Every year, the "Oracle of Omaha", Warren Buffett (Trades, Portfolio), bestows upon the investing community his eagerly awaited annual shareholder's letter, which is hotly anticipated by both Berkshire Hathaway shareholders and investors everywhere.
Each letter contains not only a review of Berkshire's operating performance for the prior year, but also sage advice from Buffett himself. It is always impressive how the world's greatest investor can boil the investment process down to its essences, making it simple enough for anyone to understand.
The 2013 letter came out in early March, and each year I like to review it for a few new points of investing wisdom to remember. Here's some good take-aways from this year's edition...
Focus on the Business, Ignore the Noise
"Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important."
This is not a particularly new revelation from Buffett, but an important one nevertheless. Analysis for him is very simple - buy a stock or business selling below or near the bottom boundary of a reasonable price estimate, given the company's earnings potential. If you cannot reasonably estimate future earnings (which Buffett admits he usually cannot do), move on.
Buffett re-iterates that macro economic situations, political environments, or the views of other people have never caused Berkshire to forego an attractive purchase. For us, maybe it's time to turn off CNBC and the endless parade of hedge fund managers pining for media face time to do nothing more than increase their own ego or perceived prestige.
Don't Let Daily Stock Prices Influence Your Decisions
"Games are won by players who focus on the playing field � not by those whose eyes are glued to the scoreboard."
Buffett mentions two small investments he has made over the years: a Nebraska farm he bought in 1986, and a commercial property near NYU. For both, he admits knowing little about the operating intricacies of either, relying instead on his son's knowledge of farming for the former, and good friends experienced in commercial real estate for the latter.
In both, Buffett has rarely visited the properties (only twice to the farm, and never to the NYU property). He focused on the economic producing power of each asset, made the purchase, and let the asset ride. Each produce annual cash flow that exceeds the original investment. Buffett doesn't know, or particularly care, what they are worth, even though both have appreciated many times over.
For us, the lesson is to not let daily price swings cause emotional buying and selling decisions.
The Economic Realities of Depreciation and Amortization
"Serious investors should understand the disparate nature of intangible assets: Some truly deplete over time while others in no way lose value."
Depreciation and amortization are topics that trip up both beginning and experienced investors alike. Buffett goes into some detail on them in this year's report.
Amortization charges, he mentions, are only sometimes economically meaningful. Charging off things like the value of customer relationships are not real costs, while software amortization charges are real because the company will eventually have to pay to upgrade or replace it.
Depreciation, on the other hand, refers to equipment and plant degradation, and represents a real economic expense, because the replacement of said equipment will eventually generate a capital expenditure for the company.
For us, particularly when estimating free cash flow, Buffett's thoughts are a good reminder that depreciation charges should always be key part of cash flow analysis.
Berkshire-Style Industries for Investment
The Berkshire letter is always a good reminder of which industries Buffett believes have highly predictable cash flows and easily identified competitive moats. For posterity, Berkshire's biggest operating businesses and stock holdings are in these industries:
Insurance (GEICO, Berkshire Re, General Re, etc.)
Regulated Utility-Like Businesses (MidAmerican, BNSF Railroad, etc.)
Consumer Goods and Retail (Heinz, Wrigley, Coca-Cola (KO), Proctor & Gamble (PG), Walmart (WMT), etc.)
Financial (American Express (AXP), Wells Fargo (WFC), U.S. Bancorp (USB), etc.)
Interestingly, 3 of these 4 sectors are not even covered by Magic Formula® Investing (MFI)! However, there are plenty of consumer goods, retail, energy, pharmaceutical, and business technology firms in the higher cap MFI screens that Berkshire currently owns or would possibly be interested in, several of which we hold in our Top Buys portfolio.
Buffet-ism for 2013
Each annual letter is good for at least one grin-inducing quote. For this year, Uncle Warren borrows from the late money manager Barton Briggs:
"A bull market is like sex. It feels best just before it ends."
Well, at least we know conclusively when one of the two is over...