Investors eagerly wait to read the annual letter to Berkshire Hathaway shareholders by its CEO and stockpicker-in-chief, Warren Buffett. You can read the latest insights from the Wizard of Omaha here.
As always, it's an illuminating, insightful read into business, the economy and investing. The big news in the letter is the company's board of directors has finally identified--but not named--the successor to the 81 year old Buffett.
However, what I like about the letter is going through his judicious comments on a wide range of subjects. For example, he covers the good and bad of corporate stock buybacks, the mechanics of the insurance industry, the allocation of capital in a regulated business like utilities, and mortgage lending to owners of manufactured homes.
Berkshire Hathaway is a diversified conglomerate with 54 companies involved in everything from candy (See's) to railroads (BNSF) to manufactured housing (Clayton). One of its companies--Marmon--itself owns 140 operation in 11 distinct business sectors. In essence, the Buffett long-term investment strategy is to own high-quality companies with good managements that reflect the diversity of the U.S. economy and businesses. He enjoys a unique perch to judge the ups and downs of the U.S. economy. He believes the economy recovery is real. Though housing-related businesses remain in the emergency room, most other businesses have left the hospital with their health fully restored," he writes.
Of course, what people really want to know is what Buffet thinks about investing. I want to highlight two aspects on his thinking.
The first is on the housing market, which he thought would revive last year and it didn’t. He still sees an improving market:
Housing will come back--you can be sure of that. Over time, the number of housing units necessarily matches the number of households (after allowing for a normal level of vacancies). For a period of years prior to 2008, however, America added more housing units than households. Inevitably, we ended up with far too many units and the bubble popped with a violence that shook the entire economy.
That created still another problem for housing: Early in a recession, household formations slow, and in 2009 the decrease was dramatic. That devastating supply/demand equation is now reversed: Every day we are creating more households than housing units. People may postpone hitching up during uncertain times, but eventually hormones take over. And while "doubling-up" may be the initial reaction of some during a recession, living with in-laws can quickly lose its allure.
At our current annual pace of 600,000 housing starts--considerably less than the number of new households being formed--buyers and renters are sopping up what's left of the old oversupply. (This process will run its course at different rates around the country; the supply-demand situation varies widely by locale.)
The gloom is housing is overdone.
He has an extended discussion about investing. Here's how he defines investing:
Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power--after taxes have been paid on nominal gains--in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.
From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability--the reasoned probability--of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.
With that definition in mind he divides the investing world into three categories. The first is fixed income securities, so-called “safe” assets. They're very risky today. The second investment category is assets that don’t produce anything, like gold. He isn’t a fan of gold, either. (I wrote in more detail about the gold market here.)
The third category is investment in productive assets, such as businesses, farms, and real estate. It's what he likes to invest in:
Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See's peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.
Our country's businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial "cows" will live for centuries and give ever greater quantities of "milk" to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of the milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well)…. I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we’ve examined. More important, it will be by far the safest.