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Buffetts Bites

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Buffett’s Bites

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What Is Buffett’s Bites About?

Buffett’s Bites explains the investing and management lessons found in Warren Buffett’s Berkshire Hathaway shareholder letters. It shows investors how to evaluate honest leadership, shareholder alignment, competitive advantages, intrinsic value, capital allocation and long-term business performance. The central lesson is to think like a business owner, ignore short-term market emotion and invest in understandable companies run by capable and trustworthy managers.

Chapter 1: What Are Shareholder Letters And Who Reads Them?

  • CEOs either write their own shareholder letters themselves, or they call on others to help them write it and barely contribute to it.
  • The average holding period for stocks was once three years, and now it is less than nine months. In the 1950s, the average holding period was closer to seven years, illustrating how dramatically trading behavior has changed.
  • This raises the question: why would shareholders read the CEO letters if, on average, they exit the stock within the same financial year?
  • Warren Buffett claims that some CEOs tell their shareholders what they want to hear, instead of what they need to hear about the underlying business.
  • Examine the company’s previous annual reports to track the consistency of the CEO’s message to shareholders over the years, then determine whether they have lived up to their words with their actions.
  • Also, confirm that management has readjusted accounting numbers in a correct manner.
  • There is lots of important business information disseminated in the shareholder letter, such as the company’s current and future position in the market, the strengths or weaknesses of leadership, and corporate culture.
  • Investors should look for a well-detailed, and easy to understand shareholder letter.
  • Warren Buffett first began writing Berkshire Hathaway’s annual letters in 1977. Today, they are widely read by individual and institutional investors alike, proving how a well-crafted CEO letter can transcend short-term shareholder churn.

Chapter 2: Why Read Shareholder Letters?

  • The shareholder letter found at the beginning of an annual report demonstrates: how the company has performed within the last 12 months, the company’s outlook for the years going forward, and other important business information about the company.
  • Investors should look for CEOs who are honest.
  • Investors should be cautious of CEOs who exaggerate future predictions.
  • CEOs who are knowledgeable about the company and its industry will have a greater chance of executing business strategies which may outperform competition.
  • An experienced CEO is more likely to build significant trust with investors.
  • When analyzing the company’s management team, the investor should try to evaluate what type of CEO runs the company: Some CEOs may choose to comment on and discuss past promises, whereas other CEOs will only focus on what’s happening in the current year.
  • Buffett asserts that CEOs should address past promises, and investors should always determine whether these past promises have come to fruition.
  • Accounting figures can be manipulated and distorted by the management team very easily.
  • Honest management teams have a greater chance of producing truthful and reliable accounting figures, while dishonest management teams will likely produce misleading and unreliable accounting figures.
  • In Berkshire Hathaway’s letters, Buffett frequently revisits past forecasts or commitments, openly discussing both successes and failures. This transparency is a benchmark for what investors should seek in other companies’ shareholder letters.

Chapter 3: What Makes Berkshire Hathaway Letters Different?

  • Buffett writes his own shareholder letters because he thinks the CEO should be able to communicate with their shareholders without any doubt or unwillingness.
  • Buffett believes that CEOs who avoid writing shareholder letters are incompetent.
  • Warren Buffett writes the longest shareholder letter in the U.S., and he is the best example of a CEO who is willing to communicate his business’s efforts to shareholders. (Note: He is known for lengthy, highly detailed letters, though “longest” can vary by definition.)
  • Buffett treats his shareholders like his family, and he writes in a manner that communicates directly and personally to each investor.
  • Buffett is known to use parables to make complex investment concepts easily understandable for novice investors.
  • Buffett always refers to the past, present, and future of Berkshire Hathaway, to demonstrate that all CEOs should always think about the company from a broader perspective.
  • Buffett’s letters often include discussions of Berkshire’s diverse subsidiaries, emphasizing his philosophy of long-term value creation and candid disclosure.

Chapter 4: What Is The Berkshire Hathaway Report Card?

