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3 Valuable Lessons from the Latest Annual Report of Warren Buffett’s Berkshire Hathaway

Every year, the Oracle of Omaha, Warren Buffett, releases the annual report from his conglomerate, Berkshire Hathaway. In it, readers can find a treasure trove of information. This year was no exception. So, let’s look at three essential lessons I gleaned from the 2017 annual report that was published at the end of last month.

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Warren Buffett’s candidness is something I admire. He started off the latest annual report with some candidness as well.

In 2017, Berkshire’s net worth grew by US$65.3 billion, which caused its book value per share to go up by 23%. However, Buffett warned that a significant portion of the year’s gain did not come from anything they had achieved at the conglomerate.

Out of the US$65 billion gain, only US$36 billion came from its operations while the rest of the US$29 billion was a one-time net benefit due to the enactment of the US Tax Cuts and Jobs Act of 2017.

Without the one-off gains, Berkshire’s per-share book value gain would have gone up around 13% “only”.

An investment checklist

Buffett reiterated the key qualities he looks out for when buying a business, and they are:

a) Durable competitive advantage;

b) Capable and high-grade management;

c) Good returns on net tangible assets needed to operate the company;

d) Opportunities to grow organically at attractive returns; and

e) A decent purchase price.

He mentioned that it was challenging to get a reasonable price for almost all the deals his firm reviewed during the year.

One of the reasons for the not-so-decent price is euphoria in the corporate world. He gave some colour on this by saying:

“Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.”

Cheap debt further exacerbated the situation.

As for Berkshire, it evaluates acquisitions based on an all-equity deal, and it never factors in synergies.

Sleep-well-at-night test

Buffett wore his “candidness” cap again when he said that his conglomerate’s returns were dampened over the years due to their strong dislike of using leverage when acquiring companies. However, this arrangement allows both Charlie, his partner, and him to “sleep well”.

Also, Buffett and Charlie would never get sucked into the euphoria of purchasing companies at high prices as they live by a simple maxim, which is, “[t]he less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.”

The Oracle of Omaha’s discipline is something to look up to. If we pay an exorbitant valuation for a business and if it cannot deliver the growth that the market expects, the share price might tank. This would be to the detriment of our portfolio.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.