Like many investors I usually take the time to read Warren Buffett’s annual letter. And after many years I’ve realized that it’s not necessarily the details that help me become a better investor. It’s the big picture things.
The details are certainly interesting, and give some insight into his world view and sense of humor. Like in 2011 when he challenged anyone to fold and throw an Omaha World-Herald newspaper closer to a front door than he (around 35 feet).
Over the years, there are a few big picture insights and lessons that have jumped out at me:
Passive income is a key to financial freedom
A large part of Berkshire Hathaway’s (NYSE:BRK-B) income and cash flow comes through investing insurance premiums. The company is, in essence, paid to invest the money. A lot of this money is invested in dividend paying companies, like Coca-Cola (NYSE:KO), and requires very little (if any) effort to manage.
Lesson: Search out passive investments and always, always, own strong dividend-paying companies for the long-term.
Exceptions to conventional wisdom are just fine, if you know what you’re doing
The majority of Buffett’s net worth is wrapped up in Berkshire stock. This works for him because of the diversity of Berkshire’s investments, and because he knows exactly what he owns. But most advisors would say it is not wise to be over invested in any one security.
Lesson: Diversification is only good if you understand how, why and where you’re diversified. A well-constructed portfolio of fewer stocks can actually be better diversified than a larger portfolio holding more stocks. Sometimes less is more, if done wisely.
Being wrong on the timing doesn’t mean being wrong on the investment thesis
In 2010 year Buffet claimed that, “…a housing recovery will probably begin within a year or so”. He admitted in 2011 that this prediction was “dead wrong”. At that time Berkshire’s pre-tax profits from its housing investments were down 71.5% over a 5-years period. Today a housing recovery is in fact well on track. And Buffett’s housing related investments are doing much better.
Lesson: Being early is better than being late. But you have to have conviction in your investment thesis.
I like this quote from the 2011 annual letter: “What is smart at one price is dumb at another“.
For long-term investors, a rising share price is not always a good thing
If your goal is to amass a significant amount of a publicly traded stock, a rising share price can work against you. Each dollar invested buys less as the price rises. It’s also true if you are reinvesting dividends, for the same reason. And it’s also true for companies that buy back their own shares at higher prices.
All of the above purchases are better when the price is relatively low because the invested dollars go further. Knowing that most stocks derive their value from future earnings, Buffett states, “low prices [are] my friend“.
Lesson: The stock market’s long-term wealth effect (its intended purpose) dictates that investors should accumulate shares when they are inexpensive. Low prices – on the right stocks – are indeed your friend.
Every year after reading Buffett’s letter I think the same thing – he has a lot more capital to invest than the vast majority of investors ever will, so trying to “buy what Buffett is buying” has never made a lot of sense to me. If that were the case it would be easiest to just buy Berkshire Hathaway and call it a day.
But for those who want to own more than one stock, having some big picture advice from the man is invaluable. And taking that into account, I think the average investor should not necessarily “buy what Buffett is buying”, but rather, “buy like Buffett”.
Making Warren Buffett Green
Since 2010, mega-investor Warren Buffett grew his wealth by an average of nearly 14% each year. Yet over this same period, a small group of investors nearly doubled these returns…tripling their wealth in the process. How? Just by investing in a select group of stocks with one thing in common.Those who understand it can experience life-changing growth.