Everyone Reads but Few Understand the Four Pillars of Buffett
It’s that time of year again.
Not March Madness — that comes a little later. It’s shareholder letter season.
Warren Buffett has issued his annual missive to the owners of his holding company, Berkshire Hathaway (NYSE: BRK-B). On May 1, 35,000 of them will gather in Omaha for what Buffett calls the Woodstock of capitalism, the annual meeting.
But what it really is, I’d say, is the greatest concentration of wealth in the United States at any given time. An arena full of multimillionaires listening to the second-richest man in the world hold court.
Every shareholder at that meeting understands something about investing that, in my view, most people just don’t get. It’s something they have learned, over the years, from the shareholder letter.
It’s this: Michael Corleone was wrong.
You get the reference. You may even remember the famous scene from the movie. The godfather, having been shot, is sick. Michael and Sonny and the capos are discussing what to do about Virgil Solluzzo and the corrupt police Capt. McClusky. Upon hearing Michael’s suggestion, the oldest brother suggests that Michael is letting things get to him.
“Nothing personal,” Michael avers. “It’s strictly business.”
That phrase drew a line that thereafter separated the two things.
It is an absolutely false dichotomy. The lesson of Warren Buffett, what he has taught for years, is that investing is extraordinarily personal. It’s a relationship that requires trust, openness, honesty and intimacy.
Consider the wording I used above.
You probably read over it.
But Buffett would notice it in a second. The word? Owners.
Buffett thinks of himself first, foremost and always, as an owner of businesses. Another word that he uses frequently in the letter is partner. No one — not one single person — does business with Warren Buffett. They have the opportunity to partner with him. The best businessmen in the world, the most successful, have the chance to align their interests with arguably the best businessman of all time — and have him do the same. Buffett is at the top of the organization chart at Berkshire, sure. But that’s paper, and to Buffett business is never about paper but about people — and the extraordinary results that people can deliver. Buffett has written for years — decades — that the money is the easy part. Berkshire always keeps plenty of cash on hand. What he can’t buy, and what he and (Vice Chairman) Charlie Munger can’t supply, is talent. They can’t just reproduce leaders like Ajit Jain, the head of National Indemnity and one of the most knowledgeable insurance minds in the world. Berkshire can’t mint able managers like Tony Neely at Geico or Dave Sokol at MidAmerican Energy.
The question is not which one of those men will be CEO when Buffett dies. (For the record, my money’s on Ajit, but Mr. Sokol, Buffett’s fixer, isn’t a bad bet. More on how to make money from this later.)
The question is what this relationship mindset can do for individual investors.
Answer: It makes them not just smarter but wiser.
Consider a rental car. Travelers are rough on them. We’ve all gunned the engine, dinged a door and taken chances when we drove them. If the car got banged up, who cares? It’s going back to the rental counter regardless.
But think about the car you owned that you loved best. You kept this chariot polished. You pumped premium gas. You knew every feature and maintained every switch in perfect working order. You parked in such a way that it avoided harsh sunlight, grocery carts and even other cars.
The stocks you own — if I had to guess — are rental cars.
But for owners of Berkshire Hathaway, their shares are treated like a favorite car. And the most careful driver in the world is Warren Buffett.
What difference does it make? Over time, this ownership mentality has delivered a +434,057% return versus a total return in the S&P 500 of +5,430%. Buffett correctly points out two things about this number in this year’s letter: First, the gain he touts is in the tangible book value per share, which has averaged +20.3% compounded annually since Buffett took over Berkshire in 1965. Second, had he used the stock price as his yardstick the results would look even better — nearly by a factor of two, in fact. Berkshire has achieved a cumulative gain of an astonishing +801,516%.
Like the proud owner that he is, Buffett continually characterizes Berkshire as underpriced relative to its intrinsic value.
There are four pillars to the Buffett mindset. Investors who embrace them, as most Berkshire Hathaway shareholders do, are miles ahead of the smartest minds on Wall Street.
Honesty. Buffett is relentlessly honest. When he errs, he owns up to it. Sometimes this means taking an action that he’d prefer not to, such as selling ConocoPhilips (NYSE: COP) at a loss. But Buffett was honest. He admitted that he got caught up in the moment and overpaid.
Commitment. Buffett doesn’t do rental cars. He treats every business as his own. When he bought Burlington Northern Santa Fe this year, he said he expected Berkshire would own it for a century. No one doubted him. When Buffett buys, he buys because he is willing to partner for the long haul.
Discipline. Buffett has a list of criteria for the investments he makes. He’s never shared what the precise guidelines are — he has hinted that there was a one-page form he used to have to fill out when he worked for his mentor, Ben Graham — but he’s outlined them generally in every annual report as well as in the Berkshire Hathaway shareholders’ manual.
Ask yourself this: Have you ever heard of a company with a shareholders’ manual? Doesn’t the fact that there is one — and that it has stayed the same for decades — make you want to invest with Buffett? I know it makes me glad I hold shares, as does the fact that Buffett doesn’t adjust the owners’ manual to suit his fancy. He addressed such tactics in this year’s letter: “[Our yardsticks keep] us from the temptation of seeing where the arrow of performance lands and then painting the bull‘s eye around it.” He’s not lying: Buffett has used the same paragraph to open the shareholders letter for at least the past 20 years. Only the numbers have changed. That’s consistency.
Warren Buffett’s greatest talent — in conjunction with this discipline — is his patience. If a deal doesn’t work, he waits until it will, or he does something else.
Communication. Buffett communicates an enormous amount of information to shareholders about Berkshire’s operating units, which are insurance, utilities, other companies owned and investments. He explains, educates and informs. This is on display no place the way it is during the upcoming annual meeting, during which Buffett and Munger answer questions for several hours. Buffett’s understanding of every business unit and his knack for detail are uncanny. He can answer questions longer than most shareholders can listen.
These four pillars are what the shareholder letter is all about. Investors who aspire to these qualities, and demand them from the companies they are owners of, are positioned for success. Investors, in other words, who make it personal.
Now, briefly, let me tell you how to make money on Buffett’s succession, which I hope is years away. Take a sum of money, say $5,000, and put it into an extremely safe investment, one that you can liquidate immediately, and then do what Buffett does: Wait for the opportunity. The opportunity you’re looking for is Buffett’s retirement, upon which I expect Berkshire stock will plummet. That — if you must time the market — is when a trader should buy Berkshire.
If you’re an investor, however — if you’re an owner of businesses like Buffett — then the best time to buy Berkshire Hathaway never changes.
It was yesterday.