Intrinsic Value > Book Value
WB shares that for Berkshire Hathaway, the ratio of the book value to the intrinsic value has remained fairly constant, resulting in the fact that the book value is a good proxy for the intrinsic value of Berkshire. He explains that this is a result of their businesses increasing earnings by a lot, while using only very little extra capital (remember Return on Equity, Return on capital, and what he mentioned in the previous year).
This accomplishment builds economic value, or "Goodwill," that does not show up in the net worth figure on our balance sheet, nor in our per-share book value.
Size Matters (and why this is important for you)
WB has mentioned several times that size matters a lot, that it's getting harder and harder for Berkshire to generate high returns (like in the past) simply because they are getting too big. This is an important point because individual investors tend to listen to their financial advisors and determine that they can't generate good returns or beat the market by themselves and should just leave their money with them. This is erroneous on several counts. Big companies like Berkshire have all kinds of difficulties which individual investors dont face.
even under favorable conditions, our returns are certain to drop substantially because of our enlarged size
The Key Principles
Halfway through the letter, WB discusses again his philosophy when it comes to buying common stock in companies, which are the 4 main principles that we adhere to all the time at BTS. It's worth repeating that WB sometimes waits for years for good opportunities to come along, and it's not possible to predict when such a deal will come along. As small individual investors ourselves, it's important to remember that even WB have to wait. But our investment universe is a lot bigger - we can access many more companies than he can, simply because our portfolios are alot smaller.
When conditions are right that is, when companies with good economics and good management sell well below intrinsic business value - stocks sometimes provide grand-slam home runs.
we have no idea - and never have had - whether the market is going to go up, down, or sideways in the near- or intermediate term future
Be greedy when everyone is fearful
Again, WB reminds everyone that the stock market is always bipolar and occasionally irrational, there will always be opportunity for you to buy, but you can't predict when it's going to come along.
What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community.
Back to basics. Basics and Fundamentals
At the end of the day, value investing requires us to look at the fundamental or intrinsic value of the businesses, and not be fooled by fancy accounting, and definitely not let the stock prices dictate how we perceive value of the businesses. WB reminds us that ultimately, the stock prices will revert back to business fundamentals.
stocks can’t outperform businesses indefinitely.
A Useful Accounting Appendix
In this letter, WB gives a numerical accounting example of two different companies, and demonstrates the correct way to value a company, and looking past the "accounting rules". Useful masterclass in catching some of these red flags.