Many Investing Lessons from Warren Buffett’s Annual Letter

MoneyShow  |

Image via Fortune Live Media/Flickr CC

Warren Buffett's annual letter to shareholders is an opportunity for investors to remind themselves of some valuable lessons, even if this year's letter didn't provide any secret insights into an eventual successor to the Oracle of Omaha, explains John Reese, editor of Validea.

Berkshire Hathaway (BRK.A) is still sitting on a greater than $100 billion cash pile, unable to find great buys at a “sensible purchase price,” Buffett wrote.

The company even backed away from a couple of situations last year, including its well-advertised attempt to buy Texas power distributor Oncor Electric after a bidding war erupted. He’s not even going on a shopping spree with the $29 billion windfall Berkshire is getting as a result of new U.S. tax laws.

Buffett’s annual letter, much like Berkshire's annual shareholder meeting, is a closely watched event among Wall Street professionals as well as with regular investors, so it is usually combed through for pearls of wisdom. Buffett talks about the four “building blocks” of Berkshire: big stand-alone acquisitions, acquisitions that fit into businesses they already own, internal sales growth and investment gains on Berkshire’s big stock portfolio.

While Buffett might be most famous as a stock investor in companies like Coca-Cola (KO), Kraft (KFT) and Wells Fargo (WFC), it is Berkshire’s deal engine that generates a lot of interest on Wall Street.

With regard to deals, Berkshire approaches a purchase on an all-equity basis, meaning they don’t consider using debt to make a deal. Buffett prefers to wait instead, knowing eventually the price will be right, or it will never get there and he hasn’t wasted his money. Higher valuations mean lower returns.

But an investor’s goal is to maximize returns given the risks. Lower valuations, on the other hand, create room for better returns in the future. This same lesson can be applied to stock investing for those who are cautious and stick to their strategies.

Buffett also is not one of those CEOs who like to pretend his stock has always been a positive story. There is a chart in his annual letter that shows the worst four periods, including three when the stock was off by more than 47%.

Buffett admits his aversion to leverage had cut into Berkshire’s long-term returns, but he also says debt can be a bad risk. “It is insane to risk what you have and need in order to obtain what you don’t need.” That might be a lesson to short-sellers of stock, who have to borrow it to sell with the hope it’ll fall in value and the loan can be repaid with money left over. It could also be a warning to investors using margin accounts.

As Buffett puts it: “Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.”

Part of his letter this year talks about a decade-old bet he made with a sophisticated hedge fund that an investment in a low-cost unmanaged S&P-tracking index found could outperform the high-fee smart money. Buffett was right. His main point is that investment fees cost investors far more than they realize. And that often the best course of action is to just find the lowest-cost, broadest index you can and stick with it.

That is also the reason Buffett says investors don’t have to have access to the smartest minds on Wall Street to do well and achieve their goals. They just need to be able to avoid mob mentality, resist the urge to chase the hottest trend, and stick to their tried and true fundamentals. And he advocates a set-it-and-forget-it approach. “Stick with big easy decisions and eschew activity.”

Buffett also looks at risk differently. As a long-term investor, the brief market turmoil we saw in early February shouldn’t really matter. Investors are giving up current consumption for greater consumption down the road, with risk being the possibility this goal won't be reached. Stocks are risky in the short term, but over decades, a well-diversified portfolio becomes less risky than bonds.

Investors would be well-served by taking a conservative and realistic view of their own future returns and by following an investment strategy that works for them, versus being influenced by something from the outside or brought into an investment that doesn't fit their style.

Employment: CVS Health To Hire 25,000 in Virtual Career Event Friday September 24

We maintain a model portfolio based on Warren Buffett's investing strategy; included in that portfolio are Credit Acceptance (CACC), Toro Company (TTC), Ross Stores (ROST), TJX Companies (TJX) and Apple (AAPL).

John Reese is editor of Validea.

Subscribe to John Reese’s Validea here…

About Founded in 1981, MoneyShow is a privately held financial media company headquartered in Sarasota, Florida. As a global network of investing and trading education, MoneyShow presents an extensive agenda of live and online events that attract over 75,000 investors, traders and financial advisors around the world.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:

Market Movers

Sponsored Financial Content