Introduction

I always wondered what goes on inside the minds of Warren Buffet and Charley Mungley. Numerous books have been written but the real insights are from the annual letter to Berkshire Hathaway shareholders.

Most annual letters are just dry financial reports, but Berkshire Letters is a treasure trove of insights, where Buffet shares his ideas, and thought process, providing you with an understanding of this business philosophy. Forget taking any masterclass in business, just take time to read his letters and you will learn way more than most can teach you.

In 2017, I spent close to a year, reading every annual shareholder letter since 1965. His letters provided me with nuggets across all aspects related to running your business and investment. I took notes on my learnings across multiple letters into different categories.

Everyone draws different conclusions reading the same material, so do read them at your convenience

Investment Lessons

1. Invest only if the company meets the following criteria:

   • Favourable economic scenario - more tailwinds than headwinds expected
   • Competent and honest management
   • Attractive purchase price compared to private ownership i.e. it should be cheaper than building the same business to scale
   • An industry that is easy to understand and comprehend

2. Preferably buy private firms with a high focus on profit.

3. Define your investment rules and stick to them. Review them if some don’t make sense. Focus on a few good investments for long-term returns.

4. Apply the same checks and logic for stock market equity purchases as you would when acquiring a new company.

5. Pro-rata businesses are sold at a discount compared to full enterprise value, and such investments make a lot of sense in the long run.

6. Buy equity at bargain prices in small proportions whenever such an opportunity arises.

7. Passive focus on investments leads to the best results. If the records speak for themselves, avoid asking or involving yourself so that it works best.

   

8. Focus on companies that pay dividends. High-growth organisations should use it to buy more shares, low growth should retain the dividend to invest in high growth. Focus on whether the dividend is paid via new share issue or profits.

9. Focus on investing in companies where every rupee retained results in a similar growth in their market value.

10. If a business looks good and makes good economic profit, then invest in more shares when the prices are down due to market sentiments.

11. Stock split leads to an increase in trading volume, hence leading to higher deviation from intrinsic value. This is one key reason why Buffet doesn’t encourage stock splits.

12. Multiple times, companies have just 1-2 businesses that deliver the returns way above market with others not giving subpar returns. However, on average they provide market returns or above, leading to high skewness that many don’t notice. This is commonly seen in acquisitions. In such cases, try to exit those with subpar and retain only those that make sense.

13. Mostly companies improve their earnings by increasing capital. Rarely do companies generate capital that can be invested elsewhere.

14. Most companies increase their value via retaining earnings rather than investing in high-rate business or something else with the capital retained.

15. If a company’s market value is worth less than its intrinsic value and on a share buyback, it’s a good opportunity to invest.

16. When investing in a company stock, evaluate as you would invest in a private business:

    • Evaluate economic prospects
    • Evaluate company management and its historical performance
    • Price of the business
    • Evaluate the business as a business analyst and not as a market or security analyst.

17. Always buy outstanding businesses at sensible prices rather than mediocre businesses at bargain prices.

18. Always check for growth of book value of business against its market value. However, it’s important to consider future prospects.

19. 3 Key Questions to be answered:

    • What’s the company worth approximately?
    • What’s the likelihood that the company will be able to meet its future obligations?
    • How good of a job has the company management done based on the economic situation presented to them? Compare with their peers to see how they stand.

20. 4 Key questions to be answered when presented with an arbitrage opportunity:

    • What’s the probability of the event occurring?
    • How long will the money be held up for?
    • What are the chances of a better opportunity arriving when money is held up?
    • What will happen if the anticipated event doesn’t occur due to some unforeseen issue?

21. Efficient Market Theory states markets are frequently efficient, hence providing you with arbitrage opportunities. Multiple examples are prevalent when individual portfolios performed better than markets over a long period due to such opportunities. As an investor, you don’t make money by committing to a particular investment category or style, but only via careful fact evaluation and adopting a disciplined approach.

22. A Simple Mental Exercise on why it makes sense to invest for the long term:

    • Scenario 1: You have an opportunity where your capital grows by 12.5% every year. Once a year ends, you encash, pay tax (assumed 30%), then reinvest. If you undertake the same opportunity for 20 years, your total value would be worth 5X.
    • Scenario 2: Same opportunity as 1 but you stay invested for 20 years and exit. You pay 30% tax on profits, then your total value would be 7.7X.
    • If you are confident of an investment, it’s always better to stay invested.

    

23. Avoid firms that don’t follow fair reporting principles as they will manipulate to meet their numbers.

24. Avoid Companies that:

    • Don’t expense for ESOPS or Options Pool
    • Pension assumptions are too good to be true
    • Use fancy accounting
    • Have too high a focus on EBITDA but say that the non-cash expense items have already been paid for
    • Have no clear footnotes, as it indicates they are hiding something
    • Sell high projections and growth numbers, as none can make accurate predictions and such companies will always make up the numbers for the same.

25. Key reasons why you don’t make money:

    • High transactional costs due to a large amount of trading
    • Portfolio diversification based on fad rather than detailed analysis
    • Entering the market when it is high and exiting when it is low.

26. Adopt simple propositions rather than complex ones. A single variable allows for 90% success, 10 variables and success is 35%. Multi-linked chains lead to complexity, further leading to more failures.

27. In the long run, a passive investor earns more due to lower transaction expenses.

28. Operating income is a better understanding for a business than net income as they don’t include unrealised gains/losses from securities.

29. Share repurchase needs to be undertaken independently of any new investment. It is a good economical idea to buy when prices are low as existing can increase stake and retain more of their earnings.

30. Evaluate risk-free investments if they are returning more than inflation as you have foregone the ability to consume now and lost purchasing power over time. Such investments should be only for liquidity concerns.

31. Certain assets produce no returns but are purchased with the hope that in the future, people will be willing to pay more to acquire them. Ex: gold. People rush to risk-free investments and no-return assets due to fear. Focus on investing in productive assets such as businesses, farms, commercial real estate, etc.

32. Evaluate Interest Coverage as = PreTax Earnings / Interest over EBIDTA.

33. It’s far better to buy a wonderful business at a fair price than a fair business at a wonderful price.

34. Use PBT as a metric and not EBIDTA for investments.

35. For stable returns, focus on what you know, take a simple approach, and avoid quick rich profit schemes.

36. Invest based on the future ability of the asset to generate returns. If you can’t estimate it, then reject it.

37. Don’t invest in the prospect of a price change to gather returns as they rarely generate the returns. Past performance of asset appreciation should never be the reason to invest.

38. Focus on what the asset is producing and not on daily returns. Players focus on the playing field and not on the scoreboard.

39. When investing in an asset, understand what value your asset is creating and not based on the economic situation. If an asset is valuable, it will be used even in a recessionary period.

40. Buy a stock on the assumption that you will be owning a small portion of the business. Analyse as you would for your business and try to estimate 5 years based on the info available. If you can’t do then avoid it. Index Funds are the best bet for most investors as experts work to identify the best stocks, and they are under high scrutiny in most cases.

41. A lot of large organisations purchase firms with low P/E ratios and then pool these shares with larger firms, indicating an increase in the value of the acquired firm.

42. A sound investment can morph into a rash speculation if it’s purchased at an elevated price.

43. Borrowed money has no place in an investor’s toolkit.

44. In any active fund, most of the additional gains plus extra goes away in management and transaction fees.