  • A company can manipulate their non-cash earnings through altering their accounts receivable, accounts payable, or non-operating cash, in order to distort and boost the company’s earning value.
  • Some management teams may focus on only company profits and growth, instead of cash and balance sheet growth, which are significant indicators of a company’s progress.
  • Cash during an economic downturn is the most important asset to withhold, since the money market constricts, and assets (stocks) become much cheaper.
  • Warren Buffett keeps high levels of company cash in case a decline in the economic market occurs, which enables him to buy bargains when no one else can.
  • Intrinsic value is the perceived and estimated value of the overall company.
  • To determine the intrinsic value:
    • Evaluate the total value of the company’s assets (both tangible and intangible).
    • Predict how much cash the company is going to generate over the business’s lifetime.
  • Next, factor in a ‘discount rate’ – which is the rate of interest charged by commercial banks for loans, to discount the present value of all future cash flows. Then, deduct a few extra points off the interest charged by banks as a margin of safety.
  • Finally, divide the calculated present value of all future cash flows by the company’s total number of outstanding shares, to determine the company’s estimated intrinsic value.
  • Avoid investing in a company if the management team are willing to dilute shareholders to purchase assets or make acquisitions. Dilution is detrimental for shareholders, because it dilutes the earnings per share of the company, and their ownership.
  • Buffett often contrasts book value and intrinsic value in his letters, reminding investors that intangible assets, brand strength, and competitive advantages must be weighed beyond just the balance sheet.

Chapter 5: Is Warren Buffett a CEO or a CCAO?

  • Warren Buffett spends most of his personal time reading and thinking.
  • His routine involves analyzing large amounts of information and data from newspapers, annual reports, books, and more.
  • His primary aim is to identify value investments overlooked by Wall Street and the general public.
  • This is Warren Buffett’s criteria for potential investment opportunities:
    • The stock price must be appropriate.
    • The company must possess a long-lasting competitive advantage(s).
    • The company must be within your ‘circle of competence’ (a business you understand well).
    • The management of the company must be motivated, passionate, and honest.
  • Buffett has famously said his favorite holding period is “forever,” emphasizing his preference for owning high-quality companies long-term.

Chapter 6: Why Does Buffett Tap-Dance To Work Every Day?

  • Warren Buffett, and his business partner Charlie Munger, own a large portion of ‘Berkshire Hathaway.’
  • Their substantial share ownership confirms to investors that both Buffett and Munger are risking their own wealth in the company (like shareholders), where a decline in company value would translate into a decline in their own wealth.
  • Remember – not all CEOs own stock of the company they manage.
  • Berkshire Hathaway distributes compensation to management according to the company’s growth per share.
  • This incentive structure benefits the investors of Berkshire, because management only receive incentives if they create value for shareholders and grow the company.
  • Companies with a compensation structure which is not aligned with company growth/performance, are likely to allocate undeserving rewards too easily.
  • The key is to invest in companies with:
    • Durable competitive advantages.
    • Run by motivated and honest managers.
    • Selling at a cheap valuation.
  • Buffett’s and Munger’s personal net worth’s are largely tied to Berkshire stock, reinforcing their “skin in the game” approach.

Chapter 7: How To Spot Great Businesses Run By Great Managers?

  • Buffett likes to invest in companies with:
    • Low and controllable levels of debt.
    • A management team that keeps their promises.
    • And avoids companies with unusual self-governing.
  • He believes in holding his investments regardless of what cycle the market is in.
  • Buffett likes to invest in companies which have a capable, honest, and motivated management team (especially the CEO). This may demonstrate a healthy corporate culture, honest accounting practices, and fair compensation plans.
  • Buffett also likes to invest in companies which confess their mistakes to shareholders, as this is a sign of honesty and integrity.
  • Buffett claims that the CEO should be able to clarify the company’s accounting records and financial statements in an easy to understand manner.
  • Berkshire’s subsidiary managers typically operate with autonomy, but Buffett requires honesty, transparency, and accountability from each CEO.

