All intelligent investing is value investing — acquiring more than that you are paying for. You must value the business in order to value the stock.” Charlie Munger

Each year during the last week of February, Warren Buffett releases the annual report and shareholder letter of his controlled company, Berkshire Hathaway. For many owners of Berkshire’s stock, it is a chance to marvel at the wisdom of the legendary investor and laugh at his unique way of imparting cherished knowledge.  From a whopping number of seven attendees when he first began holding his annual meeting, this year’s rendezvous will draw close to 40 thousand. The biggest reason for such a dramatic increase is the incredible wealth Mr. Buffett has created for its owners. Just as important are his writings and unique way of imparting his business experiences in an easy to understand and memorable way. Consequently, the annual letter to shareholder is literally required reading for participants in the investment industry.  As such, let me share some observations after digesting this year’s version.

The first area I found interesting was where the bulk of Berkshire’s investment gains in current holdings come from. The answer, in terms of absolute performance and market value, is primarily in three holdings, Coca Cola, American Express, and Wells Fargo.  The first two have market appreciation close to 10 billion dollars on investment of around one billion. The latter also has a gain of fifteen big ones, but the capital used is much higher, nearly $13 billion.  Next, Mr. Buffett remarked on his experiences with acquisitions and how he made mistakes by using stock in acquiring a few companies which subsequently performed poorly.

Cash is now probably the preferred currency in ongoing purchases of additional companies. As an individual investor, it is a reminder to pay close attention to the deal structure of companies you own when they make acquisitions.  Cash is the most conservative approach, but probably not the most tax efficient. Third, when you look at the operating earnings of the non-insurance and utility businesses that Berkshire owns, the clear emphasis is business quality. The investment holdings Coca Cola and American Express are prime examples of high quality businesses which were purchased and produced massive gains because of later growth. The common characteristic is for the company to take operating profits and reinvest that capital back in the business at high rates of return, fueling profit expansion in future years. Fourth, Mr. Buffett makes positive remarks about companies buying back their own stock, which is contrary to what some investment analysts believe. Probably the biggest takeaway there is paying attention to the leading quote from Mr. Munger.  

Buffett also gave his opinion about why passive investing (through indexes) is probably the best way to invest for most people.  Essentially, professional investors, mainly hedge funds, cannot beat indexes because of the high fees they charge. I would note Buffett has changed his tune over the years on this subject.  As he was growing his business empire, Buffett routinely made the observation on how beating the S&P 500 by small or large amounts over a long period of time could make a dramatic difference in how much wealth is accumulated.  I guess it is a case of do as I say, not as I do, which is understandable. Buffett’s position has changed a great deal so it is probably better for him to be more conservative in how he advises the general public.  The great thing about investing is you can choose whatever approach which bests suits you, either, both, or neither.  

Additionally, let me offer this copy of a funny story, which, in full disclosure, comes straight from the annual report this year (Pg 25, 2016 Berkshire Hathaway Annual Report) -

"Long ago, a brother-in-law of mine, Homer Rogers, was a commission agent working in the Omaha stockyards. I asked him how he induced a farmer or rancher to hire him to handle the sale of their hogs or cattle to the buyers from the big four packers (Swift, Cudahy, Wilson and Armour). After all, hogs were hogs and the buyers were experts who knew to the penny how much any animal was worth. How then, I asked Homer, could any sales agent get a better result than any other? Homer gave me a pitying look and said: 'Warren, it’s not how you sell ‘em, it’s how you tell ‘em.' What worked in the stockyards continues to work in Wall Street."

If you want to read the letter, here is the link.

In the financial markets, the week was full of earnings reports, including from heavyweights in the retail sector like Wal-Mart, Macy’s, Kohl’s, JC Penney’s, and L Brands.  Expectations remain very low about this group because of the competitive dynamic regarding the big A.  In case you don’t quite get it, see the prior comment about reinvesting capital.  Another area where quite a few companies reported was in quick service dining.  Jack In the Box, Cracker Barrel, and Red Robin Gourmet announced results which were varied but pretty much as expected.  December proved a difficult month for the industry because of tough weather.