Warren Buffet’s Annual Letter

On Friday, Warren Buffet released his annual ‘Letter to Shareholders‘. Given that the man has returned 21% per annum since 1965 (versus a 10% gain for the S&P), it is worth a read. He makes a number of observations, some that will bring a smile to readers of this blog,

i) On the government – ‘We made one large sale last year.  In 2002 and 2003 Berkshire bought 1.3% of PetroChina for $488 million, a price that valued the entire business at about $37 billion.  Charlie and I then felt that the company was worth about $100 billion. In the second half of last year, the market value of the company rose to $275 billion..so we sold our holdings for $4 billion.  A footnote: We paid the IRS tax of $1.2 billion on our PetroChina gain.  This sum paid all costs of the U.S. government – defense, social security, you name it – for about four hours.’

ii)  On the US Dollar – ‘The U.S. dollar weakened further in 2007 against major currencies, and it’s no mystery why: Americans like buying products made elsewhere more than the rest of the world likes buying products made in the U.S.  Inevitably, that causes America to ship about $2 billion of IOUs and assets daily to the rest of the world.’

iii) On Sovereign Wealth funds –  ‘There’s been much talk recently of sovereign wealth funds and how they are buying large pieces of American businesses.  This is our doing, not some nefarious plot by foreign governments.  Our trade equation guarantees massive foreign investment in the U.S.  When we force-feed $2 billion daily to the rest of the world, they must invest in something here. Why should we complain when they choose stocks over bonds.”

iv) On Free Trade – ‘In developing a sensible trade policy, the U.S. should not single out countries to punish or industries to protect.  Nor should we take actions likely to evoke retaliatory behavior that will reduce America’s exports, true trade that benefits both our country and the rest of the world.’ Go read the rest. Especially the Mitt Romney joke.

11 thoughts on “Warren Buffet’s Annual Letter

  1. Given that the man has returned 21% per annum since 1965 (versus a 10% gain for the S&P), it is worth a read.

    I thought you told me a while ago that Buffet beat the index using luck. You had a rather good analogy about a football stadium in which everybody had to toss a coin and those that tossed a tail had to sit down. Eventually after repeating the process many times there is one guy standing who has a track record of always tossing heads. However he isn’t better at tossing heads he just got lucky. If Buffet is successful merely because of luck why would we care what he writes? Just wondering.

  2. Terje, if markets are efficient and follow a random walk then we should be able to compute the probability that Buffet just got lucky.

    I’ve not done the calculation but my guesstimate is that the probability of one company consistently outperforming the index for 43 years through sheer luck is vanishingly small.

  3. Terje

    I thought i also told you that i knew of two exceptions. The first is Mr. Buffett ( it would indeed be interesting to determine the probability of beating the Index by 11% a year for 40 odd years) and the second is a guy called Alan Howard of Brevan Howard (http://www.brevanhoward.com).

  4. Buffet is for the msot part not a gambler so your analogy is shot.

    He gets more information than other people. His methods are mind-numbingly boring. He looks for high dividend yields and low price to NTA ratios, low corporate debt, low WACC and good EVA. He buys firms like state government employee life insurance and underwear makers. He also knows some of the top management very well, so knew when to buy GE and Coca Cola. He buys and holds and alot of his alpha is from drividend reinvestment.

    A chief coin flipper he is not.

  5. Mark

    If there was a simple and boring formula for beating the market, everyone would practice it. Those that didn’t would get quickly wiped out. Just because he isn’t a gambler has nothing to do with his unique ability to consistently beat the market.

  6. He beats the market because he has always invested in necessitys where the industry will expand as long as people breed, nearly regardless of personal tastes, like Gillette (shaving). It is very boring and low risk but he does it well and gets high returns.

  7. In his letter, he describes his methodology as finding companies that have impenetrable moats preventing ‘the destructive forces of capitalism’ from eroding their margins. This is achieved either by having
    a) powerful brands like Gillette or Coca Cola (once Coles stopped selling Coca Cola in a dispute about retailer margins. So powerful is Coke that people actually stopped shopping at Coles. They had to reinstal the Coke on the latter’s terms).

    b) being the lowest cost producer, like GEICO or WalMart.

  8. Terje – getting the calculations right would take some time since you’d have to take into account the distribution of returns in a market which is not trivial.

    As a VERY, VERY simplified example, lets just model it as a coin toss. Heads is beating the market, tails underperforming it. Looking at the shareholders letter, Buffet outperformed it 37 times / 43.

    So in our simple model it’s equivalent to someone tossing heads at least 37 times / 43. The probability of this is about 1 in a million.

    Factor in the margin by which he beat the market and we’ll be talking probabilities of one in a billion and more likely a trillion.

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