Warren Buffett (Trades, Portfolio) published his annual letter to shareholders on the final Saturday of February. This year's letter is especially highly anticipated because Buffett's long-term partner, Charlie Munger, passed away in November of last year. Investors around the globe all wanted to read the guru's tribute to Munger as well as his view of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) in the post-Munger era. He did not disappoint. After printing it out and reading it multiple times, I have to say this year's letter is the best he has written in the past decade. In this discussion, I will share the notes I took from the letter.
Remembering Charlie Munger
Buffett devoted a whole page remembering Munger. For long-term Berkshire shareholders, what Buffett wrote about Munger should not be anything new. What surprises me, though, is that the guru characterizes his relationship with Munger as “part older brother, part loving father.” I've always felt that Munger acted like an older brother for Buffett, but I never could have imagined that he would view the legend as a fatherly figure because he was only seven years older than Buffett. Also, Buffett has publicly said many times that admired his father and viewed him as his hero. Comparing Munger to his father is truly extraordinary; it reveals a lot about Munger's character and his relationship with the Oracle of Omaha. I was very moved by Buffett's words.
The importance of trust
Although Buffett and Munger repeatedly stressed the importance of a “seamless web of deserved trust,” only in recent years have I started to appreciate the power of this statement, not only in investing, but in life.
As Buffett pointed out, “Berkshire has more than three million shareholder accounts.” Granted, a portion of the shareholders are not “lifetime” shareholders. But regardless of the holding period, by and large, shareholders have put their trust in Buffett and Munger. The difference is the level of trust. Some shareholders are lifetime no-questions-asked trustors, some are in-and-out some-questions-asked trustors. This difference in the level of trust resulted in different investment results. Those “lifetime” trustors can just sit and enjoy the compounding effortlessly, such as Buffett's sister Bertie. Over the years, I am fortunate enough to have met some of the “lifetime” trustors, they are all very wise, rich and happy.
This approach is applicable in our own investing and in life as well. In investing, if we can identify great businesses with trustworthy managers, then all we need to do is to buy at reasonable price and hold it for a long period of time. In life, if we can align ourselves with trustworthy people and deserve the trust from them, we will lead a simple and happy life.
Irrational market
With regards to Mr. Market, Buffett wrote the following in the letter:
“Berkshire's ability to immediately respond to market seizures with both huge sums and certainty of performance may offer us an occasional large-scale opportunity. Though the stock market is massively larger than it was in our early years, today's active participants are neither more emotionally stable nor better taught than when I was in school. For whatever reasons, markets now exhibit far more casino-like behavior than they did when I was young. The casino now resides in many homes and daily tempts the occupants.”
There are two takeaways from this short paragraph. First, Buffett emphasized that “today's active participants are neither more emotionally stable nor better taught than he was in school.” He didn't mention passive participants, which account for a much bigger share of total trading volume nowadays. Secondly, Buffett seems to suggest Mr. Market is more irrational now than he was when the guru was young.
I agree with Buffett's observation, especially since the onset of Covid-19. For instance, the U.S. stock market circuit breaker was triggered four times in 10 days in March of 2020. Prior to 2020, the U.S. stock market circuit breaker was triggered only once in 1997 during the Asian Financial Crisis. The GameStop (GME, Financial) mania in January of 2021 is another example of the “casino-like behavior” Buffett mentioned in the letter. There's no doubt the U.S. stock market, especially the Nasdaq Index, has displayed “irrational exuberance” during the past several years.
Here is Buffett's way to cope with the current situation:
“...holds a cash and U.S. Treasury bill position far in excess of what conventional wisdom deems necessary. During the 2008 panic, Berkshire generated cash from operations and did not rely in any manner on commercial paper, bank lines or debt markets. We did not predict the time of an economic paralysis but we were always prepared for one.”
This is exactly what Berkshire Hathaway's shareholders expect Buffett to do.
Permanent holding list
In this year's letter, Buffett again wrote about Coca-Cola (KO, Financial) and American Express (AXP, Financial) and expressed Berkshire's intent to hold them indefinitely. However, he admitted that both companies are not huge commitments. In my view, American Express and Coke are more like Berkshire's operating businesses now as Buffett emphasized the importance of both companies' ability to increase dividends in the future. Berkshire can then reallocate these dividends somewhere else.
Interestingly, Buffett also revealed two investments that Berkshire expects to hold indefinitely – Occidental Petroleum(OXY, Financial) and the five Japanese conglomerates. What's noteworthy is that Apple (AAPL, Financial) is missing from the permanent holding list. Buffett also explained the reasons why Berkshire intends to hold Occidental and the five Japanese companies indefinitely. For the energy giant, he said he likes its “vast oil and gas holdings in the U.S. as well as its leadership in carbon-capture initiatives.”
In regard to the Japanese conglomerates, Buffett explained that there are five reasons why he bought them:
"Each operates in a highly-diversified manner somewhat similar to the way Berkshire itself is run."
"In certain important ways, all five companies – Itochu, Marubeni, Mitsubishi, Mitsui and Sumitomo – follow shareholder-friendly policies that are much superior to those customarily practiced in the U.S."
"The managements of all five companies have been far less aggressive about their own compensation than is typical in the United States."
"An additional benefit for Berkshire is the possibility that our investment may lead to opportunities for us to partner around the world with five large, well-managed and well-respected companies. Their interests are far more broad than ours."
"An extended period of 'friendly' prices."
Two big mistakes
Buffett admitted that he was wrong in his expectations for both BNSF and BHE. Given BNSF and BHE accounted for roughly 20% of Berkshire's operating income, the guru's mistake is quite costly.
With BNSF, Buffett underestimated maintenance capital expenditures and wage increases for railroads workers. Buffett insinuated that the president and congress should be partially blamed for BNSF's struggles since Berkshire's purchase.
With BHE, “the change in regulatory climate in a few states” basically changed the business model of the electric utility business. On top of the more adverse regulatory environment, "climate change adds to BHE's woes." For instance, costs related to forest fires have increased because "the frequency and intensity of forest fires have increased." Given the two ominous negative developments, Buffett wrote the following:
“When the dust settles, America's power needs and the consequent capital expenditure will be staggering. I did not anticipate or even consider the adverse developments in regulatory returns and, along with Berkshire's two partners at BHE, I made a costly mistake in not doing so.”
What surprises me is Buffett did not even consider the regulatory risk with BHE. It is one thing to underestimate the risk, it is another thing to fail to consider it at all. Buffett knows the utilities business very well. He certainly understands regulation. He knows a lot about insurance. His failure in recognizing the regulatory risk and his underestimation of the forest fire insurance risk with BHE reminds us that in investing, no one is infallible, not even the greatest investor of all time.
Conclusion
Buffett's superbly written 2023 letter to shareholder is a joy to read. At age 93, he is still learning new things and relentlessly honing his investment skills. This is what makes investing fun and enjoyable. Thank you, Mr. Buffett!
