The annual letter to shareholders by Warren Buffett, the legendary American investor, is a noteworthy document. It is perhaps the only letter to shareholders that has a following like popular literature. The press around the world covers it extensively. For the 2023 annual report, Warren Buffett starts with a tribute to his long-time business partner, Charlie Munger. He passed away in November 2023. Buffett credits him as an architect of Berkshire Hathaway, the firm the two ran for decades. If you search the internet, you will find lots of literature on the topic.
You may find Warren Buffett’s ideas worth noting and implementing.
Pundits should always be ignored
After paying a rich tribute to his business partner, Charlie Munger, Buffett introduces us to his sister, Bertie. She is a long-time shareholder of Berkshire. He describes her as someone who understands accounting terms but cannot appear for exams. She reads four business papers but does not call herself an expert. She is sensible in ignoring pundits making recommendations about tomorrow’s winners. If you could do that, why would you recommend and increase competitive buying of those shares? You could quietly make your investment. He says it is as silly as finding gold and sharing the location with your neighbour. You may agree or disagree with this philosophy. However, you would want to keep that in mind while considering any expert recommendation. There are a lot of reasons why anyone makes any recommendation. These could include generating a fee-based income or brokerage-based income. Buffett has always recommended reading up on yourself to invest.
Net profit growth trend is not enough
Warren Buffett’s letter dwells upon continuous disclosure standards. Companies announce quarterly financial data where they release sales and profit numbers. Such numbers are compared to previous quarters. Buffett describes the ‘net income’ figure as ‘worse-than-useless’. He argues that merely stating the change in the net income is a good starting point but not enough. Berkshire Hathaway emphasizes the operating income or the operating profit, that gives a clear idea of the operational health of the business. Operating profit is the profit before interest and taxation. It is usually used to analyze manufacturing and services companies. Investors use different yardsticks to measure performance. In banking and financial services, the operating profit is less relevant than the net interest margins. Those in financial services have to be efficient borrowers and lenders of money.
Own fundamentally strong businesses
Berkshire adopts a strategy of owning a part or 100% of businesses that are ‘fundamental and enduring’. Buffett is reiterating the Berkshire way of investing based on company fundamentals. There are multiple ways to invest directly in equities. You can own stocks for trading within a settlement cycle. You can also sell or book profits based on technical analysis and not just fundamental analysis. Buffett argues that at Berkshire, they prefer owning businesses that are generally better managers of money. His company favours the rare enterprises that can deploy additional capital at high returns in the future. “Owning only one of these companies – and simply sitting tight – can deliver wealth almost beyond measure,” he said in his letter. Such a strategy of ‘buying and holding’ quality companies allows investors to stay wealthy for generations.
Importance of solid income and cash flows
The success story of Berkshire Hathaway lies in the company’s ability to fortify from catastrophes. Not just fortify but benefit from it. Buffett outlines the ‘not-so-secret’ weapon the company uses to tackle volatile financial markets. The company’s diverse pool of free cash flows is compared to Niagara Falls, the giant freshwater body in North America. When everyone else went through a crisis in 2008, the company had such low expenses that it could depend on the earnings from operations and not on any bank credit. The company holds limited cash in the bank and parks a lot of surplus cash in government bonds. They do not pay dividends, and all share buybacks are at the board’s discretion. That allows the company to save adequate money to capitalize on the distress of others in the market when a crisis happens.
Rajas Kelkar
(The author is editor-in-chief at www.moneyminute.in)