Chapter 8: How To Become An Intelligent Investor

  • We, as investors and as a society, are influenced by news outlets more than we realize.
  • During the GFC in 2008, Buffett was cited saying “the economy will be in shambles,” which was a small portion of his full statement.
  • This headline appeared on popular news platforms, and was not a clear reflection of Buffett’s full statement; which was much more detailed.
  • This is an example of how the media publicises and distorts provocative content to boost ratings and viewership.
  • Warren Buffett has learned to treat market pessimism, particularly in downturns, as his friend.
  • During a market decline, the best opportunities present themselves in the form of undervalued securities.
  • In market downturns, optimism is Buffett’s enemy, because it causes the prices of undervalued companies to appreciate.
  • During a market downturn, the professional investors are hit just as hard as the retail investors.
  • During the market downturn, Berkshire Hathaway was down 14%, which is equal to losing billions of dollars of value.
  • In a market decline, the best investors share the same agony as the smaller and less experienced investors.
  • Buffett famously advised investors to “be fearful when others are greedy and greedy when others are fearful,” highlighting his contrarian approach.

Chapter 9: Fiduciary Genetics: The Berkshire Hathaway Owner’s Manual

  • As an executive, basic fiduciary requirements are in place to ensure a company puts aside its personal agenda to act in good faith for their shareholders.
  • Since Buffett owns a large portion of Berkshire Hathaway, he is incentivised to achieve growth for his shareholders, because he benefits from share price appreciation as well.
  • Buffett confirms that the long-term goal for Berkshire is to expand its value per share, which is known as book value per share.
  • Buffett’s portfolio consists of a diversified group of companies which generates lots of cash.
  • Buffett acknowledges that in the twenty-first century, we are wired in a way which can make us unpredictable, emotional, and irrational.
  • So when investors are faced with volatility, they tend to act with emotion instead of rationality when making market-based decisions.
  • Investors generally panic when the market falls, but get over-excited when the market climbs.
  • Buffett’s success lies in his ability to override these psychological tendencies by monitoring his own emotions; allowing him to maintain a clear perspective, while employing an effective investment decision-making framework.
  • Berkshire Hathaway’s “Owner’s Manual” lays out core corporate principles, emphasizing transparency, long-term thinking, and treating shareholders as true partners.

Chapter 10: Warren Buffett And Galileo: Traditions Of Heresy

  • The Efficient Market Hypothesis (EMH) is a theory taught to business students by academia.
  • The EMH theory declares that stock prices reflect all publicly available company-relevant information.
  • Implies there is no discrepancy between value and price, as all publicly released information has been fairly factored into stock prices.
  • The EMH claims it is impossible to profit, as all relevant information has been fairly priced into each individual stock.
  • However, famous value investor Warren Buffett strongly opposes the EMH theory, because he has managed to continuously outperform the market over his lifetime, which shows the theory’s flaws.
  • Warren Buffett discussed the prevalence of excess CEO compensation in his shareholder letters.
  • The issue of over-compensation calls on investors to be wary of companies with large and undeserving compensation payments to management.
  • The compensation arrangement should communicate to the investors, the nature of the CEO and the management team of a company.
  • Several of Buffett’s peers, such as Bill Ruane (Sequoia Fund) and Walter Schloss, also outperformed the market, adding more anecdotal evidence against EMH.

Chapter 11: Woodstock Or Camelot: Ideals, Images, And Greed

  • Buffett often refers to the Berkshire Hathaway AGM (annual general meeting) as the “Woodstock of Capitalism.”
  • Berkshire Hathaway’s AGM is important for anyone aspiring to become a successful capitalist, because many successful capitalists from around the globe attend this meeting each year. In recent years, the AGM has attracted over 40,000 attendees.
  • There is sufficient evidence that proves Buffett is not a ‘greedy capitalist.’
  • This was made very clear in 2006, when he announced that the majority of his wealth would be donated to the Bill & Melinda Gates Foundation when he passes away.
  • Buffett has created an inspiring legacy which will live on throughout human history.
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