Monday, March 1, 2010

Buffett’s Latest Wisdom

Warren Buffett’s eagerly anticipated 2009 letter to shareholders of Berkshire Hathaway arrived on the weekend. For long-time fans, this letter doesn’t disappoint. It contains more of his priceless wisdom expressed clearly and wrapped in humour. Here are some examples.

Not relying on being too-big-to-fail

In a jab at reckless banks, Buffett says “We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback position at Berkshire. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity.”

Berkshire maintains cash reserves similar to the emergency funds we’re all supposed to have for ourselves. The main difference is the size of the emergency fund: “The $20 billion-plus of cash equivalent assets that we customarily hold is earning a pittance at present. But we sleep well.”

Housing recovery

Buffett seems optimistic about the future of the US housing market saying “within a year or so residential housing problems should largely be behind us, the exceptions being only high-value houses and those in certain localities where overbuilding was particularly egregious.”

Investing climate “ideal”

“We’ve put a lot of money to work during the chaos of the last two years. It’s been an ideal period for investors: A climate of fear is their best friend. Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance.”

CEO misbehaviour

“The CEOs and directors of the failed companies ... have largely gone unscathed. ... If their institutions and the country are harmed by their recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by insurance. CEOs and, in many cases, directors have long benefitted from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.”

Accepting payments to take on enormous risks seems profitable until something goes wrong. During this period of apparent profitability, CEOs and their underlings collected obscene bonuses on the illusory profits. Without some change to the way CEOs are compensated, they have every incentive to do more of the same.

Berkshire Hathaway undervalued

Buffett wasn’t happy about issuing stock as part of the takeover of Burlington Northern Santa Fe because “Charlie and I believed (Berkshire shares) to be worth more than their market value.” Don’t be too quick to run out and buy Berkshire stock on this apparent recommendation. At the time class A shares traded for US$98,750 each, but as of Friday’s close they trade for US$119,800, a 21% increase.

Justifying poor investment choices

Buffett told an interesting story about a bank he owned stock in long ago that made a dumb acquisition. In a justification reminiscent of a recent blog post on justifying poor investments when they are small, the bank managers said “We need to show that we are in the hunt. Besides, it’s only a small deal.”

Buffet’s business partner, Charlie Munger, had a priceless reaction: “Are we supposed to applaud because the dog that fouls our lawn is a Chihuahua rather than a Saint Bernard?”

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