Since my last newsletter, where I explained how I was hedging part of my portfolio to buy some peace, I have taken a break from market analysis.
I took the opportunity to be away from the headlines to read the latest Warren Buffet's annual letter to Berkshire's shareholders. It is from February 26th, 2 days after Russia invaded Ukraine and well into the stagflation risk drama. The S&P500 was already in correction territory. I was looking at some wisdom in the middle of so much uncertainty. Here is what I found.
How good are Warren Buffet's results?
The letter starts with its results, comparing the 57 years track record of Berkshire Hathaway vs. the S&P500. I was particularly interested in how the oracle of Omaha fared in terms of volatility over the year.
How many years did they lose money?
11 years, or 19% of the time, about the same as the S&P500, which lost 12 years of 57.
What is the Standard Deviation of Buffets' results?
33 pp, vs. 17 for the S&P500 🤯. Boom, Berkshire shareholders had to endure higher volatility than the market. For example, their worst yearly drawdown was-48.7% ☢️, while the S&P500 -37%,
How many years did they underperform in the market?
19 years, that's one-third of the time.
In the end, Warren reports doubling the S&P500 yields over 57 years, with a compounded average of 20% a year (not inflation-adjusted)... This is why he is such a legend, but it is refreshing to see that even a legend can have veeeeery bad years, and not a few of them.
How did he pull this out?
Warren Buffet's core strategy
Charlie and I are not stock-pickers; we are business-pickers. Our goal is to have meaningful investments in businesses with durable economic advantages and a first-class CEO.
How to handle difficult times like right now
We own stocks based on our expectations about their long-term business performance, not because we view them as vehicles for timely market moves. 💣
The backbone of Berkshire's portfolio: Insurance
Berkshire has become the world leader in insurance "float" – money we hold and can invest, but that does not belong to us.
What is insurance float? It is the amounts that insurance companies hold but have not yet paid out to claimants. Thus, this money belongs to the policyholder until the event for which they got insured happens.
Berkshire's total float has grown from $19 million to $147 billion in 55 years. According to Buffet, it is a long-term play by definition and is "immune to precipitous decline".
So far, this float has cost us less than nothing. We have experienced several years when insurance losses combined with operating expenses exceeded premiums. However, we have earned a modest 55-year profit from the underwriting activities that generated our float.
Warren's favorite metric to measure value
The old-fashioned sort of earnings we favor is a figure calculated after interest, taxes, depreciation, amortization and all forms of compensation.
In other terms, he favors NOPAT over the typical EBITDA, or even worse, "adjusted EBITDA". He warns against using any other adjustment to earnings as "deceptive". He partly refers to stock-based compensation when he writes about "after all forms of compensation". That is to say, he considers stock-based compensation (SBC) as a direct cost, just like GAAP accounting standards. So be careful when using the Free Cash Flow definition used in earnings, Bloomberg terminals and so on. It almost always adds back SBC to the NOPAT as a non "cash expense" (but someone will still need to pay for it!).
What is Warren Buffet doing with its investments right now?
Berkshire's balance sheet includes $144 billion of cash and cash equivalents. Of this sum, $120 billion is held in U.S. Treasury bills, all maturing in less than a year.
Meaning: he is holding a significant cash position. Why?
This is the consequence of my failure to find entire companies or small portions thereof (that is, marketable stocks) that meet our long-term holding criteria(...) From time to time, such possibilities are both numerous and blatantly attractive.
He finds the overall market overpriced, can't find good buy opportunities and holds about 20% of its total portfolio in cash. However, he does not even remotely mention that he is selling his positions.
A few days ago, Warren made the headlines. It just announced a deal to acquire the U.S. insurance conglomerate Alleghany for $12Bn. So it seems he did find an attractive enough opportunity in the middle of the current volatility chaos. It's an encouraging sign for the investors freaking out, though it is just about 2 pp of its total portfolio.
What now? I am taking it slow...
Berkshire (...) might be far from the best selection our shareholders could have made. But (...) people who are comfortable with their investments will, on average, achieve better results than those who are motivated by ever-changing headlines, chatter and promises.
This is the last golden nugget from this letter, a lot of humility is needed to be a great investor, but also "comfort" in the strategy you chose in the first place. Consistency + humility, I will chew on that for the rest of the year.
As a reminder to myself, my strategy is to retire by 2030, compounding my savings for the next 8 years. It also means I cannot lose 50% of my investments as Warren did in a single year, else I would not be able to retire by 2030. Or will I? Let's say I invested 100$ in Berkshire right before its worst year ever in 1974 (yes, during the first U.S. stagflation period), and lost -48% right after that. How many years would it have taken me to recover the losses? 2 years... Wow, I was not expecting to be so quick; it would be quicker still if I kept investing regularly. What if I invested right before its second-worst year ever in 2008? It would have taken me between 4 and 5 years if I did not keep investing, and less if I did. That thinking is proper only if the past is a good indication of the future. Still, the past is precisely what bubble historians like Grantham use to warn about the current market conditions.
Right now is when I can take more significant risks without putting my plans too much at stake, and this is what I intend to do. I did hedge part of my portfolio to buy some peace of mind and to feel more "comfortable", but I will resume stock buying soon. Stay put, stay rookie, stay thirsty and happy investing!