What I’ve learnt from Berkshire Hathaway annual shareholder meetings
It’s April 2000. Tech stocks are creating hype in the markets. Amidst the excitement, Walter Aylett (founder of Aylett Fund Managers) convinces me to fly halfway across the globe with him to join about 9,000 other investors at the Berkshire Hathaway shareholder meeting in Omaha, Nebraska. Since then I’ve been back every year, making May 2017 my 18th time. Applying the lessons I’ve learned at these meetings over the years has had a significant impact on my career as a portfolio manager.
The Berkshire Hathaway annual shareholder meetings offer valuable investment lessons
The most important lessons I’ve learnt at the meetings can be summarised in the following four points.
- It’s crucial to have an investment philosophy
The most important point that stands out is that you cannot deliver sustainable investment performance without a well-founded investment philosophy. When I look back on my own investment career, I’ve always enjoyed the search for winning companies. However, I can see how the lack of a real understanding of what generates sustainable returns often led me to poor investments in the early years. Now I’m not interested in 80% of the investment opportunities I would have looked at 18 years ago – and I can trace most of these decisions back to the influence of Warren Buffett and Charlie Munger.
- Think long term and invest like you’re buying a stake in the business
Buffett quickly understood how to increase the probability of making good investments, which ingredients to look for, and to be critical about past investment decisions. Despite him patiently explaining it every year, most investors never get what he is trying to emphasise: think as if you’re investing for the long term and invest as if you’re buying a stake in the business alongside management. Most investors continue to try generating investment returns with quick ‘flash in the pan’ opportunities.
- Stick to your circle of competence
The further you move outside your circle of competence the less likely you will be able to understand the business you are evaluating as an investment. If you don’t understand the business, you can’t project the future cash flows with any certainty. If you can’t project the cash flows, you can’t determine the value of the business nor the margin of safety between the value you’ve determined and the share price.
- Never overpay
Overpaying for an investment is the biggest killer of investment returns. It all comes back to having certainty about the value of the business you’re investing in. Many investors make the mistake of getting swept up in group think and ignore their own ability to assess the value of a business independently and rationally. When you pay up for high expectations you will be disappointed with your investment results most of the time. You want to invest when expectations are low.
Examples of how these principles have worked for Berkshire Hathaway in the past
- Choosing not to invest in tech stocks when these stocks were on the rise in 2000
In 2000, the press was labelling Buffett a ‘has-been’ and a ‘dinosaur’. Investors at the shareholder meeting were pleading with him to invest even just 10% of Berkshire Hathaway’s assets in tech stocks. In response, Buffett patiently explained that Berkshire’s management don’t understand these companies, that they cannot see the moat, and that the share prices don’t reflect the future cash flows. In other words: the stocks didn’t fit into Berkshire Hathaway’s investment philosophy and fell outside their circle of competence. In addition, there was no margin for error in the differences between the apparent valuations and share prices. After the tech bubble burst in May 2001, investors were thanking Buffett and Munger for staying within their circle of competence and not investing in tech stocks.
- Making substantial investments in quality business amidst the 2008 financial crisis
In 2008, Buffett’s investment philosophy and his emotional stability led him to invest billions of US dollars when the market was fearfully selling. This allowed him to swoop in on good businesses when there were huge differences between their valuations and share prices. He bought large stakes in, amongst others, Harley Davison, Goldman Sachs, and Bank of America. Buffett knew that, even if 2008 would lead to a depression, the probability was high that these businesses would survive and be stronger afterwards. In addition, the discounts to true value meant the margin of safety was significant.
- Ignoring the negative press and economic circumstances
Buffett increased Berkshire Hathaway’s investment in banks when everyone was ignoring or selling them. He focused on their attractive valuations and ability to grow shareholder value. Banks are now Berkshire Hathaway’s largest listed sector exposure.
Despite his success, Buffett does not shy away from learning from past mistakes
During the May 2017 shareholder meeting Q&A session, Buffett admitted where they made mistakes:
- Apple: The question from shareholders was why did they invest in Apple in 2016/2017 after ignoring it for so long? Buffett’s response was that they actually should have bought Apple earlier. They were late in realising that it is a consumer company rather than an IT company.
- Google: Buffett also mentioned they were at fault for not investing in Google. He said they knew enough about the business and if they had applied their minds they would have seen the value. However, their bias against tech companies stood in the way.
Buffett’s simplistic statements are often generalisations – not hard and fast rules
Investing isn’t as simple as Buffett sometimes makes it sound. If investing was easy, 50% of professional investors would outperform the index, while generally only 7% do. Buffett has the knack of reducing complex problems to simplistic statements – but one must read these statements in the context of everything else he says, including:
‘Our favourite holding period is forever.’
‘We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.’
‘…be fearful when others are greedy and greedy only when others are fearful.’
These statements were never meant as generic rules. In fact, Buffett’s actions highlight that they are generalisations:
- By selling Tesco and IBM he showed that there are times when the holding period isn’t forever.
