Highlights from Warren Buffett’s latest shareholder letter

From Justin Brill, Editor, Stansberry Digest:

Warren Buffett released his latest annual letter for Berkshire Hathaway shareholders over the weekend…

As always, it contained several invaluable insights and lessons from the legendary investor, and we’ll highlight a few of these below…

First, Buffett shared his thoughts on corporate share repurchases…

And they should sound familiar to longtime Digest readers…

Buffett explained that while discussions about share repurchases (or “buybacks”) often become “heated,” judging whether they’re beneficial for shareholders in any particular situation is actually simple. Here’s an excerpt from the letter (emphasis added)…

From the standpoint of exiting shareholders, repurchases are always a plus. Though the day-to-day impact of these purchases is usually minuscule, it’s always better for a seller to have an additional buyer in the market.

For continuing shareholders, however, repurchases only make sense if the shares are bought at a price below intrinsic value. When that rule is followed, the remaining shares experience an immediate gain in intrinsic value. Consider a simple analogy: If there are three equal partners in a business worth $3,000 and one is bought out by the partnership for $900, each of the remaining partners realizes an immediate gain of $50. If the exiting partner is paid $1,100, however, the continuing partners each suffer a loss of $50. The same math applies with corporations and their shareholders. Ergo, the question of whether a repurchase action is value-enhancing or value-destroying for continuing shareholders is entirely purchase-price dependent.

It is puzzling, therefore, that corporate repurchase announcements almost never refer to a price above which repurchases will be eschewed. That certainly wouldn’t be the case if a management was buying an outside business. There, price would always factor into a buy-or-pass decision.

When CEOs or boards are buying a small part of their own company, though, they all too often seem oblivious to price. Would they behave similarly if they were managing a private company with just a few owners and were evaluating the wisdom of buying out one of them? Of course not…

My suggestion: Before even discussing repurchases, a CEO and his or her Board should stand, join hands and in unison declare, “What is smart at one price is stupid at another.”

Later, Buffett warned against the growing use of “adjusted earnings” to manipulate corporate performance…

Here, too, Buffett’s warnings should sound familiar… We’ve discussed how 90% of companies in the S&P 500 now also report earnings that are not based on traditional “GAAP” accounting rules. This is up from 72% of companies in 2009. And Buffett believes this trend is bad for shareholders and management teams alike. More from his letter (emphasis added)…

Too many managements – and the number seems to grow every year – are looking for any means to report, and indeed feature, “adjusted earnings” that are higher than their company’s GAAP earnings. There are many ways for practitioners to perform this legerdemain. Two of their favorites are the omission of “restructuring costs” and “stock-based compensation” as expenses.

Charlie [Munger] and I want managements, in their commentary, to describe unusual items – good or bad – that affect the GAAP numbers. After all, the reason we look at these numbers of the past is to make estimates of the future. But a management that regularly attempts to wave away very real costs by highlighting “adjusted per-share earnings” makes us nervous. That’s because bad behavior is contagious: CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be “helpful” as well. Goals like that can lead, for example, to insurers underestimating their loss reserves, a practice that has destroyed many industry participants.

Charlie and I cringe when we hear analysts talk admiringly about managements who always “make the numbers.” In truth, business is too unpredictable for the numbers always to be met. Inevitably, surprises occur. When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers.

He also railed against the excessive fees charged by Wall Street brokers, hedge funds, and the like…

Buffett went so far as to say that even the wealthiest investors would be better off investing in low-cost index funds rather than giving their money to high-cost advisors…

The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.

Of course, we fully agree with Buffett’s criticisms of high-cost managers. But we also know individual investors can do far better than the market with just a little effort… and without taking excessive risks or paying high fees to managers to do it.

How do we know? Because each of our $199/year “entry level” investment services – Porter’s Stansberry’s Investment Advisory, Steve Sjuggerud’s True Wealth, and Dr. David “Doc” Eifrig’s Retirement Millionaire – have earned market-beating, double-digit returns over the past 10 years. And we believe our new Stansberry Portfolio Solutions product will make even better returns available to virtually any investor.

We also note that Buffett himself doesn’t follow this advice. He and Berkshire own – and continue to buy – large positions in individual equities

Finally, Buffett reminded investors of the importance of being a contrarian…

He reiterated the idea behind one of his best known and most important axioms: “Be greedy when others are fearful“…

The years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: “We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.”

During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.

He also admitted that while he expects Berkshire Hathaway to be among those that do well, its large size means it’s unlikely to do as well in the future as it has in the past…

As for Berkshire, our size precludes a brilliant result: Prospective returns fall as assets increase. Nonetheless, Berkshire’s collection of good businesses, along with the company’s impregnable financial strength and owner-oriented culture, should deliver decent results. We won’t be satisfied with less.

This, too, should sound familiar to regular readers…

As Porter explained in the February 10 Digest, Buffett himself has said he could earn upwards of 50% annually if he managed less money and were able to buy high-quality, small-cap businesses.

And it’s why we’re thrilled about the launch of our new Stansberry Venture Value service, dedicated to finding small, capital-efficient stocks capable of growing revenues rapidly for years. We believe Venture Value subscribers could see total long-term returns of 1,000% or more in safe, “plain vanilla” stocks.

Regards,

Justin Brill 

Crux note: As we noted on Friday, Stansberry Venture Value will be closing to new subscribers tonight, Tuesday, February 28 at midnight. If you’re interested in learning more, we must hear from you soon. Click here for all the details on our special charter offer.

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