My goal for 2022 is to read one Warren Buffett letter to shareholders every week, spanning from 1977 to 2021. As I begin my investing career, Buffett’s letters are a no-brainer place to start in helping shape my investment philosophy.
While there are plenty of summaries and tweet threads regarding Buffett’s letters, nothing compares to reading the original material. Reading the letters myself and highlighting what I’ve learned will make the material mine and help commit to memory what I want to retain. Hopefully you’ll find something of value in reading my highlights, and more importantly, that it spurs you to read some of Buffett’s letters yourself. So, let’s go.
1977 Annual Letter
Framework for purchasing equity in a company
We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very [my emphasis] attractive price. We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price.
I love this simple framework, although for it to be useful, requires some unpacking and defining.
First, for me, a business I can understand means I grasp the consumer value proposition. In other words, why are customers hiring this company for its services? What problem are they solving? In the case of Coca-Cola, it’s because people love sugary, refreshing drinks. In the case of Olo, it’s because restaurants need a way to take orders online and deliver food without being disintermediated by 3P marketplaces.
Second, favorable long-term prospects to me means that the problem a company is solving will continue to exist for the foreseeable future, and that this company is best positioned (competitively advantaged) to continue solving said problem.
Third, how do I judge whether someone is honest or competent? Chances are I won’t be able to talk to the CEO or CFO before investing in a given company, so I have do what I can, including listening to podcast interviews, and more importantly, see if their actions and company performance aligns with what they say. Ultimately, the ability to judge management’s character will take time for me to build.
Fourth, I noticed that Buffett didn’t say “available at an attractive price,” but rather, “available at a very attractive price.” This sets a high bar for investing in any company, especially in today’s environment, and necessitates that truly good opportunities are rare. My tendency is to squint on valuation and buy a stock because “I might not get a chance lower.” This is erroneous, and Buffett’s words of patience are wise. Taking a step back, however, the challenging part of this mandate is to determine what I think is a very attractive price, while not letting stock price action influence my thinking. In the end, feeling comfortable with the price I buy something at is where true conviction (referenced below) has a foundation.
Having a long-term mindset
Most of our large stock positions are going to be held for many years and the scorecard on our investment decisions will be provided by business results over that period, and not by prices on any given day. Just as it would be foolish to focus unduly on short-term prospects when acquiring an entire company, we think it equally unsound to become mesmerized by prospective near term earnings or recent trends in earnings when purchasing small pieces of a company; i.e., marketable common stocks.
Incredibly relevant for today’s market, in which we’re all glued to daily upticks and downticks of our portfolio. While Buffett’s approach seems simple on paper, I’ve realized that a necessary prerequisite of such an approach, and the only way to sleep well at night, is to have conviction in the quality of the business and the price at which I buy it. If conviction is lacking, there may be good reason why I’m hyper-attuned to the daily price actions of a business.
Regarding the insurance business
It is comforting to be in a business where some mistakes can be made and yet a quite satisfactory overall performance can be achieved. In a sense, this is the opposite case from our textile business where even very good management probably can average only modest results. One of the lessons your management has learned - and, unfortunately, sometimes re-learned - is the importance of being in businesses where tailwinds prevail rather than headwinds.
This touches on the idea of margin of safety → where can I invest my money so that even if the industry or overall market faces headwinds, my investment will perform adequately? Things I would consider in this bucket include companies with pricing power or staples goods that are resilient in downturns. Tesla is probably an example of this in 2020-21, during which the broader auto industry faced headwinds related to chip shortages, but Tesla’s growth accelerated (possibly from the power of the EV secular trend, or the quality of its products, I’m not sure).
Not chasing unprofitable growth (as it relates to insurance underwriting)
As markets loosen and rates become inadequate, we again will face the challenge of philosophically accepting reduced volume. Unusual managerial discipline will be required, as it runs counter to normal institutional behavior to let the other fellow take away business - even at foolish prices.
This is a great quote that captures the importance of disciplined management teams that prioritize for durable growth rather than easy, unprofitable growth. This scenario is especially pertinent to the dynamic that played out between Zillow and Opendoor in 2021, in which we saw Zillow pursue break-neck growth that proved to be a fool’s errand. While Zillow’s complete exit from iBuying was near-impossible to foresee, there were signs they were overpaying for homes to gain market share.
On owner earnings
Such investments initially may have negligible impact on our operating earnings. For example, we invested $10.9 million in Capital Cities Communications during 1977. Earnings attributable to the shares we purchased totaled about $1.3 million last year. But only the cash dividend, which currently provides $40,000 annually, is reflected in our operating earnings figure.
This is the first of what I expect to be many references to owner’s earnings. Buffett correctly points out that the underlying value of a business is not simply the cash it returns to shareholders in the form of dividends, but also “the ability” to pay more dividends in the future by retaining cash and reinvesting it in the business.
The last quote that stood out to me is more of a fun tidbit about Buffett than an investing insight
A few shareholders have questioned the wisdom of remaining in the textile business which, over the longer term, is unlikely to produce returns on capital comparable to those available in many other businesses. Our reasons are several: (1) Our mills in both New Bedford and Manchester are among the largest employers in each town, utilizing a labor force of high average age possessing relatively non-transferable skills...
Buffett showing that he’s not only about profit seemed like an optimistic note to end on, and a reminder that business at the end of the day is not just about profits, but also people.