I hope you had a wonderful weekend! The days are getting longer and the darkness is receding. Warmer weather is just around the corner!
LRPC’s Monday Morning Minute for this week, “Buffett’s Investing Advice From His 2017 Shareholder Letter” (presented below) comes to you courtesy of ThinkAdvisor. As an independent, objective Registered Investment Advisory firm, Lawton Retirement Plan Consultants, LLC has access to research from many sources. Be assured that I will share enlightening, useful information with you each week.
Every year Berkshire Hathaway’s shareholder letter contains insights on investing from Warren Buffet that many eagerly await reading. You may be surprised at some of Mr. Buffet’s thoughts this year outlined below.
Have a wonderful week!
Buffett’s Investing Advice From His 2017 Shareholder Letter
By Janet Levaux, Editor in Chief, Research Magazine
According to Chairman Warren Buffet, the market value of Berkshire Hathaway’s shares has roared ahead at a compound annual growth rate of 20.8% since 1965 — more than double the S&P 500’s 9.7%. In 2016, Berkshire shares soared 23.4%, beating the S&P’s 12.0% improvement. A year earlier, the shares dropped 12.5%, while the S&P gained 1.4%.
While the information on returns is always welcome by investors and market watchers, it is the Oracle of Omaha’s musings on a variety of topics that are eagerly anticipated. Read on for the top eight nuggets of wisdom gleaned from this year’s 28-page letter to investors:
1. America the bountiful
As investors watch the Dow Jones industrial average top 21,000, there is a mix of euphoria and concern. Buffet focuses on the upside of this achievement.
“America’s economic achievements have led to staggering profits for stockholders,” he said in the letter. “During the 20th century, the Dow Jones industrials advanced from 66 to 11,497, a 17,320% capital gain that was materially boosted by steadily increasing dividends.” And the trend continues. By Dec. 31, 2016, the index advanced a further 72%, to 19,763, he points out.
“American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that.”
2. Fear is your friend
Regardless of whether or not an equity downturn is a day or a decade away, Buffett says market movement is a positive, not negative, phenomenon.
During a period of panic (or worse), don’t forget: “First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted,” he explained. In other words, put your eggs in a well-priced basket – and keep them there.
“Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively financed American businesses will almost certainly do well,” he explained.
3. Buybacks = bonus
Though considered controversial by some investors, repurchases are always a plus for existing shareholders. “Though the day-to-day impact of these purchases is usually minuscule, it’s always better for a seller to have an additional buyer in the market,” Buffet pointed out.
For shareholders keeping their investment, repurchases only make sense when the shares are bought “at a price below intrinsic value,” he says. “When that rule is followed, the remaining shares experience an immediate gain in intrinsic value,” Buffett said.
For instance, in a business with three equal partners worth $3,000, if one is bought out for $900, the other partners have an immediate gain of $50. “It is puzzling, therefore, that corporate repurchase announcements almost never refer to a price above which repurchases will be eschewed,” he stated.
Still, Buffet adds that repurchases should not take place when a business needs its available funds to protect or grow operations and is not comfortable taking on more debt. Another exception concerns an acquisition that offers much more value than do the undervalued shares of a potential repurchaser.
CEOs and boards, according to Buffett, should always remind themselves: “What is smart at one price is stupid at another.”
4. Regulatory rewards
Two firms – Berkshire Hathaway’s holdings in BNSF railroad and Berkshire Hathaway Energy (BHE), the utility business of which it owns 90% – accounted for 33% of Berkshire’s after-tax operating earnings in 2016.
“A key characteristic of both companies is their huge investment in very long-lived, regulated assets, with these partially funded by large amounts of long-term debt that is not guaranteed by Berkshire,” Buffet explained.
Berkshire Hathaway’s credit is not needed since each company has earning power “that even under terrible economic conditions would far exceed its interest requirements.”
BHE, for instance, has recession-resistant earnings (as do many utilities) and “an ever-widening diversity of earnings streams, which shield BHE from being seriously harmed by any single regulatory body,” Buffett stated.
