Tue Mar 04 2014
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Warren Buffett Hides 10 Clues in Shareholders’ Letter

On Saturday morning, Warren Buffett released his latest annual letter to shareholders of Berkshire Hathaway Inc. (BRK.B).

Just like his last 50 or so, it’s a must-read for every investor.

Not only does it contain nuggets of timeless investing wisdom, but thanks to Berkshire’s sprawling enterprise – spanning from railroads, utilities, and homebuilders to insurance, sneakers, and ketchup – it also contains timely revelations into the current state of the economy and the market.

Perhaps the most shocking revelation of all is the fact that the Oracle of Omaha was upstaged by both potential heirs to his investment management throne…

“In a year in which most equity managers found it impossible to outperform the S&P 500, both Todd Combs and Ted Weschler handily did so… I must again confess that their investments outperformed mine. (Charlie says I should add ‘by a lot’).”

So has Buffett lost his Midas touch?

Hardly! Even if we include his “underwhelming” performance in 2013 in relation to his protégés, Buffett has increased Berkshire’s book value at a staggering rate of 19.7% compounded annually over the last 49 years.

I highly doubt Mr. Combs, Mr. Weschler, or any of us will ever be able to make a similar boast. So we all stand to learn a thing or two from Mr. Buffett.

With that in mind, here’s a rundown on the 10 most shocking and important revelations from this year’s letter…

~Buffett Shocker #1: Small Caps Are Where It’s At!

If you continue to refuse to take my advice to keep betting on small caps because of their superior fundamentals, consider Warren Buffett’s words of wisdom: “Our many dozens of smaller non-insurance businesses earned $ 4.7 billion pre-tax last year, up from $ 3.9 billion in 2012. Here, too, we expect further gains in 2014.”

~Buffett Shocker #2: The End of America is NOT Nigh!

Ever since the Great Recession, fearmongers attempted to convince us that the era of American dominance is over, that our capitalistic system is teetering on the brink of utter and complete destruction.

Buffett’s response? Fat chance!

Or in his words, “Could anyone really believe the earth was going to swallow up the incredible productive assets and unlimited human ingenuity existing in America?”

I certainly can’t.

If you prefer to keep things on a more quantitative level, Buffett asks, “Who has ever benefited during the past 237 years by betting against America?”

I can’t think of anyone, can you?

Add it all up, and Buffett contends that “America’s best days lie ahead.” (I agree.)

And he plans to put his money where his mouth is, too. “Though we invest abroad, as well, the mother lode of opportunity resides in America.”

We’d be well served to do the same. Unless, of course, you’re convinced it’ll be different this time…

~Buffett Shocker #3: Tenths of a Percent Matter, Too

Too often we get caught up trying to uncover big winners – investments that go up hundreds and hundreds of percent. But Buffett reminds us not to overlook tenths of a percent…

“Ponder this math: For the four companies in aggregate [American Express, Coca-Cola, IBM and Wells Fargo], each increase of one-tenth of a percent in our share of their equity raises Berkshire’s share of their annual earnings by $ 50 million.”

The corollary for individual investors comes in with expenses. Reduce them, even by a few tenths of a percent over time, and the gains add up.

Or as Buffett puts it later in his letter (emphasis mine), “The ‘know-nothing’ investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results.”

~Buffett Shocker #4: Never Be Fully Invested

Even with cash yielding next to nothing, Buffett recommends keeping a stockpile on hand.

Why? So you can put it to work to earn an above-average return when the opportunity presents itself.

Or in his words, “Tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.”

~Buffett Shocker #5: Don’t Ignore Your Critics… Embrace Them!

As I’ve warned before, we’re prone to confirmatory bias. That is, only seeking out information that jives with our own beliefs. To truly be successful investors, we need to learn to embrace contradictory viewpoints.

Buffett’s actions reveal that he agrees. When writing about the upcoming shareholder meeting, he said, “We will again have a credentialed bear on Berkshire. We would like to hear from applicants who are short Berkshire.”

Why bother? Because entertaining critics’ opinions and analysis serves a vital purpose…

It either strengthens our convictions on our investment, leading us to increase our stake and earn larger returns. Or, more importantly, it reveals the error of our own analysis, allowing us to exit the position without suffering a major loss.

Stay tuned for tomorrow’s column, where I’ll share five more shocking revelations from Warren Buffett.

Ahead of the tape,

Louis Basenese


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