Warren Buffett, known as the “Oracle of Omaha”, is one of the most successful investors of all time. He is the chairman and CEO of Berkshire Hathaway, which owns more than 60 companies. Of which, the five largest holdings being American Express, Apple, Bank of America, Coca Cola and Wells Fargo. Warren Buffett annually releases letter addressing the shareholders. Here, we’ll decode the lessons from Warren Buffett’s Annual Letter to Shareholders for you.
Who is Warren Buffett?
Warren Buffett is an American business magnate, investor, speaker, and philanthropist. He is considered one of the most successful investors in the world. As of 4/8/2019, his real-time net worth is $84.2B. That is how magnificent an investor he is. The most fascinating story told about Buffett is how he made his first stock market investment of $114.75 on 11th March 1942 at the age of 11, and how he first filed taxes at the age of 13. He bought 3 shares of Cities Services from those $114.75. And now, he is #3 on the Forbes Billionaires List.
Every year, Warren Buffett releases a letter addressing his shareholders along with the annual report. These letters reflect his wisdom on investing. There are a lot of insights to be gained from these letters. Here, we’ll tell you the few Lessons from Warren Buffett’s Annual Letter to Shareholders that you can use to increase your investing wisdom. But before we go on that, let’s learn about the S&P 500.
What is the S&P 500?
S&P 500 is the US Stock Market’s index. As Nifty and Sensex are Indian Stock Market indices, similarly, the S&P 500 is the US Stock Market’s Index.
There are basically two types of funds- Active Funds and Passive Funds. Active Funds are managed by Fund Managers, which means, the decision of buying shares and when to buy them are made by Fund Managers. For which, Fund Managers usually charge a fee of 1% per year of the total investment. Whereas, in Passive Funds, Fund Managers do not need to select the stocks.
Examples of Passive Funds-
The examples of Passive Funds includes S&P 500 Index Fund, Sensex Index Fund, Nifty Index Fund, etc. When an investor invests in Sensex Index Funds, that fund is automatically invested in the 30 stocks in Sensex. The fund manager does not need to select a stock for that.
Lesson 1: Invest in Index Funds Instead of Active Funds
Warren Buffett says if he would have invested those $114.75 in S&P 500 index in 1942 instead of Cities Services, its value as on 31st March 2019 would have been $606,811. In simple terms, the value of an investment of $1 Million made on 11th March 1942 in the S&P 500 Index would have been $5.3 Billion on 31st March 2019. Whereas if we would have invested those $1 Million on Active Funds in 1942, its value on 31st March 2019 would have been just $2.65 Billion which is half of the S&P 500 Index Fund.
To sum up, 1% Management Fees can reduce the value of your investment by a great margin. As we can see from the above example, the returns reduced as much as half because of this Management Fees. Here, Mr. Buffett has made an assumption, that from March 1942 to March 2019, the S&P 500 has given a return of 11.8% annually. He has assumed that Active Funds have also given a return of 11.8% annually. After deducting the 1% Management Fees, the total return becomes 10.8%.
Mr. Buffett suggests, if we don’t have a good knowledge of the stock market and we can’t invest in our own then we should invest in Index Funds instead of Active Funds. He has repeated the same thing in almost every newsletter and emphasizes that we should focus on index funds.
Lesson 2: Gold Investment is NOT a Good Investment
…The magical metal was no match for the American mettle.
– Warren Buffett
According to Warren Buffett, gold investment is not a good investment. He says that if he would have invested those $114.75 in gold in 1942 then its value would only have been $4200 on 31st March 2019. Which is not even 1% of the S&P 500 Index Fund. We can see how huge a difference is there between these two investment options.
Lesson 3: Investing in Stock Market VS Investing in Gold
When a person invests in the Stock Market, it benefits the economy as companies get funds to expand their businesses. On the other hand, when someone invests in gold it does not benefit the economy at all. Particularly in India, if we invest in gold it has a negative impact on the economy since India has to import a lot of gold. The demand for gold is already very high in India which burdens the economy further. Which means gold investment is neither good from return perspective nor from the economy’s perspective.
Lesson 4: Debt VS Retained Earning
Warren Buffett has also talked about debt. He says, his company Berkshire Hathaway uses very less debt. They try to utilize retained earning to take the company ahead. And he suggests the same thing to others because in bad times debt can turn out to be lethal.
Lesson 5: The Role of the Management
Warren Buffett has also talked about the insurance company Geico. Before 1976, Geico which is an insurance company was facing a lot of problems. Then in 1976, Jack Byrne became the CEO of the company. After him taking in charge of the company, the performance of the company improved. Warren Buffett met Jack Byrne after that, and after meeting him he realized that Jack Byrne can change the situation of the company. Mr. Buffett purchased around 33% shares in Geico then. After this, Geico started buying back its shares regularly. And because of the buy-back of shares, the shareholding of existing shareholders automatically increased. Because of which Berkshire Hathaway’s share in Geico reached 50%.
All Berkshire shareholders owe Tony their thanks. I head the list.
Then in 1993, Tony Nicely became the CEO of Geico. And after his arrival, the performance of the company improved manifold. After his arrival, Warren Buffett decided to purchase the remaining 50% share of Geico as well. Mr. Warren Buffett purchased the remaining 50% share of Geico for $2.3 Billion. This amount was 50 times more than the amount he paid to purchase the previous 50% share in Geico. Now, Geico is the #2 Auto Insurance company of America. In his letter, Mr. Warren Buffet has immensely praised Mr. Tony Nicely. In each of his letters, Mr. Buffett makes it a point to recognize the efforts made by his managers, CEOs and Top Level Managers and praise them.
Lesson 6: The 15 Biggest Investments
Warren Buffet has told about his 15 big investments according to the market cap as shown in the image below. These are those 15 companies according to the market value in which Berkshire Hathaway has the maximum investment. There are other companies as well in which Berkshire Hathaway has invested but these are the 15 biggest ones.
We can see the cost price at which the shares were purchased and their current market value. For example, Berkshire Hathaway has 17.9% ownership in American Express Company. He had purchased this stake at $1,287 Million whose current market value is $14,452 Million.
Lesson 7: Retained Earnings
Warren Buffett says that behind the success of Berkshire Hathaway, there’s a huge role of Retained Earnings. That’s why he says he gives a lot of importance to retained earnings. You can learn more about retained earnings and how to analyze them from the Fundamental Analysis course which you can get from here.
Lesson 8: The Importance of Savings
Mr. Buffett has also talked about America in his annual letter to shareholders about how America became so prosperous. He has mentioned, that if their fathers and forefathers have not had a habit of savings, America won’t have been able to achieve such level of prosperity. What he means is, if we’re spending all that we’re earning then it’s not going to help the economy. And if we save the money but we are leaving it idle, then also it’s not going to help the economy.
But if we save the money and invest it or keep it at the Bank then it’s definitely going to help the economy. Because the money we invest goes to the businesses with help of which businesses can expand their business. And its direct benefit is enjoyed by the economy and the country. To conclude, he has said that saving is very important and we should invest our savings to ensure passive earnings. If a country wants to be prosperous, saving and investment are equally important factors.
Mr. Warren Buffett’s Annual Letters to Shareholders are an epitome of knowledge. We should try to reap as much benefit from it as we can. If you have any queries about the lessons, drop them in the comments below.