Secret to Investing Success on 2020

Warren Buffett is one of the most respected investors globally. Over the last five decades, he writes a letter to his shareholders every year. The letter analyzes the performance of Berkshire Hathaway (BH) and also provides his insights on the global economy, markets and investing trends.

The 2020 letter was published this past week and you can access the letters from 1977 here. Let us look at some of his key observations which would be relevant for us from a personal finance viewpoint.

Fixed Income Investors world-wide face a bleak future

• Interest rates have dropped from 15.8% to 0.93% – Over the last four decades, Interest rates have dropped from 15% in 1980 to 0.93% by end of 2020. The trend of falling rates is very clear over this time period, with several large economies having negative interest rates
• Purchasing lower credit papers is not the answer – As a massive insurance firm, Berkshire has 138 Billion dollars of float. Getting higher yields by purchasing lower credit paper has proved disastrous for investors in the past and it is not the solution
• Role of fixed income is to provide safety – Berkshire follows an equity-heavy investment strategy which is not traditionally done by insurers. They are able to do this due to the heavy cash flows plus additional buffer capital (in addition to the regulatory requirement)

Equity Investing Lessons

• From chocolates to furniture, promoters make the difference – The BH portfolio has several examples where they have invested in promoters with a passion for growth. This covers a range of companies from See’s Candy (chocolates) to Nebraska Furniture Mart (NFM). They have all been multi baggers for BH
• A compact set of high-quality companies works well – The market value of the equity portfolio is 280 Billion USD. Out of these the top 15 companies have a value of 240 Billion (17 lakh crores). Clearly, we don’t need too many stocks in our individual portfolios !
• Focus on earnings growth in high quality companies – BH has built their energy business over decades. The earnings have grown from 122 million USD to 3.4 Billion USD over the last 21 years. Do note the focus on earnings growth (not share price increase)
• Share Repurchases are a very powerful way to increase ownership – BH owns 5.4% of Apple and it is their largest investment with a market value of 120 Billion USD. Both Apple and BH have been repurchasing their shares regularly. Because of this BH shareholders own 10% more of Apple then they did in 2018
• Hold manufacturing and services in your portfolio– The two largest investments BH owns now is BNSF (America’s largest railroad by freight volume) and Apple. These two companies are at the opposite end of the spectrum and they provide stability as well as growth
• Money can be made outside technology – BNSF has paid 41 Billion USD in dividends to Berkshire while maintaining a good cash balance and has made money in 2020 which has been a very tough year for industries

Investment Behavior Lessons

• Remain optimistic and “Never bet against America” – Warren Buffett has continued to make giant bets on America. By making giant bets in industries like railroads, utilities, travel homes etc. He could make these bets only by remaining optimistic about the growth prospects of the US economy.
• Don’t be afraid to learn and invest in new sectors –For decades Warren Buffett did not invest in technology. While being a close friend of Bill Gates he stayed away from firms like Microsoft. However, he went ahead and made investments in Apple starting from 2016. The investment of 30 Billion USD has grown four times to 120 Billion USD and is his single biggest investment today
• Do not hesitate to admit your mistakes – Every year, he talks about the biggest investing mistakes he made. This year Buffett talks about a 11 Billion USD loss from an investment in Precision CastParts. When we take decisions, some of them will go wrong. The key is to get more decisions right, admit your mistakes and learn from them (rather than hiding them and pretending we never make mistakes)
• Power of Sequence of returns and long-term performance – For the past two years (2019 and 2020), BH shares have underperformed the S&P 500 by big margins. For e.g., in 2020 BH shares moved up 2.4% when the S&P 500 moved up 18.5%. However, over the last five decades BH continues to outperform the S&P 500 by a huge margin (20% returns for BH from 1965 to 2020, compared to 10% for S&P 500 over the same period). Having a long-term view makes all the difference

Summary 

As always, the biggest takeaway for us is to understand and internalize the two long term trends a) Fixed income investors are in for a tough time and b) It pays to remain optimistic and invest in equity via high quality companies. The 2020 BH letter reinforces these points and provides five decades of experience across industries. As Individual investors, we should try to learn and improve our investment decision making ignoring short term market movements and noise. This will help us generate substantial wealth in the long run.