Warren Buffett (Trades, Portfolio) is arguably the greatest investor of all time and is a fount of knowledge, wisdom and wit. He has grown Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) from a struggling textile business to one of the largest companies in the world with a $670 billion market capitalization as of this writing through his battle-tested value investing and capital allocation strategy.
On Feb. 25, Buffett released his widely anticipated shareholder letter for the year of 2022. In this report, he outlines stock returns, Berkshire business highlights, and surprisingly, a whole treasure trove of wisdom related to his business partner and friend Charlie Munger (Trades, Portfolio). Here are my key takeaways and thoughts on the letter.
Performance was low, but still market-beating
Buffett is known for his genius ability to “beat the market” consistently since 1965. His overall compounded annual gain between 1965-2022 has been a staggering 19.8%, which is double the 9.9% annual return generated by the S&P 500.
This means a $10 dollar investment into Berkshire in 1965 would be worth ~$373,000 by the end of 2022. A $100 investment would be worth a staggering $3.7 million.
Despite the 19.8% average annual return, not every year has been easy for Buffett. For example, in 2022, Berkshire Hathaway generated a share price return of just 4%. This may seem terrible at first glance. However, when we compare it to the S&P 500, which generated an eye-watering loss of 18.1%, we can see that Buffett still “beat the market."
Thus, the quality of a great investor is not just how much they can generate during good times, but how much they can avoid losing in bad times. In this case, Berkshire has a tendency to outperform the market during the good times and not fall as much during the bad times. You can see more details on the image below from the 2022 shareholder letter; I have highlighted the 2022 year in red and some “market-beating” Berkshire years in green.
Battle-tested investment strategy
Buffett reiterates his battle-tested value investing strategy and philosophy. His goal has been to make “meaningful investments” into businesses with “long-lasting favorable economic characteristics” and “trustworthy managers.”
Buffett clarifies that he and Munger are “not stock pickers” but “business pickers." This is an irony given Buffett is often known as the greatest stock picker of all time. However, ever since he read the investment book "The Intelligent Investor" written by his mentor Benjamin Graham, Buffett adopted a business owner mentality to buying stocks, which he believes helped him to be successful.
In order to identify the right time to time to invest, Buffett looks for opportunities to buy and sell when prices are foolish” at either a major low or a major high. Thus it becomes “easy” to buy “wonderful businesses at wonderful prices."
Traditional financial theory believes that markets are efficient, in that all known information is reflected at any one time. However, Buffett believes “efficient markets only exist in textbooks” and emotional irrationality is an inherent part of the human condition.
Everyone makes mistakes
Investing is a challenging game, and even the great Buffett admits to making “many mistakes," as some of the businesses he invested in died as their products were “unwanted by the public." An example which comes to mind for me is Blue Chip Stamps, which he first bought during the 1970s before its business model was disrupted. In fact, the Berkshire Hathaway textile mill was a poor business with low returns on capital, and Buffett had to figure out out to create a good business out of that failing one.
Buffett says he believes capitalism has “two sides." One side creates “improved goods and services" through a natural selection style competition process. However, on the other side, there is an “ever-growing pile of losers." Quoting Schumpeter, this is “creative destruction."
It only takes a few winners
The positive with investing is you don’t need to win every bet. In fact, Buffett believes he has only invested in a “few enterprises” with “truly extraordinary economics."
A prime example is Coca-Cola (KO, Financial), which Berkshire only completed its seven-year purchase of back in 1994. For all 400 million shares, I estimate the total cost was approximately $1.3 billion. However, in 2022, the dividend alone had grown to a staggering $704 million, from just $75 million in 1994.
American Express (AXP) was also a similar story. Berkshire completed its most recent purchase of American Express in 1995. Now in 2022, the annual dividend of this position equates to a staggering $302 million, up from just $41 million in 1995.
These solid dividend results are also not taking into account the stock price increases. As of this writing, the firm's investment in Coca-Cola was valued at a staggering $25 billion and its American Express position at a substantial $22 billion.
The lesson for investors is simple: “The weeds wither away in significance as the flowers bloom." It only takes “just a few winners to work wonders" Of course, it helps if you live into your 90s, as Buffett wittly remarks.
Operating earnings, not GAAP earnings
Buffett briefly discusses Berkshire Hathaway’s operating earnings, which he believes is a much better measure of Berkshire Hathaway’s health than GAAP earnings.
Buffett believes its GAAP earnings are “100% misleading” when viewed quarterly or even annually, as after a change to GAAP accounting rules, unrealized stock market gains and losses must be included as a part of GAAP earnings. For example, Berkshire reported an eye watering GAAP loss of $43.8 billion in the second quarter of 2022 thanks to the bear market, whereas its operating earnings were actually $9.3 billion.
Insurance expansion
One major unique part of Berkshire Hathaway’s business model is its vast insurance operations, which give the company a large “float” of funds to invest. Thus, Berkshire effectively has an extremely low cost of capital. Since purchasing its first property casualty insurer in 1967, Berkshire has increased its insurance float by ~8,000-fold through a variety of acquisitions.
Recently Berkshire further bolstered its insurance portfolio through the purchase of Alleghany Corporation, which was completed in the fourth quarter of 2022 at an $11.6 billion cost. Buffett believes this acquisition adds “special value” as its insurance subsidiaries can be effectively backed by the largest insurance giant on the world, which is not an advantage its competitors have.
Importance of keeping dry powder
Berkshire Hathaway and Buffett have often been criticized as holding “too much cash." As of the third quarter of 2022, the company had a staggering $108.96 billion in cash and short-term investments.
Buffett believes Berkshire will always hold a “boatload of cash” in order to take advantage of opportunities, “financial panics” and to cover black swan-driven insurance losses.
Nothing beats having a great partner
Buffett heavily praises his business partner and good friend Munger, while also reciting some of his favorite quotes which were apparently lifted from an "investing podcast." Here are just a few of the “Mungerisms” that Buffett shared in the shareholder letter:
“The World is full of foolish gamblers and they will not do as well as the patient investor.”
"You don’t, however, need to own a lot of things in order to get rich."
"If you don’t care whether you are rational or not, you won’t work on it. Then you will stay irrational and get lousy results."
"You have to keep learning if you want to become a great investor. When the world changes, you must change."
Final thoughts
Warren Buffett (Trades, Portfolio) is a tremendous individual who at 92 years old age still continues to “tap dance to work” and enjoy the game of investing. It is not an easy road to success, but luckily for us, we have the great Buffett and also Munger as our guides on the best practices for investing and living a happy, fulfilled life.
