Warren Buffett's latest annual letter looks back on his 50 years at the helm of Berkshire Hathaway, during which time the legendary Oracle of Omaha has fashioned an unparalleled investment record.
Buffett is a unique figure with a unique tale, a born investor who accumulated a $73 billion fortune while remaining indifferent to the trappings of wealth, an investing genius who prizes emotional stability and discipline above intellectual prowess, a risk-averse investor who nevertheless uses leverage to juice returns.
A born investor Buffett made money by selling chewing gum and Coca-Cola to neighbours at the
age of six. He had bought his first shares at 11, and filed his first tax return at 13 (he claimed a deduction of $35 for his bicycle, which he used to deliver newspapers). Aged 14, he used his $1,200 savings to buy a 40-acre farm. By the age of 17, he began a pinball machine business, buying a used machine for $25 and making a $50 weekly profit by setting it up in a barber shop. A year later, having bought two more machines, he sold the business for $1,200.
Buffett is famously frugal in his tastes. He lives in the same five-bedroom house in Omaha that he bought in 1958 for $31,500. His annual salary has remained at $100,000 for more than three decades, and he reimburses Berkshire for items such as personal phone calls and postage.
He uses an old-fashioned Nokia flip phone – “the one Alexander Graham Bell gave me” – and says he doesn’t throw anything away until he’s had it for 20 or 25 years. Expensive “toys”, he says, “are just a pain in the neck”. His favourite meal is a cheeseburger and a Cherry Coke.
There is one obvious exception to all this frugality – Buffett's ownership of a corporate jet, appropriately nicknamed the Indefensible.
Berkshire Hathaway’s book value has grown an annualised 20 per cent over the last 50 years. Over a five-year period, Berkshire’s book value has outperformed the S&P 500 in 43 out of 44 years.
Nothing quite captures Berkshire’s astonishing growth, however, as its ever-increasing share price. The shares have never split, increasing from $18 in 1965 to $425 in 1980, $6,625 in 1990, $71,000 in 2000 and more than $220,000 today.
A lesson in compounding
Buffett’s annual percentage returns were much greater in the first half of his 50-year investment career, but the snowballing nature of compound interest means almost all of his $73 billion fortune has been accumulated in later years. Now he is 84, roughly 95 per cent of his wealth was earned after his 60th birthday, and 99 per cent of it after his 50th birthday.
The Tao of Warren Buffett
notes that her former father-in-law has been known to turn down a $2 golf bet as he felt the odds were against him. Discipline, not cheapness, is the reason: “If you let yourself be undisciplined on the small things,” he says, “you will probably be undisciplined on the large things as well.”
Buffett says his best investment was not a stock purchase; it was buying Benjamin Graham’s
The Intelligent Investor
, the 1949 value investing classic that ultimately changed his life.
Todd Combs, who manages money at Berkshire, once related how Buffett was asked by students how best to prepare for an investing career. "Read 500 pages like this every day," said Buffett, holding up a bunch of reports and trade publications. "That's how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it."
Buffett continues to spend about 80 per cent of his day reading, but he is not interested in reading about other people’s opinions. “We want to get the facts, and then think.”
Berkshire Hathaway is a sprawling conglomerate that has grown by delegating “almost to the point of abdication”, Buffett jokes. When Berkshire buys a company, it pledges to hold it forever, and allows existing management a lot of autonomy.
This trust-based culture holds obvious appeal for business owners such as Nebraska Furniture Mart's Rose Blumkin. "Mrs B accepted my offer without changing a word, and we completed the deal without the involvement of investment bankers or lawyers," Buffett said of his 1983 purchase. "Though the company's financial statements were unaudited, I had no worries. Mrs B simply told me what was what, and her word was good enough for me."
In contrast, Berkshire doesn’t want “to join with managers who lack admirable qualities, no matter how attractive the prospects of their business. We’ve never succeeded in making a good deal with a bad person.”
When stock markets crashed on Black Monday in 1987, Berkshire’s share price suffered its biggest-ever one-day fall, plunging 18 per cent and denting Buffett’s fortune by an estimated $347 million. Market turmoil in mid-1998 resulted in Buffett enduring paper losses of $6.2 billion, notes investment author
, with even bigger losses to come during the global financial crisis of 2008-2009.
Berkshire’s share price suffered four major drawdowns ranging from 37 to 51 per cent between 1987 and 2009, or roughly once every five years.
Buffett shrugs off these paper losses; in his 1987 annual letter, he did not even refer to Black Monday. This approach has served him well, with Berkshire’s share price soaring from $2,675 in 1987 to last December’s all-time high of $229,000.
Investors don’t need “extraordinary intelligence”, says Buffett, but they do need to be able to watch their holdings halve in value without becoming panic-stricken.
Investors understandably obsess about Buffett’s unique stock-picking record, but stock selection is less crucial to Berkshire than it used to be. In the mid-1990s, stocks accounted for three-quarters of the company’s assets. By the end of 2014, Berkshire’s stock portfolio was worth $110 billion, less than one-third of the company’s $360 billion market capitalisation.
That's because, over the years, Berkshire has continued to buy businesses outright, ranging from railway giant Burlington Northern Santa Fe to insurer Geico and battery brand Duracell as well as a host of lesser-known but valuable companies. As for picking stocks, that is increasingly done by Berkshire's Todd Combs and Ted Wescher, both of whom are in the running to succeed Buffett ultimately at the helm.
Simply buying what Buffett buys or adopting a value investing approach won’t net you Buffett-like returns. According to a 2013 study, entitled
, leverage is the secret to his success. The paper found that, typically, Buffett leveraged his capital by 60 per cent – that is, he would buy $160 worth of stock with $100 of his own money, juicing returns with $60 of borrowed money.
Isn’t that reckless? Not in Buffett’s case. First, AAA-rated Berkshire was able to borrow money at extremely low rates. Second, Buffett purchased low-risk, quality stocks. The combination of low rates and safe stocks meant Buffett’s portfolio was no riskier than conventional stock portfolios. Indeed, Berkshire’s worst performance in a calendar year was a relatively modest loss of 9.6 per cent.
Anyone who followed this relatively simple formula would have enjoyed Buffett’s remarkable returns. Of course, as the researchers admit, no one did – Buffett discovered the secret half a century before everyone else.