- Ignoring the economic forecasts and investing when everyone else is selling out of fear doesn’t always work. Investing in Irish banks in 2008 was a pretty silly thing to do, but I think this mistake was more due to Ireland being outside Buffett’s circle of competence.
To benefit from the power of compounding requires patience
Buffett has demonstrated what Einstein originally said about compounding, namely that compounding is the eighth wonder of the world. However, exercising patience is the key to making compounding work for you – and Buffett’s track record of over 50 years is simply out of this world. An investment in Berkshire Hathaway of $1 million in 1964 now exceeds $20.8 billion, while a similar investment in an S&P 500 index tracker would have grown to only $140.6 million. Figure 1 shows a comparison of the track records. The compounding effect of Berkshire Hathaway’s 20% annual returns versus the S&P 500 over 50 years is so vast that it makes it look as if the S&P 500 hasn’t moved.
Figure 1: Growth in shareholder value – Berkshire Hathaway versus the S&P 500 (June 1964-June 2017)
Source: Denker Capital
Other highlights from this year’s meeting – learning more about Buffett’s views
- Public criticism of Wells Fargo
For the first time since the events at Wells Fargo, where the use of aggressive sales incentives eventually led to employees resorting to illegal practices to meet sales targets, Buffett publicly criticised top management. He said it was inexcusable that the CEO ignored warnings that this was happening. What made it worse was that even once top management became aware of the problem, they didn’t act aggressively enough. It was as if they didn’t grasp the seriousness of what was taking place. The scenario reminded me of Buffett’s speech in the early 1990s when he temporarily took the reins at Salomon Inc. after probes of alleged trading violations (at a time when Salomon was the forerunner of Citigroup). In his address to staff he said: ‘Lose money for the firm and I will be understanding, lose a shred of reputation for the firm and I will be ruthless’.
- How to incentivise his successor
One of the excellent questions to Buffett was: ‘How do you think your successor should be incentivised?’ Buffett responded as follows: ‘I would actually hope that we would have somebody that’s already very rich, which they should be. Working a long time and really not motivated by whether they have 10 times as much money… and they might even wish to set an example by engaging for something far lower… If the board hires a compensation consultant to advise them after I go, I will come back.’ He also indicated that he hopes the remuneration package will support long-term growth in shareholder value, rather than the share price.
Buffett’s belief that a business must be productive and profitable shows his capitalist nature
At both the 2016 and 2017 annual shareholder meetings, Buffett was criticised for his co-investment in 3G – a private equity firm that buys out poorly performing businesses and then merges them or cuts out unproductive businesses. Buffett’s view is that keeping people in jobs when they’re not productive does nobody a favour. Eventually the inevitable will happen and the business will fail.
Capitalism does a great job focusing on productivity. While it seems heartless, it is important both for a country’s economy and society. Keeping unprofitable workers employed burdens the economy and tax payers with unnecessary costs, while the resources could be employed in industries and businesses that create an economic advantage for the country and its citizens. Resources must be used to train the workforce to ensure the economy remains internationally competitive. For example, 150 years ago the main method of transport was the horse buggy. If the government at the time had tried to keep that industry alive it would have done future generations a huge disservice. Yet, this doesn’t free the government and society of the responsibility to look after those who are displaced when businesses or industries fail.
Back home, staying within our circle of competence has enabled market-beating returns
As Madalet Sessions also mentions in her article, Buffett often states that the most important rule of investing is to avoid losing money. And the second most important rule is to never forget the first rule.
Personally, I’ve learnt that the best way to generate returns is to stay inside my circle of competence. This becomes apparent when I look at the returns of both the Sanlam Global Financial Fund and the Nedgroup Investments Financials Fund (managed by us), which have generated good returns since inception. Building a circle of competence brings about the advantages of:
- being able to identify winners,
- avoiding value traps and losers, and
- acting with conviction.
These advantages, which are my personal learnings, have allowed the Sanlam Global Financial Fund to outperform its benchmark, the MSCI World Financials Index over 10 years (as shown in Figures 2 and 3). In fact, the fund has consistently outperformed its peers since inception. Read my other article on the global financials bull run for more detail on the performance of the Sanlam Global Financial Fund.
Figure 2: Sanlam Global Financial Fund – annualised performance since inception
Note: The relatively lower 3- and 10-year returns can be attributed to short periods of low returns due to a struggling economy (in 2015/2016) and a recession (in 2008/2009).
Figure 3: Sanlam Global Financial Fund – cumulative performance since inception
Applying the lessons from the Berkshire Hathaway meetings is the biggest value-add
I think the main takeaway of the annual shareholder meetings each year is to be reminded of the importance of investing in businesses that generate positive, sustainable returns on capital at the right price, and then exercising patience. Even businesses with moats (protection against competition, enabling sustainable margins) and ethical management who allocate capital rationally will have bad years. It is during these times that your confidence in your investment philosophy and process as well as your patience is put to the test. Although attending the annual shareholder meetings is a very interesting experience, when I look back, the real value is unlocked when you reflect on and apply the wisdom afterwards.
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