Warren Buffet's Letter to Investors(berkshirehathaway.com)
berkshirehathaway.com
Warren Buffet's Letter to Investors
http://www.berkshirehathaway.com/letters/2008ltr.pdf
13 comments
A counter to #4:
The point that I, and so many like me, keep coming back to is... Every man, woman, child and dog has a credit card now; a large percentage of people are carrying unbearable amounts of debt. In the past, America was a creditor nation; today, Hilary Clinton goes quietly begging in China while Obama gets on TV and tries to act as though we're so much better than China - "Can you believe that they're beating us at cleantech! Impossible!" (Disclaimer: I voted for him, and attended one of his fundraisers.)
I'm not saying this because I want to be some doomsayer fuddy-duddy. I'm saying this because I like the people in this community we have here at HN, and I want to make sure people understand what we're looking at here -- years of economic contraction. You can't spend your way out of a de-leveraging economy, and it is quite dangerous to borrow money and theoretically finance "stimulus" from tax revenues dependent on future rich people who may or many not exist (see: California's economic disaster, wherein they thought the golden era of dotcom millionaires would continue ad infinitum).
Thankfully, the online software industry seems to have made some enormous gains in efficiency/automation, and you can now operate enterprise-grade services at extremely low cost. This will allow many of us here to thrive, even in this contracting environment (i.e., I may have 1/3rd the customers I would in 1999, but I'm spending 5% of the money it would have cost to service them). We are in a unique and special place; unfortunately, however, the rest of the economy is in for continual hurt.
Also, there are some very smart people questioning whether the golden era of equities is over. What this means is -- yeah, equities had a great run for 60 years, but what if that doesn't actually mean anything? What if the past and the future are completely disconnected? In a world in which young innovators such as ourselves can operate at such low cost, and when Sarbanes Oxley and friends lead most smart people who value their sanity to avoid the public markets, this could certainly be the case. Most equities these days are held by institutional investors, who I can tell you from personal experience tend to be quite moronic (i.e., I begged the top shareholders in Motorola to make some activist moves against the crony executive/board structure there, but they did absolutely nothing - even while watching their equity value dip by 50% or more). A democracy - whether involving citizens or shareholders - only works when people are smart enough to know what to do; if we can learn anything from the idiocy of the past several years, it is that the shareholder democracy is utterly broken, because they were the ones who kept voting in corrupt boards and awarding retarded salaries. Anyone staking their future/kids' futures/etc on these people is a fool whose money will be soon taken from him/her.
If I sound slightly pissed at the state of American business/political society today, well... :)
The point that I, and so many like me, keep coming back to is... Every man, woman, child and dog has a credit card now; a large percentage of people are carrying unbearable amounts of debt. In the past, America was a creditor nation; today, Hilary Clinton goes quietly begging in China while Obama gets on TV and tries to act as though we're so much better than China - "Can you believe that they're beating us at cleantech! Impossible!" (Disclaimer: I voted for him, and attended one of his fundraisers.)
I'm not saying this because I want to be some doomsayer fuddy-duddy. I'm saying this because I like the people in this community we have here at HN, and I want to make sure people understand what we're looking at here -- years of economic contraction. You can't spend your way out of a de-leveraging economy, and it is quite dangerous to borrow money and theoretically finance "stimulus" from tax revenues dependent on future rich people who may or many not exist (see: California's economic disaster, wherein they thought the golden era of dotcom millionaires would continue ad infinitum).
Thankfully, the online software industry seems to have made some enormous gains in efficiency/automation, and you can now operate enterprise-grade services at extremely low cost. This will allow many of us here to thrive, even in this contracting environment (i.e., I may have 1/3rd the customers I would in 1999, but I'm spending 5% of the money it would have cost to service them). We are in a unique and special place; unfortunately, however, the rest of the economy is in for continual hurt.
