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clifp 03-02-2014 07:49 PM

My thoughts on Warren Buffett's 2014 shareholder letter.
Warren Buffett's Berkshire is my largest holding at ~8% of portfolio, so I read his shareholder letter and annual report pretty carefully.

It gets a lot of coverage, I liked this Fortune article the best.
Since I posted this in Fire and Money, instead of the stock forum, I won't discuss much about the particulars of Berkshire, but rather makes some comments about Buffett's views on the economy, for those of you who don't feel like reading all 23 pages for the letter, 140 pages for the report... :)

Berkshire performance.

Berkshire earning on the non insurance businesses (railroads, candy shops, burger joints, house paint, bricks, jewelry shops, utility companies and 50 odd more ) increased by 12.85 . This is significantly better than then S&P but well below a company like Google. Berkshire, more than most huge companies is very US centric so that was impressive growth.
Berkshire employment was 330,745, up 42,283 from last year. Now much of this rise in employment was from acquisition, but still they hired plenty of workers in fairly mundane industries, which I think is good news for the US economy.

Of particular interest to me was the observation that since 1970 the earning of the operating companies have increase 20.6% and the value of the investments at rate of 19.3% compounded. The stock price has appreciated at rate between these to. Much of the letter focuses on the concept that the income generated by asset is really critical thing to be focused on..

Warren's mentor Ben Graham, says that over the short run the market is a voting machine (i.e. popularity) but over the long run it is a weighing machine. The weight being a companies earnings; so the close correlation between the rise in Berkshire earning and its stock price is an excellent example. The same is true for the S&P at large.

Buffett on investing

Investment is most intelligent when it is most businesslike.
The Intelligent Investor
by Benjamin Graham
It is fitting to have a Ben Graham quote open this discussion because I owe so much of what I know about investing to him. I will talk more about Ben a bit later, and I will even sooner talk about common stocks. But let me first tell you about two small non-stock investments that I made long ago. Though neither changed my net worth by much, they are instructive.

This tale begins in Nebraska. From 1973 to 1981, the Midwest experienced an explosion in farm prices,
caused by a widespread belief that runaway inflation was coming and fueled by the lending policies of small rural banks. Then the bubble burst, bringing price declines of 50% or more that devastated both leveraged farmers and their lenders. Five times as many Iowa and Nebraska banks failed in that bubble’s aftermath than in our recent Great Recession.

In 1986, I purchased a 400-acre farm, located 50 miles north of Omaha, from the FDIC. It cost me $280,000, considerably less than what a failed bank had lent against the farm a few years earlier. I knew nothing about operating a farm. But I have a son who loves farming and I learned from him both how many bushels of corn and soybeans the farm would produce and what the operating expenses would be. From these estimates, I calculated the normalized return from the farm to then be about 10%. I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out.

I needed no unusual knowledge or intelligence to conclude that the investment had no downside and potentially had substantial upside. There would, of course, be the occasional bad crop and prices would sometimes disappoint. But so what? There would be some unusually good years as well, and I would never be under any pressure to sell the property. Now, 28 years later, the farm has tripled its earnings and is worth five times or more what I paid. I still know nothing about farming and recently made just my second visit to the farm.

In 1993, I made another small investment. Larry Silverstein, Salomon’s landlord when I was the company’s CEO, told me about a New York retail property adjacent to NYU that the Resolution Trust Corp. was selling. Again, a bubble had popped – this one involving commercial real estate – and the RTC had been created to dispose of the assets of failed savings institutions whose optimistic lending practices had fueled the folly.

Here, too, the analysis was simple. As had been the case with the farm, the unleveraged current yield from the property was about 10%. But the property had been undermanaged by the RTC, and its income would increase when several vacant stores were leased. Even more important, the largest tenant – who occupied around 20% of the project’s space – was paying rent of about $5 per foot, whereas other tenants averaged $70. The expiration of this
bargain lease in nine years was certain to provide a major boost to earnings. The property’s location was also superb: NYU wasn’t going anywhere.

I joined a small group, including Larry and my friend Fred Rose, that purchased the parcel. Fred was an experienced, high-grade real estate investor who, with his family, would manage the property. And manage it they did. As old leases expired, earnings tripled. Annual distributions now exceed 35% of our original equity investment. Moreover, our original mortgage was refinanced in 1996 and again in 1999, moves that allowed several
special distributions totaling more than 150% of what we had invested. I’ve yet to view the property. Income from both the farm and the NYU real estate will probably increase in the decades to come. Though the gains won’t be dramatic, the two investments will be solid and satisfactory holdings for my lifetime and, subsequently, for my children and grandchildren.

I tell these tales to illustrate certain fundamentals of investing:
  • You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well.
  • Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”
  • Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake. If you instead focus on the prospective price change of a contemplated purchase, you are speculating.There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; noneof those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it

Nor is the fact that asset has appreciated a reason to sell it. I see many forum members saying, "stocks are record levels therefore I should sell them".

Now there are many sound reasons to sell stocks; "I have a target AA and I have to sell stocks to get back to my target AA", "I need the money to pay for house, kids college", or "The price/earning ratio of stocks high by historical standards"

But if you are just focused on the price, you are speculating not investing.
It is also important to understand that adjusting for inflation the S&P 500 is not at a record high. Actually 8% below the Aug 2000 record, and most importantly earning have increased by more than 50% since Aug 2000.

Buffett on Asset Allocation and Indexing.


Most investors, of course, have not made the study of business prospects a priority in their lives. If wise,they will conclude that they do not know enough about specific businesses to predict their future earning power.

I have good news for these non-professionals: The typical investor doesn’t need this skill. In aggregate,American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot.

The 21st Century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do

that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal. That’s the “what” of investing for the non-professional. The “when” is also important. The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become
disillusioned when paper losses occur. (Remember the late Barton Biggs’ observation: “A bull market is like sex. It feels best just before it ends.”) The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs. Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long- term results than the knowledgeable professional who is blind to even a single weakness

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all
of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P
500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.

So a 90/10% AA is his recommendation.

Buffett on Pensions


Local and state financial problems are accelerating, in large part because public entities promised pensions they couldn’t afford. Citizens and public officials typically under-appreciated the gigantic financial tapeworm that was born when promises were made that conflicted with a willingness to fund them. Unfortunately, pension mathematics today remain a mystery to most Americans. Investment policies, as well, play an important role in these problems. In 1975, I wrote a memo to Katharine Graham, then chairman of The Washington Post Company, about the pitfalls of pension promises and the importance of investment policy. That memo is reproduced on pages 118 - 136.

During the next decade, you will read a lot of news – bad news – about public pension plans. I hope my memo is helpful to you in understanding the necessity for prompt remedial action where problems exist]

This post is crazy long already,so the only thing I'll say about pensions is read Warren's memo from 1975.

Spanky 03-02-2014 10:44 PM

Thanks for sharing.

springnr 03-02-2014 10:53 PM

"So a 90/10% AA is his recommendation.'
Scale makes a difference?
If you have 100 million invested at 90/10, might be a little different than 650K at 90/10.

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