3 Lessons Learnt From Buffett’s Annual Letter to Berkshire Hathaway Shareholders

Each year, millions of investors around the world look forward to reading Warren Buffett’s letter to Berkshire Hathaway shareholders. And every year, the legendary investor never fails to provide useful insights and inspiring quotes for the everyday investor. In fact, Buffet’s annual letters have become such a hit for investors that they have been compiled into a book.

This year, once again, his letter did not disappoint with quotable quotes, invaluable insights, and entertaining investing anecdotes. With that in mind, here are three lessons from Buffett’s 2018 annual shareholder letter.

Lesson 1: Don’t be fooled by companies that embellish their earnings.

Too often, company executives, in a bid to impress investors, use metrics that fluff up their earnings:

“The brand of earnings (what is reported in Berkshire Hathaway’s statements) is a far cry from that frequently touted by Wall Street bankers and corporate CEOs. Too often, their presentations feature ‘adjusted EBITDA,’ a measure that redefines ‘earnings’ to exclude a variety of all-too-real costs.”

Buffett warns investors that adjusted earnings metrics such as EBITDA (a number that removes interests, tax, depreciation, and amortisation expense from earnings) are often touted by CEOs as a better gauge of performance, but in reality, they exclude important expenses that ultimately affect what can be returned to shareholders.

As shareholders, we need to be wary of such companies and do our own due diligence on their earnings performances.

Lesson 2: Investors should rejoice when a company buys back shares at reasonable prices.

Buffett has said multiple times that share repurchases are a better way for companies to reward shareholders than dividends. By buying back shares when prices are low, companies reduce the number of outstanding shares, and each shareholder will therefore own a larger piece of the company. However, it is still important that company management ensures share buybacks are made only when the share is trading below its intrinsic value and there is arguably no better use of the capital.

Buffett explains:

For continuing shareholders, the advantage is obvious: If the market prices a departing partner’s interest at, say, 90 [cents] on the dollar, continuing shareholders reap an increase in per-share intrinsic value with every repurchase by the company. Obviously, repurchases should be price-sensitive: Blindly buying an overpriced stock is value-destructive, a fact lost on many promotional or ever-optimistic CEOs.”

Lesson 3: Innovative humans have driven economic growth and will continue to do so for years to come.

Buffett ends his letter with a description of how the world has evolved since he purchased his first stock 77 years ago, when he was just 11 years old. In the spring of 1942, the United States was facing a crisis as it and its allies were facing heavy losses in a war that they had only entered three months earlier. However, Americans were optimistic that the war would be won and the country would return to post-war boom. To say they were right would be an epic understatement. If the $114.75 Buffett had in his pocket had been invested in a no-fee S&P500 index fund when he was 11, he would have made a gain of 5,288 for 1, and his small investment would now be worth a staggering $606,811. A $1 million investment would have grown to $5.3 billion.

Buffett ended his letter by writing:

“Charlie and I happily acknowledge that much of Berkshire’s success has simply been a product of what I think should be called The American Tailwind. It is beyond arrogance for American businesses or individuals to boast that they have ‘done it alone.’ The tidy rows of simple white crosses at Normandy should shame those who make such claims.

There are also many other countries around the world that have bright futures. About that, we should rejoice: Americans will be both more prosperous and safer if all nations thrive. At Berkshire, we hope to invest significant sums across borders.

Over the next 77 years, however, the major source of our gains will almost certainly be provided by The American Tailwind. We are lucky — gloriously lucky — to have that force at our back.”

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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 Jeremy Chia owns Berkshire Hathaway Inc Class B shares. The Motley Fool Singapore recommends Berkshire Hathaway.