Also, there are some very smart people questioning whether the golden era of equities is over. What this means is -- yeah, equities had a great run for 60 years, but what if that doesn't actually mean anything? What if the past and the future are completely disconnected? In a world in which young innovators such as ourselves can operate at such low cost, and when Sarbanes Oxley and friends lead most smart people who value their sanity to avoid the public markets, this could certainly be the case. Most equities these days are held by institutional investors, who I can tell you from personal experience tend to be quite moronic (i.e., I begged the top shareholders in Motorola to make some activist moves against the crony executive/board structure there, but they did absolutely nothing - even while watching their equity value dip by 50% or more). A democracy - whether involving citizens or shareholders - only works when people are smart enough to know what to do; if we can learn anything from the idiocy of the past several years, it is that the shareholder democracy is utterly broken, because they were the ones who kept voting in corrupt boards and awarding retarded salaries. Anyone staking their future/kids' futures/etc on these people is a fool whose money will be soon taken from him/her.
If I sound slightly pissed at the state of American business/political society today, well... :)
"Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it
sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier.
Beware the investment activity that produces applause; the great moves are usually greeted by yawns."
Also, surprising to me that this landed in his shareholder's letter:
Indeed, recent events demonstrate that certain big-name CEOs (or former CEOs) at major financial institutions were simply incapable of managing a business with a huge, complex book of derivatives. Include Charlie and me in this hapless group: When Berkshire purchased General Re in 1998, we knew we could not get our minds around its book of 23,218 derivatives contracts, made with 884 counterparties (many of which we had never heard of). So we decided to close up shop. Though we were under no pressure and were operating in benign markets as we exited, it took us five years and more than $400 million in losses to largely complete the task. Upon leaving, our feelings about the business mirrored a line in a country song: “I liked you better before I got to know you so well.”
Imagine how Citibank would have worded the same sentiment in its shareholder letter.
Also, surprising to me that this landed in his shareholder's letter:
Indeed, recent events demonstrate that certain big-name CEOs (or former CEOs) at major financial institutions were simply incapable of managing a business with a huge, complex book of derivatives. Include Charlie and me in this hapless group: When Berkshire purchased General Re in 1998, we knew we could not get our minds around its book of 23,218 derivatives contracts, made with 884 counterparties (many of which we had never heard of). So we decided to close up shop. Though we were under no pressure and were operating in benign markets as we exited, it took us five years and more than $400 million in losses to largely complete the task. Upon leaving, our feelings about the business mirrored a line in a country song: “I liked you better before I got to know you so well.”
Imagine how Citibank would have worded the same sentiment in its shareholder letter.
Starting on page 17, Buffet discusses the failures of Freddie and Fannie and their oversight committee, the OFHEO. It's a fascinating read.
This particular caption is my favorite on derivatives:
"Improved “transparency” – a favorite remedy of politicians, commentators and financial regulators for averting future train wrecks – won’t cure the problems that derivatives pose. I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives. Auditors can’t audit these contracts, and regulators can’t regulate them. When I read the pages of “disclosure” in 10-Ks of companies that are entangled with these instruments, all I end up knowing is that I don’t know what is going on in their portfolios (and then I reach for some aspirin)."
I also find it hilarious that he ends by trying to sell his shareholders auto insurance at their annual meeting next month:
"GEICO will have a booth staffed by a number of its top counselors from around the country, all of them ready to supply you with auto insurance quotes. In most cases, GEICO will be able to give you a shareholder discount (usually 8%). This special offer is permitted by 44 of the 50 jurisdictions in which we operate. (One supplemental point: The discount is not additive if you qualify for another, such as that given certain groups.) Bring the details of your existing insurance and check out whether we can save you money. For at least 50% of you, I believe we can."
This particular caption is my favorite on derivatives:
"Improved “transparency” – a favorite remedy of politicians, commentators and financial regulators for averting future train wrecks – won’t cure the problems that derivatives pose. I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives. Auditors can’t audit these contracts, and regulators can’t regulate them. When I read the pages of “disclosure” in 10-Ks of companies that are entangled with these instruments, all I end up knowing is that I don’t know what is going on in their portfolios (and then I reach for some aspirin)."
I also find it hilarious that he ends by trying to sell his shareholders auto insurance at their annual meeting next month:
"GEICO will have a booth staffed by a number of its top counselors from around the country, all of them ready to supply you with auto insurance quotes. In most cases, GEICO will be able to give you a shareholder discount (usually 8%). This special offer is permitted by 44 of the 50 jurisdictions in which we operate. (One supplemental point: The discount is not additive if you qualify for another, such as that given certain groups.) Bring the details of your existing insurance and check out whether we can save you money. For at least 50% of you, I believe we can."
