The Crown Prince of Investing Speaks

Warning: The following article contains very little original thought from the author. Rather, the article will focus on several items from the Berkshire Hathaway (NYSE: BRK.A) 1999 annual report, and the Chairman's Letter, penned by Warren Buffett. For anyone whose investing philosophy extends beyond "that which might go up tomorrow," there is no better allocation of time than to study these annual "state of investing" letters. The education that one would receive spending a week reading all of the Chairman's Letters is incalculable. I can safely say that someone who gains no insight from Warren Buffett -- even if that insight comes from disagreement -- has no business investing.

I could write a tome (and as stilted as my writing is, that wouldn't be much of a stretch) and not communicate what Mr. Buffett does in a single paragraph. Have I genuflected enough? OK, let's get started. Wouldn't want to be accused of being wordy.

By far, my worst-performing investment over the last 12 months has been Berkshire Hathaway, with a total performance -- for me -- of about -30%. This performance came in part because I chose several points along its current swoon to buy it "on sale." But those shares came at a level somewhat dear compared to the current stock price. I am not alone. On the Fool Berkshire Hathaway message board, as every psychological barrier was pierced, even some longtime holders expressed some dismay at the recent performance of their signature holding. And yet, we all awaited the Berkshire annual report with bated breath, because we wanted to see what new wisdom Warren Buffet would share. You would be hard-pressed to name another company, another manager, who would command such loyalty after such a dismal short-term showing. And the reasons for this are simple.

First and foremost, Warren Buffett is completely freaking honest with his shareholders. In his letter, above the fold, on the front page, he said, in effect, "My fault." No simpering about the economic conditions that conspired to crush several of Berkshire's key holdings. The laggards included Rule Maker Coca-Cola (NYSE: KO), Gillette (NYSE: G), Wells Fargo (NYSE: WFC), the Washington Post Company (NYSE: WPO), Disney (NYSE: DIS), and wholly owned General Re. The public holdings were down by an average of 28% last year, and yet Mr. Buffett's letter was critical not of their managerial lapses, but of his own capital allocation performance. I defy anyone to find such a blunt self-critique from any other corporate leader, particularly following such a bad annual performance.

"But wait," you say, "Warren Buffett has made many of his shareholders fabulously wealthy. He can expect latitude that other managers do not have." Certainly, this is true. But this is why a read through of all of the Berkshire Chairman's Letters is so crucial. Buffett was just as brutally honest 30 years ago, before he had a track record to hang his hat on.

The last time Berkshire Hathaway's performance trailed that of the S&P 500 was 1980 (it has only done so four times since Berkshire Hathaway entered its present form: 1967, 1975, 1980, and 1999). Read the report from that year and you'll see similar remarks as you do in the current version.

"You'd have been better off if I had gone to the movies."

"We try to be conservative, but an unpleasant surprise is always possible."

"I have erred to the side of not making repurchases [of shares]."

I want to expand upon this last remark, because it relates to Rule Maker companies, purchasing strategies, and management techniques. Warren Buffett has never in the past repurchased from investors any shares of Berkshire Hathaway, for the reason that he has always felt that he would be overpaying. In effect, for any company to execute a repurchase under such a scenario rewards departing shareholders at the expense of those who remain. Still, share repurchases have become the vogue among companies, being used to bolster investor confidence and prop up shareholder value. While the goal for any and all companies should be to make superior returns for their owners, the concept of paying $1.10 for something worth $1 for the sake of appearances or short-term gains does in fact seem myopic. Buffett in the past has used market inefficiencies to purchase not Berkshire shares, but rather portions of other companies.

It is interesting that he has chosen this year to repurchase Berkshire shares, as a major component of losses came from its publicly traded holdings. Still, with all the stock price decreases at these companies, Buffett does not find any of them to be at a price worth purchasing. (Makes me feel a bit estupido for recommending that the Rule Maker buy Coke two weeks ago.) But make no mistake, Buffett is not opting to repurchase company shares to make shareholders feel better; he is doing so because the market price of his company makes it the most compelling investment at this time. This important distinction may be lost on many investors, especially ones who have only experienced the stock market gains of the last decade. The "by any means necessary" concept of propping up share prices makes perfect sense to such investors used to success through momentum.

This comes back to my column of last week, in which I wondered what the buying criteria should be for the Rule Maker Portfolio. We have a constriction that Buffett lacks, namely, our investments are timed and programmatic. We purchase monthly, at a level dollar amount, where Berkshire Hathaway could go years without adding to or subtracting from its market positions. But if an over-50% drop in Gillette doesn't make it attractive for additional purchases by one of its largest shareholders, it's pretty clear that the shareholder is using something different from market performance to evaluate its attractiveness. But what is it?

Well, I can't really speak to Buffett's methods here. In this past year, he has elected to hold on to all of his major holdings except Disney. Something in Disney's prospects told Buffett that not only had its last 18-month performance been miserable, but also it wasn't going to get any better. He sold, not because it went down, certainly not because it went up, but because he saw no reason to expect good returns from Disney in the next 10 years.

If I may be so bold, I'd like to add an "Amen, brother!" Buffett's got this much right. He asks himself not "Where are we?" (i.e., "How much are we up, or down?") but rather "Where are we going?" That's making rules. Buffett believes that Gillette still does, but Disney does not.

And that's the thing I think I've been missing. I'm looking to manage a portfolio, shore up the defense, buy the laggards, when what I need to do -- what is Foolish -- is make sure that the company I recommend, even if it is just for a monthly contribution, is the one with the best prospects over the next decade from that moment onward.

Put it that way, and it seems pretty simple.

Fool on!
Bill Mann, TMFOtter on the Fool Boards

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