• Matt Morizio

5 lessons from Warren Buffett's annual letter to his shareholders

Warren Buffett writes a letter to the shareholders of Berkshire Hathaway every year. I read it. You should too. There are so many golden nuggets about life, leadership, and of course investing. Here are a few I really appreciated:

Warren Buffet, Bloomberg Photo

Photo courtesy of bloomberg.com

Lesson 1: Bonds aren’t as “safe” as conventional teaching says they are.

The Oracle of Omaha himself said it perfectly, emphasis my own,

“It is a terrible mistake for investors with long-term horizons…to measure their investment “risk” by their portfolio’s ratio of bonds to stocks. Often, high-grade bonds in an investment portfolio increase its risk

In 100% of the 43 ten-year periods since we took control of Berkshire, years with gains by the S&P 500 exceeded loss years.

By November 2012, our bonds – now with about five years to go before they matured – were selling for 95.7% of their face value. At that price, their annual yield to maturity was less than 1%. Or, to be precise, .88%. Given that pathetic return, our bonds had become a dumb – a really dumb – investment compared to American equities. Over time, the S&P 500 – which mirrors a huge cross-section of American business, appropriately weighted by market value – has earned far more than 10% annually on shareholders’ equity (net worth).”

In the last quote, Buffett is referring to the time frame 2007-2017. His “safe” bonds were returning 0.88% per year while inflation averaged around 1.7% in that same time frame. In other words, you were losing money every year by holding a “safe” bond.

But the “risky” stock market returned 10% per year in that same time…you do the math.

Lesson 2: Honesty is the best policy.

Buffett starts the letter the same way every year, by reporting Berkshire Hathaway’s earnings. In the very next paragraph, he writes:

“The format of that opening paragraph has been standard for 30 years. But 2017 was far from standard: A large portion of our gain did not come from anything we accomplished at Berkshire.

The $65 billion gain is nonetheless real – rest assured of that. But only $36 billion came from Berkshire’s operations. The remaining $29 billion was delivered to us in December when Congress rewrote the U.S. Tax Code.”

Instead of saying the tremendous year was a result of something Berkshire actually did, he does something I’ve noticed all true leaders do, or rather don’t do - they don’t take credit when credit isn’t due. Nearly half of Berkshire’s bottom line was because of a new tax code, not increased productivity in his business, and he names that at the start of the letter.

Lesson 3: It’s not what you know, it’s who you know.

In the next section of the letter, Buffett talks about notable acquisitions made by Berkshire Hathaway in 2017. For context, Clayton Homes is already owned by Berkshire Hathaway, and Pilot Flying J (PFJ - owned by the Haslam family) was partially acquired by Berkshire in 2017.

Look at the incredible note below:

“Both Clayton Homes and PFJ are based in Knoxville, where the Clayton and Haslam families have long been friends. Kevin Clayton’s comments to the Haslams about the advantages of a Berkshire affiliation, and his admiring comments about the Haslam family to me, helped cement the PFJ deal.”

We’re talking about a company whose net worth is $65 billion acquiring a company that does about $20 billion in annual volume, and what sealed the deal was a long standing friendship. Think about that - an 11 digit deal was cemented because of a great relationship. Surround yourself with great people, and great things happen.

Lesson 4: Opportunities are everywhere if you’re savvy enough to spot them.

Later in the acquisition section, Buffett highlights an acquisition that had an unexpected diamond buried within it:

"I have told you several times about HomeServices, our growing real estate brokerage operation. Berkshire backed into this business in 2000 when we acquired a majority interest in MidAmerican Energy (now named Berkshire Hathaway Energy). MidAmerican’s activities were then largely in the electric utility field, and I originally paid little attention to HomeServices."

Fast forward to now, and HomeServices is close to leading the country in home sales. Buffett recognized a hidden gem and capitalized on it. HomeServices wasn’t the original target to acquire, but with careful attention, it is now one of the top home sales companies in the US.

Lesson 5: Dream BIG

"Despite its recent acquisitions, HomeServices is on track to do only about 3% of the country’s home-brokerage business in 2018. That leaves 97% to go."

Here is one of the most successful investors in history and one of the richest men on the planet saying his business is only 3% of where he wants it to be. In other words, he wants to be part of EVERY home sale in the US.

It reminds me of a law in Dan Sullivan’s The Laws of Lifetime Growth, always make your future bigger than your past. It’s this massive goal setting mindset that helped Buffett achieve all he has to date, and it is this mindset that keeps him coming back for more.

Dan Sullivan Laws of Lifetime Growth

I’m a believer in learning from the best in all disciplines, and if this is what Buffett has learned, I’m listening. His letter offers insight into what’s most important to him - honesty, friendships, community, keeping investing simple, and when in doubt, bet on America.

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