Some Lessons From Warren Buffett s Annual Letter
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Insights from Warren Buffett's Annual Letter
Warren Buffett's annual letter to Berkshire Hathaway shareholders was released over the weekend, offering a wealth of investment insights over its 23 pages. As usual, Buffett begins by outlining the change in Berkshire's per-share book value:
"Our gain in net worth during 2005 was $5.6 billion, increasing the per-share book value of both our Class A and Class B stock by 6.4%. Over the last 41 years, this value has grown from $19 to $59,377, a rate of 21.5% compounded annually."
Many might wonder why Buffett emphasizes the change in per-share book value over earnings per share (EPS). Over time, per-share book value better reflects returns to shareholders. While net income is important, it’s a subset of comprehensive income, which provides a fuller picture of wealth creation.
Comprehensive income, often overlooked, reflects total financial performance, including non-operating earnings like changes in market value. Reporting it prominently, as some companies do, offers a more accurate measure of wealth creation.
For Berkshire, the gain in net worth closely aligns with comprehensive income, underscoring its importance. While neither net income nor comprehensive income fully captures an owner's true economic performance, they are crucial in evaluating a company's growth and competitive position.
Buffett emphasizes the importance of competitive positioning:
"Every day, our businesses grow stronger or weaker. Delighting customers, cutting costs, and improving products enhance our strength. But indifference can lead to decline."
Investors must look beyond financial statements and assess qualitative factors affecting a business's long-term viability. Even if a company incurs losses, it might still be strengthening its competitive edge, anticipating greater future gains.
All costs reflect opportunity costs, a key consideration for Buffett. Historical losses at Berkshire's units weighed heavily due to the high opportunity costs of foregone returns.
Importantly, a business operating at a loss can still add value by enhancing intangible assets. For instance, significant investments in brand and market share at GEICO have yielded substantial returns:
"GEICO's market share grew from 5.6% to 6.1%, equating to $1.6 billion in sales per share-point increase. Our advertising budget rose from $31 million to $502 million since 1996, and I’m eager to spend more."
Such strategies are also evident in other businesses like PetMed Express, where increased advertising can boost sales in fragmented markets, emphasizing brand recognition and customer retention.
Buffett concludes with a powerful lesson:
"Sir Isaac Newton's genius gave us three laws of motion but not investment acumen; he lost heavily in the South Sea Bubble. If not traumatized, he might've discovered a Fourth Law: For investors, returns decrease as motion increases."
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