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Market Wrap-up for Mar. 3 - Berkshire's Annual Letter

Over the weekend, Berkshire Hathaway released its annual letter to shareholders. Today I’d like to take a closer look at some of the key insights from legendary investing minds Warren Buffett and Charlie Munger.

Investment Sins

Berkshire’s letter hones in on the idea of “investment sins”, which according to Warren Buffett involves investors (both average and institutional alike) not focusing on long-term objectives. Buffett states:

“For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.”

Some of the investment sins Buffet talks about are:

  • Fear of Meaningless Price Volatility
    • “If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things.” Buffett gives an example from the financial crisis, when investors piled into “safe haven” instruments such as Treasury Bills. If fear had not dominated these investors, an investment in U.S. equities would have paid off tremendously, in both capital appreciation and current income terms.
  • Risky Behavior
    • “Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy.” Buffett also warns of investors relying too much on what other people are saying about the markets, including advisors, economists, TV commentators, and even Charlie and himself.

Aptly dubbed “investment sins”, these behaviors can significantly impact the success of any long-term portfolio. And with a constant barrage of “information” in today’s high-tech world, it is sometimes difficult to essentially cancel out the noise. For us dividend-focused investors, it is crucial to stick to our fundamentals and try to avoid falling into the herd mentality.

A Lesson from Charlie

In the section titled “Berkshire – Past, Present and Future,” Buffett describes the very beginnings of Berkshire Hathaway, as well as his several “monumentally stupid decisions,” and how Charlie Munger finally managed to “straighten” him and the company out. Buffett attributes Berkshire’s successful business model to Munger’s wise words:

“Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.”

This principle is in itself quite simple, but actually adhering to it can be quite difficult. Buffett himself admits how hard it is to change our behavior, and how following this particular blueprint can be really hard. Sometimes we can be easily fooled by certain investments, the most common being the dividend trap, where a high yield can sometimes mean that a deal is too good to be true.

Another example occurs during earnings season, when companies post “better-than-expected” results, which easily surpass analyst estimates. While beating the Street’s view is typically a positive sign, sometimes the reason why the results are higher are because of cost cutting and operational reductions, not because the company is actually doing “better.” Furthermore, investors sometimes forget to weigh a company’s forward guidance, which outlines how management believes the company will fare in the upcoming quarters.

Buffett's Wise Words

While we encourage you to read the entire annual letter, I’d like to wrap up with one last quote from Buffett describing why he believes his company will continue to thrive long after him and Charlie retire. The quote, not surprisingly, can be applied to our own investment philosophy:

“The reason for our conservatism, which may impress some people as extreme, is that it is entirely predictable that people will occasionally panic, but not at all predictable when this will happen. Though practically all days are relatively uneventful, tomorrow is always uncertain. (I felt no special apprehension on December 6, 1941 or September 10, 2001.) And if you can’t predict what tomorrow will bring, you must be prepared for whatever it does.”

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