Last year, BHE and BNSF invested close to $9 billion in plant and equipment, representing “a massive commitment to their segments of America’s infrastructure.” Buffet says such investments are “relished” by investors, as long as they promote “reasonable returns.”
5. Clean energy
Both BHE and BNSF have delivered low costs to customers and invested in “planet-friendly technology.”
In Iowa, BHE generated about 55% of its megawatt-hours from wind. And this figure is estimated to grow (via new wind projects) to 89% by 2020. Low energy prices and renewable energy mean that high-tech firms are attracted to the state for business, Buffett points out. When it comes to wind energy, Iowa “is the Saudi Arabia of America,” he explains.
And BNSF, like other railroad companies, uses just one gallon of diesel fuel to move a ton of freight roughly 500 miles. These economic facts “make railroads four times as fuel-efficient as trucks!” Buffet boasted. “Furthermore, railroads alleviate highway congestion – and the taxpayer-funded maintenance expenditures that come with heavier traffic – in a major way.”
Overall, he adds, these two firms own assets “of major importance to our country as well as to shareholders of Berkshire.”
6. Insurance upside
It may not be the most “exciting industry,” but the property/casualty holdings have “been the engine that has propelled our growth since 1967,” Buffet says.
That’s when Berkshire Hathaway bought National Indemnity and its sister company National Fire & Marine for roughly $8.5 million. National Indemnity is the largest property/casualty company in the world as measured by net worth, according to the Oracle of Omaha.
These insurers get premiums up front and pay claims later, which means they hold large sums – or “float” – that they are able to invest for their own benefit.
“We recently wrote a huge policy that increased float to more than $100 billion,” he stated. “Beyond that one-time boost, float at Geico and several of our specialized operations is almost certain to grow at a good clip.”
While it’s true that there can be times when floats decline, this drop will be quite gradual – he insists – and no more than 3% in any given year.
“The nature of our insurance contracts is such that we can never be subject to immediate or near-term demands for sums that are of significance to our cash resources,” Buffet explained. “This structure is by design and is a key component in the unequaled financial strength of our insurance companies. It will never be compromised.”
7. Diversification makes a difference
A review of Berkshire’s main holdings shows that Buffett does focus his bets, but not in one industry. Rather, his holdings include everything from drug firms to tech giants and from airlines to gas stations.
Buffett’s largest holding is in Wells Fargo and accounts for a 10% ownership stake. Berkshire owns about 9% of Coca-Cola. While the Oracle of Omaha didn’t address the fake accounts scandal at the bank in his letter, he did discuss it Monday on CNBC.
“They made a huge mistake. The huge mistake wasn’t necessarily the dumb incentive system. The problem was they didn’t do something about it until they learned about it,” he explained on “Squawk Box”.
“I keep preaching to our guys: If you see a problem, attack it immediately,” Buffett said, referring to Berkshire staff members. Despite the $190 million the bank paid to settle the matter with regulators, its stock has performed very well, rising 19.5% over the past 12 months.
Other key holdings for Berkshire are a 17% stake in American Express, an 8.5% share of IBM, a 7% interest in Southwest Airlines, 3% of Goldman Sachs, a 2% holding of Sanofi and 1% of Apple.
8. Buffet believes in Bogle
Buffett ended his letter with a homage to the founder of Vanguard. “If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle,” he wrote.
Bogle and Vanguard’s business of selling “ultra-low-cost index funds” has netted the fund family founder “only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing.”
Buffett added: Bogle “is a hero to them and to me.”
Pension funds for public employees have lost out, he says, and are very underfunded today. The “resulting shortfalls in their assets will for decades have to be made up by local taxpayers.”
Plus, he calculates that wealthy individuals and organizations’ search for “superior investment advice” likely has led them “to waste more than $100 billion over the past decade.”
“Even a 1% fee on a few trillion dollars adds up,” Buffett stated.
Lawton Retirement Plan Consultants, LLC (LRPC) Monday Morning Minute is crafted to provide decision-makers with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.
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