to themselves and expect shareholders to simply thank them for their returns without asking any questions. Buffett is very different. Check out page 89 of this year’s annual report for his and investment partner Charlie Munger’s attitude toward shareholders:

Charlie Munger and I think of our shareholders as owner-partners. We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets. We hope you visualize yourself as a part owner of a business that you expect to stay with indefinitely, much as you might if you owned a farm or apartment house in partnership with members of your family.

Excuse me while I wipe a tear from my eye. Warren views me like a member of his family! No wonder shareholders flock to Omaha every year – they’re going to a family reunion. Great marketing to be sure, but what makes it so special is that I believe it to be genuinely sincere (not the family part, since I unfortunately won’t be mentioned in his will, but his respect for shareholders is real).

Words of Wisdom

Check out pages 89-94 of the shareholder letter for the investment principles that guide Buffett and Berkshire. These principles are reprinted every year but always worth reviewing. In addition, below are just a few memorable quotes specific to this year’s shareholder letter:

• In the past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910), aircraft (in 1930) and television sets (in 1950). But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy. At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable.

• When it’s raining gold, reach for a bucket, not a thimble.

• If shares of a prospective acquirer are selling below their intrinsic value, it’s impossible for that buyer to make a sensible deal in an all-stock deal. You simply can’t exchange an undervalued stock for a fully-valued one without hurting your shareholders.

• The best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow.

• We’ve put a lot of money to work during the chaos of the last two years. It’s been an ideal period for investors: A climate of fear is their best friend. Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance. In the end, what counts in investing is what you pay for a business – through the purchase of a small piece of it in the stock market – and what that business earns in the succeeding decade or two.

Berkshire’s Stock Portfolio: Wal-Mart 1, ConocoPhillips 0

When evaluating Berkshire’s top stock holdings, I like to print out and compare two pages from the shareholder letters: the page with his holdings at December 31, 2009 and the page with his holdings from a year earlier.  I then look to see which stocks he reduced positions in and which he increased:

The big story here is the sale of a majority chunk of ConocoPhillips and the virtual doubling purchase of Wal-Mart Stores. The investment implications of purchases deserve more weight than the sales since Buffett had to raise cash for his purchase of Burlington Northern Railroad. I view the Wal-Mart purchase as a ringing endorsement of the economic recovery and the expected return of consumer spending.

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Warren Buffett may have lost interest in ConocoPhillips, but Energy Strategist editor Elliott Gue remains enthusiastic about several energy stocks poised for explosive growth. Buffett’s investment in electric-car manufacturer BYD Company is up more than seven-fold in less than two years. Portfolio 2020 editor Roger Conrad has discovered several small-cap technology stocks with similar potential. For emerging markets, check out editor Yiannis Mostrous’ Silk Road Investor to find out which stocks he likes even better than Korean steelmaker POSCO. Try any of them risk-free!