Sunday, February 26, 2012

Berkshire Hathaway's 2011 Annual Letter to Shareholders

While there's a lot of Buffett books out there that sought to explain Buffett's stock-picking techniques, will not it be best to hear it from Warren Buffett himself? I shall share with you some of the more important point from his report. For the full text, you can check it out here:

"Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.

We have witnessed many bouts of repurchasing that failed our second test. Sometimes, of course, infractions – even serious ones – are innocent; many CEOs never stop believing their stock is cheap. In other instances, a less benign conclusion seems warranted. It doesn’t suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value."

Many companies have been doing aggressive share buyback in the recent correction, of which I supposed many are not putting the cash to good use. I supposed a easier way to see if the share buyback is well done will be first to check if the company has any high-interest yielding debt (Hyflux ?) that can actually be repaid. Secondly, perhaps we should ask ourselves if we will buy the company at the current price of which share buyback is being done. Else, distributing dividend might have been a better policy.

"The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply."

For someone like me with no foreseeable cash-generating abilities in the near future, I doubt it will make a difference if the stock tanks. However, for the rest out there, this is once again a great advice. Do not rejoice over the fact that your holdings have caught the attention of institutional funds and analyst.

"At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained."

A structure of which we can use to assess insurance company...

"To fulfill its societal obligation, BNSF regularly invests far more than its depreciation charge, with the excess amounting to $1.8 billion in 2011.

Massive investments of the sort that BNSF is making would be foolish if it could not earn appropriate returns on the incremental sums it commits. But I am confident it will do so because of the value it delivers. Many years ago Ben Franklin counseled, “Keep thy shop, and thy shop will keep thee.” Translating this to our regulated businesses, he might today say, “Take care of your customer, and the regulator – your customer’s representative – will take care of you.” Good behavior by each party begets good behavior in return."

Our dearest 2 Public Transport Operators should really take note of this point. This is perhaps the difference in running a business with a owner's mentality. This is also why I do have a slight preference for a family-owned business sometimes.

"This group of companies sells products ranging from lollipops to jet airplanes. Some of the businesses enjoy terrific economics, measured by earnings on unleveraged net tangible assets that run from 25% after-tax to more than 100%. Others produce good returns in the area of 12-20%. A few, however, have very poor returns, a result of some serious mistakes"

Always take into account the leverage level when assessing return on equity or return on net tangible asset.

"The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis.

As “bandwagon” investors join any party, they create their own truth – for a while. "

While I have always thought that gold can be a safe asset given the past Gold Standard, he really knocks the senses out of me with his reference to the tulip bubbles in the 17th century. While I have read about that story before, I will never have thought that this is precisely what Gold is all about now.

"My own preference – and you knew this was coming – is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment."

This is a short and sweet summary of what a long-term investment should be.

The annual letter does deserve a read and I have find that reading his letter to shareholder proves to be more worth it than many other books out there. And what's more its free, which implies an infinite return on investment:)


  1. Have u read the book that is a compilation of the more pertinent points of his past shareholder letters? It is called "The essays of Warren Buffett".

    1. I have read it before and from there you can actually see that the buffettology series might be based on those letters instead. I have a collection of all Buffett's letters from 1957 -1970 and 1977 till now.

      I plan to re-read the intelligent investor and Buffett's letter, but time is of the issue as I also have to look out for great stock and also to manage the blog.