The weekend saw the release of the latest Warren Buffett letter.
Every year, investing legend Buffett releases a letter to shareholders in his company, Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B). It often contains a wealth of investing insights and this year was no exception.
Here are three of the powerful investing lessons I gleaned from the latest letter.
1. Earnings alone cannot describe a company’s business performance
Often people focus on a company’s earnings, whether as post-tax profits, earnings per share, or some other such measure.
“At Berkshire,” the new Warren Buffett letter reads, “our view is that ‘earnings’ should be a sensible concept that Bertie will find somewhat useful – but only as a starting point – in evaluating a business.” Bertie is Buffett’s sister and a Berkshire shareholder, whom he uses as an example of a private investor.
Why can earnings mislead?
Consider Berkshire’s performance last year. Operating earnings were $37bn. Yet its net earnings were $96bn. Those are wildly different numbers.
Earnings are an accounting concept that can include non-financial items, such as a markdown in the value at which an asset is carried on a company’s books. With its large insurance operations and investment portfolio, Berkshire can experience significant swings in earnings that do not necessarily reflect its cash flows.
So while — as Buffett says — earnings can be a useful starting point for understanding a firm’s performance, they are only that.
A smart investor also needs to consider other figures, such as the cash flow statement.
2. Identifying future great businesses is very difficult
Buffett writes that Berkshire aims to invest in businesses with “good economics that are fundamental and enduring”.
So far, so good. That alone makes great sense to me as a long-term investor. But how to find such investment opportunities?
According to the latest Warren Buffett letter, “it’s harder than you would think to predict which will be the winners and losers. And those who tell you they know the answer are usually either self-delusional or snake-oil salesmen”.
Note that Buffett does not say always. He says “usually”. In this case I think that is an important distinction.
His own method to find shares to buy involves factors such as looking for industries with large demand that is likely to last for decades and buying at valuations that offer a margin of safety.
3. Seizing opportunities as a private investor
Without Buffett’s massive cash pile can I really apply his investment approach?
I think the answer is yes. In fact, private investors have some advantages over him.
Buffett thinks the best days for Berkshire to make huge, brilliant acquisitions may well be behind it. Why? “Size did us in, though increased competition for purchases was also a factor”.
Size has not done me in. As a small private investor, I can buy shares in businesses that are simply too small to attract the attention of Berkshire with its enormous funds.
In that way, I can apply a key lesson of the Warren Buffett letter to potentially brilliant opportunities Buffett himself would likely not even consider.
