In the Loop: May 2022

The 2022 Berkshire Hathaway annual shareholders meeting took place this past Saturday, April 30^th.  An estimated 40,000+ attendees lined up for hours in Omaha, happy for the opportunity to attend the first live Berkshire event in two years.  The main event is a long question and answer session on Saturday.  During the Q&A session Warren Buffett, the Chairman of Berkshire Hathaway, and Charlie Munger, his less-well-known but equally important partner and Vice Chairman of Berkshire Hathaway, addressed shareholders’ questions ranging from investing to politics to macroeconomics to career advice.  

In addition to the more cerebral Q&A session, there is a huge ‘mini-mall’ of booths set up in event space next to the CHI Health Center Arena. Many of Berkshire’s companies, including See’s Candies, business jet operator NetJets and the railroad BNSF have ‘storefronts’, and this year shareholders could learn about the Berkshire companies and buy everything from a Jimmy Buffett-designed pontoon boat, a pair of Tony Llama boots, a Clayton manufactured home, Fruit of the Loom T-shirts or an Oriental Trading rubber duck, while enjoying a Dairy Queen Dilly Bar. 

The weekend is a spectacle, and attendees range from famous investors, including Bill Ackman, Mario Gabelli and Tom Russo, to celebrities like Bill Gates, who is a former member of the Board of Directors.  This year I spotted the actress Glenn Close from afar.  Most attendees are long-term Berkshire shareholders and/or are professional investors from all over the world.  It’s a fun, interesting event, but most importantly the Q&A session, in addition to Buffett’s annual letters, are a condensed course in investing and common sense.  Recently Buffett has been criticized, most pointedly by Peter Thiel, a well-known venture capital investor, co-founder of Paypal and founder of firm Palantir, who called Buffett a “sociopathic grandpa” and part of the “finance gerontocracy” for his unsupportive views on bitcoin.  Is Thiel right? Is old-fashioned, long-term investing based on business fundamentals outdated?

The market today has certainly changed from when Berkshire was founded in 1965.  Today, it is characterized by “computers trading against computers”, as Munger puts it, a high concentration of passive assets (ETFs and index funds) and a gambling feel as quick-trading apps, options trading strategies and cryptocurrencies are heavily marketed to consumers.  It’s also true that Buffett and Munger are older – Munger is 98 and Buffett 91.  However, with age comes decades of insight and wisdom, and despite their folksiness and clear language they are highly intelligent, reciting Costco’s member growth or BNSF’s trainloads unprompted.   Most importantly, their investment approach has worked.  Berkshire Hathaway’s compounded annual gain in per-share market value, as reported in their annual letter, is 20.1% from 1965-2021.  The S&P 500’s compounded gain over the same time period, including dividends, is 10.5%^[1].  This has included years with substantial outperformance vs the S&P 500, and years with substantial underperformance. 

While not all investments have been successful, including the initial purchase of a textile mill which gave the conglomerate its name, over the long-term Berkshire Hathaway has been an outstanding investment.  Here are a few highlights of their investment approach:

• Look for high quality businesses with a competitive moat:  One of Buffett’s aphorisms is that a good business is like a castle with a moat around it. Moats can include a great brand, a patent, or being the low-cost provider of a product. Assessing a company’s moat, whether it is widening or shrinking, and how long it will last, is a key component to successful investing.

• Know businesses and what they’re worth, and then patiently wait for your opportunity: Buffett often refers to quickly making a deal, but the casualness of these comments belies how much work goes into assessing the value of a business to enable him to make such a quick deal. A recent example is the acquisition of insurance firm Alleghany over a steak dinner in New York.  While the deal-making can be rapid, Buffett knew the value of a company from decades of reading annual reports and reviewing financial statements and quantitative information. Because of preparation, he can make a rapid decision when given an opportunity to buy for a good price. 

• Assets without cash flow are speculative: Buffett and Munger often refer to farmland or apartments as investments that will produce a stream of cash flows, farmland in the form of crops and apartments in the form of rent. They caution against assets without cash flows and were particularly critical of bitcoin and cryptocurrency (“just say no”). Neither believe that bitcoin is worth anything because it doesn’t produce anything.  Holders rely on a “bigger fool” to be willing to pay more for it than they did. 

• Approach investments from the perspective of a business owner, not a trader: Buffett and Munger’s criticism of the current market environment was striking this year.  Munger likened the markets today to a gambling parlor, commenting that “business ownership is traded like poker chips”.   Buffett and Munger emphasize that when one buys stock, they are buying a piece of a real business, not a piece of paper.  An investor in Nike owns a portion of the profits from selling sneakers, in Microsoft a portion of profits from selling software, etc.

• Focus on the long-term:  Driven by increased trading automation, trading apps, social media’s influence on behavior and shorter company lifespans, the average holding period for stocks in June 2020 was only 5.5 months, down from 8 years in the 1950s.^[2]  An advocate for the long-term buy-and-hold approach to investment, Buffett has said “our favorite holding period is forever”.  It is much more difficult to have investment success if one is attempting to time the market.

• Have humility: Buffett and Munger have an incredible track record, but it isn’t perfect, and they often remind us that they make mistakes.  Buffett said that while they took advantage of sale opportunities during the Global Financial Crisis of 2008-9, they “totally missed March 2020”.  They often say, “we blew it”, “we missed it”, “we’re not that smart”.  An approach assuming one doesn’t know it all, and learning from mistakes, is key to success. 

The investing world has changed considerably over the past several decades. Businesses have also evolved over time, driven by innovation and competition. While the environment has changed, business fundamentals have not.  Companies continue to generate revenues, earn profits and cash flows, and management continues to make decisions about investments, acquisitions, debt load, dividends, and share repurchases.  It is the investor’s job to predict these cash flows, assessing how the business and management team will do over the long-term. Then, the biggest challenge is to remain patient, waiting for an attractive price.  Buffett and Munger’s investment approach is as sound today, in a changed and changing world, as it was in 1965.

The information presented is not intended as an offer or solicitation to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This information should not be relied upon as the sole factor in an investment making decision. Lariat Wealth Management, LLC is not affiliated with any company or fund mentioned in this article. Lariat Wealth Management, LLC is a fee-only investment adviser and as such the firm and its associates does not receive any compensation from any company or fund mentioned in this article.

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[1] https://www.berkshirehathaway.com/letters/letters.html; 2021, p. 3

[2] https://www.visualcapitalist.com/the-decline-of-long-term-investing/, Marcus Lu, December 8, 2021