3 Timeless Lessons from the Oracle
3 Timeless Lessons from the Oracle
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Every year, about 40,000 value investing nerds fly down to the middle of nowhere to watch two old guys drink Coca-Cola and eat peanut brittle.
Dubbed the “Woodstock for Capitalists,” the Berkshire Hathaway AGM finally resumed in-person attendance after two years of doing it online.
The fanfare was plenty as 91-year-old Buffet and 98-year-old Munger took questions on stage from shareholders for five hours.
When you go back through prior question periods, there are always incredible nuggets of wisdom as well as hilariously blunt answers (mostly from Munger).
The history of Berkshire is familiar to many, but the AGM and letters to shareholders, always drop something fresh in an ever-changing macroeconomic landscape.
For the purpose of this newsletter, we’ll give a lightning-round update on how these guys got here, but more importantly, go through the top three timeless lessons from Berkshire & Buffett that we can takeaway.
This week, in <5 minutes, we’ll cover the Berkshire Boys:
Brief Berkshire Breakdown 👉 Origin & ethos
Lesson #1 👉 Extend Your Time Horizon
Lesson #2 👉 Have an Owner’s Mindset
Lesson #3 👉 Patience Creates Opportunity
Takeaways from Recent Actions 👉 Bought more stock this quarter than in 2008
Let’s get started!
1. Brief Berkshire Breakdown 👉 Origin & ethos
Berkshire Hathaway was founded in the 19th century as two separate Massachusetts cotton mills—Berkshire Fine Spinning Associates and Hathaway Manufacturing.
The two companies merged in 1955 to become Berkshire Hathaway. In 1965, Warren Buffett and his investment firm came in to purchase and take full control of the struggling company.
Under his leadership, Berkshire Hathaway became one of the world's biggest holding companies.
I find it pretty funny that this all started in textiles because that is exactly what you think of in old-timey movies when people talk about “industry, my boy!”
Berkshire divested away from that and really built the early days of its powerhouse around insurance businesses, starting with National Indemnity. These insurance businesses were essentially what funded every single acquisition to be made in other businesses like financials, clothing, entertainment, food & beverage, furniture, household products, etc…
The insurance side was collecting premiums that contributed to a large float (AKA cash balance that was not yet paid out to any claims). This float ballooned to 3,000x what it was in 1970, essentially padding a war chest that allowed Berkshire to quickly purchase distressed assets at a discount and completely restructure them in order to get massive lifts.
Buffet frequently comments that his investment style is attributed to Benjamin Graham in that they seek assets that are significantly undervalued and to, “buy ably-managed businesses in whole or in part, that possess favorable economic characteristics”
So without further ado, let’s check out a couple of these core principles…
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2. Lesson #1 👉 Extend Your Time Horizon
For those of us starting out early in the investing game, extending our time horizon does several key things:
Allows the power of compound interest to take over
“Time is the friend of the wonderful company, the enemy of the mediocre,” -Warren Buffett.
We are all aware of the effects of compound interest and how much of a profound change it can make on your life as you set out to build wealth. The same can be said for a company.
This is why Buffett has always focused on businesses with measurable cash flow and companies that have proven track records of return on equity, and return dividends to their holders.
The best example of this is his holding in Coca-Cola. Buffet has held this stock since 1988 with a cost basis of $1.3B. The dividend that this holding paid in 2021 was $672M, which equates to a modern-day yield of 52% based on cost. Now THAT is compounding at its finest within a corporate structure.
Berkshire also finally bought a tech company recently! Apple! Wow! This is way different than his normal strategy, right?
Nope. The dividend on Buffett’s Apple holding pays out roughly $750M/year. Is this another Coca-Cola in the making?
Blocks out mob mentality in regards to short term volatility
“A low-cost index fund is the most sensible equity investment for the great majority of investors,” - WB
Since none of us have a crystal ball, market timing usually ends up in abysmal results:
Low-cost ETFs allow for disciplined dollar-cost averaging that ignores market timing and sets up investing as a forced auto-pilot behavior rather than chasing any day-trading-like activities.
Half the battle is keeping your cool when others are losing their minds.
Before we continue, let’s check in with our Outrageous Chartered FinMEME Analyst Dr. Patel!
3. Lesson #2 👉 Have an Owner’s Mindset
The concept of having an owner’s mindset is key to the core tenants of owning stocks. By owning equity in corporations, you are essentially becoming a part-owner, usually with voting rights, that can participate meaningfully to the upside of the earnings potential of the company, this forces you to do several things when buying stocks:
Invest in what you know
“If you are uncomfortable with the asset class that you have picked, then chances are you will panic when others panic,” -WB
One of my first jobs on the street was a summer internship on the sell-side working under a real smart equity research analyst. This taught me to really get to know the individual companies.
Some guys do more homework on which barbeque to buy than which stocks to buy. Don’t be that guy.
This experience also taught me very quickly what I didn’t know. I can’t tell you the intricacies of certain industries so I avoid investing in them. Always remember:
KISS - Keep it simple, stupid.