The annual meeting is one huge sales event for Berkshire companies. For good reason: 25,000 mostly wealthy people (investors and their guests) are there. Borsheim's sells millions of dollars of jewelry, people sign up for NetJets, the Nebraska Furniture Mart has its best day of the year, etc. And up on the stage during the meeting, Buffett conspicuously eats See's Candies and drinks Coca-Cola.
BTW, if anyone else is going to the meeting this year, email me (in my profile). I'm considering it. I've gone for the last three years and enjoyed it a lot.
BTW, if anyone else is going to the meeting this year, email me (in my profile). I'm considering it. I've gone for the last three years and enjoyed it a lot.
"Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our
cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the
moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one."
Nicely stated. Interesting how the American government's dramatic intrusions into the credit market have inverted pre-existing systemic signals.
Nicely stated. Interesting how the American government's dramatic intrusions into the credit market have inverted pre-existing systemic signals.
I've never seen this discussed before:
Buffett thinks the Black-Scholes formula produces "absurd results" when applied to long-dated options (see page 19).
"Though historical volatility is a useful – but far from foolproof – concept in valuing short-term options, its utility diminishes rapidly as the duration of the option lengthens."
Berkshire Hathaway has sold equity put options that require payment if various stock market indexes (S&P 500, the FTSE 100, the Euro Stoxx 50, and the Nikkei 225) have gone down after 15 or 20 years from the inception of the contracts.
Buffett think that the likelihood of these indexes going down over such an extended period is extremely unlikely, due to inflation and an increase in corporate retained earnings. But, even if the indexes do decline, he has already received the option premium up front and is able to invest that money for 15-20 years, before having to pay out anything.
"Clearly, either my assumptions are crazy or the formula is inappropriate."
Buffett thinks the Black-Scholes formula produces "absurd results" when applied to long-dated options (see page 19).
"Though historical volatility is a useful – but far from foolproof – concept in valuing short-term options, its utility diminishes rapidly as the duration of the option lengthens."
Berkshire Hathaway has sold equity put options that require payment if various stock market indexes (S&P 500, the FTSE 100, the Euro Stoxx 50, and the Nikkei 225) have gone down after 15 or 20 years from the inception of the contracts.
Buffett think that the likelihood of these indexes going down over such an extended period is extremely unlikely, due to inflation and an increase in corporate retained earnings. But, even if the indexes do decline, he has already received the option premium up front and is able to invest that money for 15-20 years, before having to pay out anything.
"Clearly, either my assumptions are crazy or the formula is inappropriate."
Here, in one sentence fragment, is why Buffet is a better investor than any of us: "the U.S. Treasury bond bubble of late 2008"
(He is arguing that the flight-to-safety is causing assets which are riskier than T-bills to be grievously underpriced relative to their true values. Accordingly, he is buying.)
(He is arguing that the flight-to-safety is causing assets which are riskier than T-bills to be grievously underpriced relative to their true values. Accordingly, he is buying.)
What I found entertaining and a big lesson is how on page 8, he asks his readers to call Geico and find out how you can save money on car insurance.
"Our advice: Beware of geeks bearing formulas."
WB is never one for tech companies.
Thats because he never invests in anything that he doesn't understand. He wants to fully understand how they make money. That is great investment advice, too.
Summary:
1) 2008 sucked badly, and so will 2009
2) Even Buffett makes mistakes. Last year he made moves that lost his company billions of dollars. One bank stock he bought lost 90% of its value.
3) The Government has taken actions that will have many negative consequences, but swift action was necessary to avoid a giant collapse.
4) Even though the near future looks gloomy, America has been through worse. We've been involved in World Wars, had great recessions and depressions, and have emerged stronger.
5) 75% of the last 44 years have had positive gains in the S&P 500. He thinks the next 40 years will be similar, but we will have some rough years. Don't be an idiot and try to go all-in catching falling knives or timing the bottom, average in your investments slowly, buy things you can afford, work hard, invest in well-run businesses, and you'll be aiight.