2014 Berkshire Hathaway annual letter out

[Otsog]

http://www.berkshirehathaway.com/letters/2014ltr.pdf

[RichMoose]

Good read as always. I enjoy his simplistic explanations and humor.

I found it interesting how he again noted returns will be lower in the future because of "scale" problems. Essentially BRK has gotten too big to grow fast.

[gimp]

This is fantastic, highly recommend reading it all. I started to quote the best parts but quickly realized I would be quoting at least 10% of the letter, without the context it deserved.

[infogoon]

Love this:

"Periodically, financial markets will become divorced from reality – you can count on that. More Jimmy
Lings will appear. They will look and sound authoritative. The press will hang on their every word. Bankers will
fight for their business. What they are saying will recently have “worked.” Their early followers will be feeling very
clever. Our suggestion: Whatever their line, never forget that 2+2 will always equal 4. And when someone tells you
how old-fashioned that math is --- zip up your wallet, take a vacation and come back in a few years to buy stocks at
cheap prices."

[skyrefuge]

Love this:

"Periodically, financial markets will become divorced from reality – you can count on that. More Jimmy
Lings will appear. They will look and sound authoritative. The press will hang on their every word. Bankers will
fight for their business. What they are saying will recently have “worked.” Their early followers will be feeling very
clever. Our suggestion: Whatever their line, never forget that 2+2 will always equal 4. And when someone tells you
how old-fashioned that math is --- zip up your wallet, take a vacation and come back in a few years to buy stocks at
cheap prices."

That's the part I would have highlighted too, but because I think it's the worst part of the whole letter! Or at least the last line is. I think he temporarily forgot that almost no one reading his letter is named Warren Buffett, and accidentally deviated from his normal advice.* While market-timing might work great for him, it doesn't for anyone else!

* Luckily he explicitly contradicts himself elsewhere in the letter:

"Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet."

[phillyvalue]

Love this:

"Periodically, financial markets will become divorced from reality – you can count on that. More Jimmy
Lings will appear. They will look and sound authoritative. The press will hang on their every word. Bankers will
fight for their business. What they are saying will recently have “worked.” Their early followers will be feeling very
clever. Our suggestion: Whatever their line, never forget that 2+2 will always equal 4. And when someone tells you
how old-fashioned that math is --- zip up your wallet, take a vacation and come back in a few years to buy stocks at
cheap prices."

That's the part I would have highlighted too, but because I think it's the worst part of the whole letter! Or at least the last line is. I think he temporarily forgot that almost no one reading his letter is named Warren Buffett, and accidentally deviated from his normal advice.* While market-timing might work great for him, it doesn't for anyone else!

* Luckily he explicitly contradicts himself elsewhere in the letter:

"Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet."

I don't think it's a contradiction, he's talking about different kinds of phenomena. In the first, he is essentially saying that someone, somewhere will always invent a new get-rich-quick scheme, and that people will tend to ignore obvious risks and latch onto it. In the 80s, this was LBOs where you put down $5 of equity to buy a $100 business, and people were happy to lend you 95% of the purchase price. In the 90s, it was internet companies with no revenue and crazy business models. In the 2000s, it was literally the idea that you could have 2+2=5, that you could package mortgages and other debt in ways that virtually eliminated the underlying risks.

In the 80s, in the 90s, and in the 2000s, you did well by buying a diversified set of stocks like the S&P, because regardless of the above phenomena, the economy and businesses in general will do better over time. Even if you observed the above phenomena, generally it would have been a bad decision to time the market; for example, you could have observed the craziness of the Dot-Coms in 97, and you would have done worse than someone who just held the S&P the whole time, even considering the crash in 2000-2002. Unless you timed the real estate bubble perfectly by selling in 07 and buying in 09, you probably did poorly or at least no better than the market.

The point being, micro-level events that are crazy and irrational are bound to happen in financial markets, and you should zip up your wallet when confronted with opportunities that don't make sense. But that doesn't mean you can effectively time the market by buying and selling an index based on the activity you see.

[clifp]

Love this:

"Periodically, financial markets will become divorced from reality – you can count on that. More Jimmy
Lings will appear. They will look and sound authoritative. The press will hang on their every word. Bankers will
fight for their business. What they are saying will recently have “worked.” Their early followers will be feeling very
clever. Our suggestion: Whatever their line, never forget that 2+2 will always equal 4. And when someone tells you
how old-fashioned that math is --- zip up your wallet, take a vacation and come back in a few years to buy stocks at
cheap prices."

That's the part I would have highlighted too, but because I think it's the worst part of the whole letter! Or at least the last line is. I think he temporarily forgot that almost no one reading his letter is named Warren Buffett, and accidentally deviated from his normal advice.* While market-timing might work great for him, it doesn't for anyone else!

* Luckily he explicitly contradicts himself elsewhere in the letter:

"Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet."