Seek valuable companies, not cheap ones
“It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” -WB
Some companies are cheap for a reason. It could be bad management or the kiss of death: deteriorating fundamentals. We call buying these stocks “catching a falling knife.”
Instead, let’s go back to the core principle of what Berkshire does best: “buy ably-managed businesses in whole or in part, that possess favorable economic characteristics”
Buffett started evolving his investing style from the classical cigar-butt value investing approach to one where you look at a business’s competitive advantage, intangibles like brand value, cost superiority, and strong growth prospects.
4. Lesson #3 👉 Patience Creates Opportunity
Warren Buffet is also very well known for having massive hoards of cash that he just sits on. He amasses this through the cash flow generative side of his holdings, the insurance companies as mentioned above. This allows him to do several key things:
Pounce on distressed assets
“Every decade or so, dark clouds will fill the economic skies and they will briefly rain gold. When a downpour of that sort occurs. It is imperative that we rush outdoors carrying washtubs and not teaspoons” - WB
A massive cash balance allows you to deploy capital when you see dislocations in the market. You can look into Buffett’s view on the market through the capital allocation strategy he pursues.
He will buy distressed assets (ex. Fruit of the Loom) once they file for Chapter 11 to be opportune with this balance.
He will deploy capital when at a point of massive turmoil, as seen in the 2008 global financial crisis.
He will buy back his own stock aggressively (ex. 2020 buybacks) when he believes Berkshire is undervalued.
Or he will sit and wait, and do absolutely nothing until an opportunity presents itself.
Allows you to “weather the storm”
“Only when the tide goes out do you discover who's been swimming naked” - WB
I think this quote can be related to what is happening right now in the spec tech market. These names continue to get absolutely crushed, and many names without measurable free cash flow are down 50-90%.
The “tide” in this case is the Fed. Once the Fed tightens monetary policy, all multiples contract and investor cash starts flowing towards free cash flow generating assets. We now have a massive division between those companies that provide real earnings and those that do not.
On top of this, the Fed tightening is dragging overall equity markets down, as the S&P 500 has gotten off to one of its worst annualized starts in history.
This brings us to what Berkshire is doing about it…
5. Takeaways from Recent Actions 👉 Bought more stock this quarter than in 2008
With all the fear out there right now, Buffett seems to be taking his own medicine:
“Be fearful when others are greedy and greedy when others are fearful”-WB
Berkshire spent more than $51B on stocks in the first quarter of 2022:
After considering the cash flow generation from the existing asset base, the cash Buffet deployed in the quarter shrunk the cash balance by about $41B to $106B.
Big buys in the quarter included $3.2B of their own stock, Chevron (from a $4.5B position to $25.9B), Occidental Petroleum (from $10B stake to $16B), Alleghany Insurance (purchase of entire company for $11.6B), HP Inc (bought $4.2B), Apple (bought $600M), and Activision as an arbitrage play (9.5% stake for about $5.6B).
The most notable purchase, of course, is the stake in Chevron which makes a lot of sense right now. 2022 has been the year of the “real” economy and with WTI prices spiking, energy companies are absolutely printing Buffett’s favourite thing: cash flow.
During the recent AGM, Buffett also stayed his course against bitcoin, saying that he wouldn’t purchase the entirety of outstanding BTC even for $25. His reason was that it was a greater fool theory and produced no intrinsic value or cash flow. This take to me seemed out of touch, but who am I to refute the Oracle. I’ll leave this one alone for now.
Wrapping Up…
With all the bullshit being peddled today, it’s always nice to listen to a couple of old guys who had a system, kept to the system, and have experienced profound success.
Never trust a skinny chef, don’t take physical fitness advice from someone who sits on the couch all day, and don’t listen to day traders.
Warren Buffett is the most successful investor of all time and practices exactly what he preaches while having a lot of skin in the game.
Ignore his advice with caution.
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
P.S. Have you subscribed to our *NEW* CRYPTO NEWSLETTER?
What else we Grittin’ On?
10-YEAR. The yield on the US 10-year Treasury rose above 3% for the first time since 2018. The yield has almost doubled this year.
AIRLINE M&A. Spirit Airlines has rejected JetBlue's $3.6B cash takeover bid. Spirit will move forward with plans to merge with rival Frontier.
FAT FINGER. Citi trader made an error which led to a flash crash in Europe stocks. The main European index lost as much as 3% at one point.
OIL. China's lockdowns offset OPEC's failure to boost production. OPEC added 10k barrels a day in April, compared with a scheduled 274k.
FORECASTS. Analysts are dropping profit forecasts for the Nasdaq 100. Estimates for 12-month forward EPS fell about 0.2% last week on aggregate.
Sources:
https://www.investopedia.com/articles/markets/041714/how-warren-buffett-made-berkshire-hathaway-worldbeater.
https://www.etmoney.com/blog/9-lessons-in-investing-by-warren-buffett/
https://www.reuters.com/business/buffett-says-berkshire-hathaway-has-95-activision-stake-2022-04-30/
https://www.reuters.com/business/buffetts-berkshire-bought-51-bln-stock-first-quarter-operating-results-flat-2022-04-30/
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