Warren Buffett (Trades, Portfolio)'s annual letter to Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) shareholders offers great wisdom to value investors, and this year is no exception to this rule. The highly successful value investor released his 2021 letter on Saturday. Here are my five top takeaways from the letter
1. Focus on operating earnings
Operating earnings are the most accurate representation of a company's performance. "Operating earnings are what count most, even during periods when they are not the largest item in our GAAP total," Buffett wrote. The legendary investor has been critical of companies using broader performance measures like Ebitda, which doesn't count for all business expenses.
2. Don't underestimate the power of retained earnings
Retained earnings are the "magic" that makes millions for shareholders in the long-term. "What's out of sight, however, should not be out of mind: Those unrecorded retained earnings are usually building value – lots of value – for Berkshire," wrote Buffett. "Investees use the withheld funds to expand their business, make acquisitions, pay off debt and, often, to repurchase their stock (an act that increases our share of their future earnings)."
3. Invest in businesses with good economic characteristics and good managers
"It took me a while to wise up," he explained. "But Charlie – and also my 20-year struggle with the textile operation I inherited at Berkshire – finally convinced me that owning a non-controlling portion of a wonderful business is more profitable, more enjoyable, and far less work than struggling with 100% of a marginal enterprise."
4. Use common sense to look at a company's competitive strengths and core capabilities
"Simply deploy your capital into whatever we believe makes the most sense, based on a company's durable competitive strengths, the capabilities and character of its management, and price," he wrote. "If that strategy requires little or no effort on our part, so much the better."
5. Don't overpay for what you buy
The legendary investor has often been quoted that "price is what you pay value is what you get." Paying more than the intrinsic value leaves no room for error and may result in losses that undermine portfolio performance.
That's what happened with one of the investments Buffett made back in 2016 when he purchased Precision Castparts ("PCC"), which resulted in an $11 billion write-down. "No one misled me in any way – I was simply too optimistic about PCC's normalized profit potential," he explains. "Last year, my miscalculation was laid bare by adverse developments throughout the aerospace industry, PCC's most important source of customers."
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