Sunday, February 27, 2011

Warren Buffett's 2010 Letter to Berkshire Shareholders

So as of a couple of weeks ago, the market was up almost 100% since the 12 year low reached in March 2009. It was also up 7% since the beginning of this year. I have to agree with the headline in the linked article though- this feels like "the unhappiest bull market ever."

Maybe it is just what I focus on, but despite the numbers on the big board, all of the other news seems pretty negative for the average US investor. In fact, it's downright depressing if you think about it. For example, some of the major themes that have pounded into our skulls for the past couple of years are:

1) The FED has been printing money and flooding it into circulation, devaluing the US dollar
2) China's economy is going to overtake the US economy by 2018
3) We are entering a "New Normal" era of low stock returns, low GDP growth, deleveraging, etc. I think this view is most convincingly espoused by Bill Gross and his colleagues at PIMCO
4) The US government has bailed out shareholders at the expense of taxpayers, (more about that here and here, here (it bailed out people who couldnt pay for their mortgages also)). It also put other costly programs into place,
5) Based on pundit's views, state governments are headed for bankruptcy also
6) Stocks are overvalued  - note this is a more recent trend
7) Unemployment is high in the US. We are losing manufacturing jobs hand over fist. We no longer make stuff in the US, we are a "knowledge economy"
8) The rich are getting richer, at the expense of the poor

Oh, not to mention the social security crisis starting now as the baby boomer generation reaches retirement age and global warming (to anyone on either side of the debate, im not taking a stance on global warming, merely saying it is often in the news). These are all off the top of my head.

Combine these with the myriad personal financial problems each of us might be having - job security, sickness, disability, disease, divorce, credit card debt, foreclosure, car repairs, taxes, home maintenance, rent (which is too damn high by the way)- and it seems like the situation is pretty hopeless.

However, among this host of negative news, Warren Buffett's 2010 letter to shareholders arrived this weekend as a beacon of hope.

I suggest you read the letter yourself, but I just wanted to give you my $0.02 and call out some of the more interesting/informative parts of the letter.

Almost right off the bat, Buffett wrote something that you won't hear very often from the talking heads on CNBC in the current unhappy environment:

I agree with Warren and I don't share what seems to be the prevailing sentiment that the US is doomed to failure. This is why I invest the biggest portion of my retirement savings in US equity index funds. Put simply, I believe in the American system.

"Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders
for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective.

...We are not natively smarter than we were when our country was founded nor do we work harder. But look around you and see a world beyond the dreams of any colonial citizen. Now, as in 1776, 1861, 1932 and 1941, America’s best days lie ahead."

The next part of his letter that I liked (and anyone who has studied Buffett will be familiar with) is the section entitled "Intrinsic Value - Today and Tomorrow." In it, Warren talks about the three components of intrinsic value (which is the only value you should care about), specifically as it relates to Berkshire. You're better off getting the details from his letter, but I'd summarize the components as 1) Investments (stocks, bonds, cash equivalents) 2) earnings from sources other than investments and insurance underwriting and 3) (the most subjective category) "the efficacy with which retained earnings will be deployed in the future." I recommend you check that section out.

The highlight of the letter came near the end, however, in a section entitled "Life and Debt." Buffett reprinted a letter from his grandfather Ernest to his uncle Fred. In the letter, Ernest tells Fred that he has saved him $1,000 cash and is giving it to Fred on his 10th wedding anniversary. Ernest recommends Fred keep this money as a reserve in a safe deposit box so he can easily get at it. He writes "You might feel that this should be invested and bring you an income. Forget it -- the mental satisfaction of having $1,000.00 laid away where you can put your hands on it, is worth more than what interest it might bring..."

I checked an inflation calculator, and $1,000 back in 1939 would be the equivalent of about $15,425 today.

Buffett says they take a similar philosophy at Berkshire and will always keep $10 billion of liquid funds on their balance sheet in extremely safe but low yielding investments such as treasuries and other short term securities. He quoted investment advisor Ray DeVoe who said "More money has been lost reaching for yield than at the point of a gun."

Truer words have never been spoken, and although you hear it from most financial advisors, I'll say it again- build up your own reserve fund and put it somewhere you know you will be able to get at it. You will earn basically nothing for investing in treasuries or in your typical FDIC insured savings account right now, but you will sleep safely at night knowing that a financial setback won't knock you off your feet.

The rest of the letter hit on a number of the usual Berkshire areas: the difficulty of continuing to grow given Berkshire's huge size, the story of how he met Lorimer Davidson at GEICO, reviews of all of Berkshire's businesses, the often meaningless figure known as GAAP net income, Berkshire's culture, repeated requests to spend money at the annual meeting etc...

All in all, another great letter from the Oracle and well worth your time. I like to say that if I was only allowed to read one investment newsletter a year, it would be Buffett's shareholder letter. If you care about investing or saving, do yourself a favor and head over to and read this year's letter.

If you haven't read the previous years' letters, do that too.