Yes but even those of us not named Warren Buffett can benefit from his wisdom. First buy his stock, and second listen to his advice.  If you listened to his advice in June 2000 that tech stocks were widely overvalued and that while eventually the automobile business was a very profitable, that virtually all of the early automaker went ouf of business, and acted selling tech stock or at least stop buying them,which I did, you would have save yourself a lot of money.   Also if you had done what he strongly suggested in Oct 2008 and bought stocks you would have come out quite well as it turns out he was 6 to 9 months early with the calls.  But recognizing when stocks are particularly cheap, or particularly expense and adjusting appropriately is an important skill.

[Otsog]

On market timing I think there is a subtle, but important distinction.  It will appear at many times through his career that Buffett And Munger used market timing.  But, they never had a lot of cash on hand because they thought the market was going to drop, it was because they couldn't find stocks that met their criteria. If you set yourself rough quantitative metrics of not paying more than 15 PE or 10x pretax earnings then there are going to be points where you can't find quality companies that meet your quantitative criteria. Due to some basic human tendencies we'll find ourselves tempted to bend our own rules, this is where Buffett means do not get sucked in to some flashy looking deal. If you can't find something cheap, you need to be patient.  Buffett is making the call that at some point in the future that you will be able to find something cheap, but he is not calling that this will be due to a market correction/crash.

Still, I can see how that could be called market timing. I'd just propose that Buffett's market timing is due to him looking at many thousands of companies and determining nothing is cheap enough to meet his criteria.  Versus what is conventionally called market timing which is making broad macroeconomic calls that have questionable supporting data and are more driven by human emotion/fear.

[clifp]

On market timing I think there is a subtle, but important distinction.  It will appear at many times through his career that Buffett And Munger used market timing.  But, they never had a lot of cash on hand because they thought the market was going to drop, it was because they couldn't find stocks that met their criteria. If you set yourself rough quantitative metrics of not paying more than 15 PE or 10x pretax earnings then there are going to be points where you can't find quality companies that meet your quantitative criteria. Due to some basic human tendencies we'll find ourselves tempted to bend our own rules, this is where Buffett means do not get sucked in to some flashy looking deal. If you can't find something cheap, you need to be patient.  Buffett is making the call that at some point in the future that you will be able to find something cheap, but he is not calling that this will be due to a market correction/crash.

Still, I can see how that could be called market timing. I'd just propose that Buffett's market timing is due to him looking at many thousands of companies and determining nothing is cheap enough to meet his criteria.  Versus what is conventionally called market timing which is making broad macroeconomic calls that have questionable supporting data and are more driven by human emotion/fear.

This is somewhat true, but there have been several times when Buffett has said stocks are expensive (June 2000) and they are cheap Oct 2008.

Here are some selected portions of his NY Times Op Ed.

THE financial world is a mess, both in the United States and abroad....

So .. I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities...

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over...

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

This is a pretty explicit market timing moving from 100% bonds to 100% stocks and suggesting that other do the same. On the Friday before his Op Ed the SP closed at 940, it rally to 985 the Monday after his Op Ed and it was a full 5 months before hitting the low. 

[Kriegsspiel]

On market timing I think there is a subtle, but important distinction.  It will appear at many times through his career that Buffett And Munger used market timing.  But, they never had a lot of cash on hand because they thought the market was going to drop, it was because they couldn't find stocks that met their criteria. If you set yourself rough quantitative metrics of not paying more than 15 PE or 10x pretax earnings then there are going to be points where you can't find quality companies that meet your quantitative criteria. Due to some basic human tendencies we'll find ourselves tempted to bend our own rules, this is where Buffett means do not get sucked in to some flashy looking deal. If you can't find something cheap, you need to be patient.  Buffett is making the call that at some point in the future that you will be able to find something cheap, but he is not calling that this will be due to a market correction/crash.

Still, I can see how that could be called market timing. I'd just propose that Buffett's market timing is due to him looking at many thousands of companies and determining nothing is cheap enough to meet his criteria.  Versus what is conventionally called market timing which is making broad macroeconomic calls that have questionable supporting data and are more driven by human emotion/fear.

This is somewhat true, but there have been several times when Buffett has said stocks are expensive (June 2000) and they are cheap Oct 2008.

This is a pretty explicit market timing moving from 100% bonds to 100% stocks and suggesting that other do the same. On the Friday before his Op Ed the SP closed at 940, it rally to 985 the Monday after his Op Ed and it was a full 5 months before hitting the low.

He's said before (I just read it in Tap Dancing To Work) that a good way to valuate the TSM is to look at the ratio of market cap to GNP, with the area below 90% being optimal for investing. When Buffett made his bet against the hedge funds in 2008, the ratio was below 90%.

One of the more interesting lines in that letter, to me, was

... If an investor’s entry point into Berkshire stock is unusually high – at a price, say, approaching double book value, which Berkshire shares have occasionally reached – it may well be many years before the investor can realize a profit. In other words, a sound investment can morph into a rash speculation if it is bought at an elevated price. Berkshire is not exempt from this truth.