Like many investors, whether individual or even mutual and hedge fund managers, I look forward to the Chairman’s Letter penned by Warren Buffett inside Berkshire Hathaway’s (BRK.A) annual report. The latest one, which recaps 2014, was released over the weekend, and, as usual, Buffett offers some insight into the company as well as sage advice for investors.
Before we get started, there’s no way to sugarcoat it — in 2014, Buffett and his team underperformed the S&P 500. Berkshire’s per share book value rose 8.3% in 2014, trailing the 13.7% increase in the S&P 500 (including dividends). I’ll explain what happened soon, but the short story here is the company had several underperforming investments. I find it a rather sobering reminder that even once you’ve done all your homework, there are still pitfalls to be had in the market.
Remember, though, that like my approach in the Growth & Dividend Report, Buffett is a long-term or patient investor, and that strategy continued to outperform the market over the longer term. If we look at the compound annual gain in Berkshire Hathaway over the 1965-2014 period, the math kicks out a 19.4% return. That’s significantly better than the 9.9% annual gain the S&P 500 averaged during the same period. Again, it probably makes sense to listen to what Buffett has to say with an open mind.
Here are my takeaways from the Chairman’s Letter:
Attentive readers will notice that Tesco, which last year appeared in the list of our largest common stock investments, is now absent. An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling.
At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount.
In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)
During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.
We sold Tesco shares throughout the year and are now out of the position.
The lesson here is to ensure the reasons behind your initial investment are still valid. If the data starts to turn, keep a watchful eye to see if it is a blip or the start of something more ominous. In this case, Buffett clearly held on too long, and, as he points out, it cost him.
If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement. (The S&P 500 was then below 700; now it is about 2,100.)
Investors should never fear price volatility — but, rather, embrace it as an opportunity to buy quality companies — growers and dividend payers — at more affordable prices. Much like a shark, we must always be looking for new opportunities while minding our existing investments.
In striving to achieve the desired per-share number, a panting CEO and his “helpers” will often conjure up fanciful “synergies.” (As a director of 19 companies over the years, I’ve never heard “dis-synergies” mentioned, though I’ve witnessed plenty of these once deals have closed.) Post mortems of acquisitions, in which reality is honestly compared to the original projections, are rare in American boardrooms. They should instead be standard practice.
Mergers and acquisitions (M&A) deal making boomed in 2014, and it looks like it will continue further in 2015, but Buffett is correct in that companies need to do a shakedown analysis of what went wrong. Did we ever hear Time Warner (TWX) or AOL (AOL) discuss how that mega-merger failed miserably relative to all the hyped expectations and synergies that content and connectivity marriage was supposed to deliver?
Understanding what went wrong or failed to materialize is an important part of the investing cycle. It’s also standard practice in the Growth & Dividend Report — after all, how are we supposed to improve our investing skills if we simply turn a blind eye to a position that doesn’t work out? Understanding what shifted against us and so on is crucial in helping us not repeat the same mistake.
Anything can happen anytime in markets. And no advisor, economist, or TV commentator — and definitely not Charlie nor I — can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.
Cable TV and regular TV pundits and programs are designed to trap your eyes and ears. Remember, it is ratings that dictate their advertising revenue streams, not informing you about what is really going on in the world. My subscribers are probably sick of me reminding them to look below the headlines, but each month I wade into the data to present them with the latest and greatest economic data in the context of the world around us.
While I’ve never met Buffett, it seems to me at least that our investing styles overlap in several areas. Perhaps that’s why I’ve been able to deliver so many double-digit percentage winners to Growth & Dividend Reportsubscribers.
Here’s a link to my appearance yesterday on TheStreetTV where I discussed the mismatch between the falling domestic movie box office and the lofty share prices of movie theater stocks. I’m not sure how the herd expects those companies to deliver… those high-margin snacks and drinks can’t be bought if people aren’t showing up to the theater!
In case you missed it, I encourage you to read my e-letter column from last week about why the market may be peaking.