After I read The Snowball (for the first time) I was inspired to read all of Buffett’s Berkshire Hathaway’s annual letters. Unlike other CEO’s Buffett writes an annual letter in March of the following year. What I have found is that it provides insight to his ‘partners’ of the many businesses that BRK owns, while sprinkling in some of his thoughts about other topics. Granted, some parts of these letters are dry (especially if you don’t know the story behind some of the businesses he refers to) but there is also so many ideas and tidbits straight from Warren Buffett’s mind. Where else can you read such unadulterated thoughts from a self-made billionaire?
For example in the past he has discussed, his views on stock splits and why they aren’t appropriate for Berkshire Hathaway, why shareholder’s should be treated like his fellow owners more like partners rather than faceless shareholders, and even the ridiculousness that are stock compensation plans.
Every year I am excited to check out the letter and 2018 was no different. I didn’t compare it to year’s past, but the letter felt a bit shorter, but it had some fantastic points that really resonated with me. This post should not be considered a full review of this year’s annual letter, rather, these are just two themes that really made me sit back and think about my particular situation. If you take the 20 minutes or so it may take you to read the letter you may pull an entirely different idea from it.
Reducing Leverage and Risk
If you follow the business news at all it isn’t hard to find Buffett talking almost quarterly about his dislike of leverage and debt. Notwithstanding the repetitiveness of his message of the years, he had a fantastic thought in this year’s letter that made me really think about the risk I am willing to incur,
The ample availability of extraordinarily cheap debt in 2017 further fueled purchase activity. After all, even a high-priced deal will usually boost per-share earnings if it is debt-financed. At Berkshire, in contrast, we evaluate acquisitions on an all-equity basis, knowing that our taste for overall debt is very low and that to assign a large portion of our debt to any individual business would generally be fallacious (leaving aside certain exceptions, such as debt dedicated to Clayton’s lending portfolio or to the fixed-asset commitments at our regulated utilities). We also never factor in, nor do we often find, synergies.
Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need. We held this view 50 yearsago when we each ran an investment partnership, funded by a few friends and relatives who trusted us. We also hold it today after a million or so “partners” have joined us at Berkshire.
The emphasis was obviously added by me, but that very short sentence hit me hard. When I read it all I could think about was Fight Club (a movie I doubt Mr. Warren E. Buffett has seen):
How many people do you know are out there taking unnecessary risk to buy material bullshit? They are risking their life working jobs they hate just so they can buy shit they don’t need. They are taking on risk, leveraging themselves out with shitty penny stocks or cryptocurrencies, for what? At what likely and very immediate cost?
Further, into the letter Buffett provides us with the following thought,
There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.
In the next 53 years our shares (and others) will experience declines resembling those in the table. No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow. When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt.
That’s the time to heed these lines from Kipling’s If:
“If you can keep your head when all about you are losing theirs . . .
If you can wait and not be tired by waiting . . .
If you can think – and not make thoughts your aim . . .
If you can trust yourself when all men doubt you…
Yours is the Earth and everything that’s in it.”
I have been getting more and more comfortable with taking on leverage and debt to increase my exposure. I had a bit of a run-in in February with regard to a maintenance call issue (not margin call). So, I am going to take his advice to heart and slow down on the increased leverage. Which leads us to the second very powerful theme that Buffett brought up multiple times.
Buffett’s View on Cash as Evidenced in the 2017 Annual Letter
Similar to his view on debt, Buffett is not shy when it comes to sharing his view on cash. I am not sure if it is how he said it or the state of mind I was in when I read the letter, but this time it really has stuck with me for the past week or so,
Charlie and I never will operate Berkshire in a manner that depends on the kindness of strangers – or even that of friends who may be facing liquidity problems of their own. During the 2008-2009 crisis, we liked having Treasury Bills – loads of Treasury Bills – that protected us from having to rely on funding sources such as bank lines or commercial paper. We have intentionally constructed Berkshire in a manner that will allow it to comfortably withstand economic discontinuities, including such extremes as extended market closures.
This paragraph single handly convinced me to increase my cash reserves both in my non-qualified and retirement accounts. I am fully convinced (although I’d be pretty ecstatic to be wrong) that there is some type of ridiculous correction coming. Ten years seems way too long of a time not to have a complete meltdown of the system. And like Buffett, I do not want to be in the place where I am going to have rely on the “kindness of strangers” when there is a downturn (even if it is just to take advantage of the market conditions).