Rising Tide Raises All Boats
Similar to how we should hold on to our portfolio when the market unfairly undervalues our businesses, we shouldn't be too exuberant when the market irrationally overvalues our businesses - ultimately we focus on the intrinsic business value of companies, continue to study the industry, and allow our businesses to grow, slowly but steadily, at 15% p.a.
Any investor can chalk up large returns when stocks soar, as they did in 1997. In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond.
This is particularly poignant in light of what we saw in the last decade, when Berkshire lagged the S&P500 (2010 - 2020). WB already acknowledges this universal truth back in 1997.
When the market booms, we tend to suffer in comparison with the S&P Index. The Index bears no tax costs, nor do mutual funds, since they pass through all tax liabilities to their owners. Last year, on the other hand, Berkshire paid or accrued $4.2 billion for federal income tax, or about 18% of our beginning net worth.
Again, in this letter, WB emphasizes that Berkshire cannot continue to do as well simply because it's a lot larger, the investment universe that it can access and that can give it meaningful returns are smaller, and it's going to be increasingly harder to maintain the same levels of return.
It's no wonder that my annual results in the 1950s were better by nearly thirty percentage points than my annual gains in any subsequent decade. Charlie's experience was similar. We weren't smarter then, just smaller. At our present size, any performance superiority we achieve will be minor.
High prices doesn't mean price will fall
One important point that WB brings up this year, is that even though relative to intrinsic business value, prices are high, it doesnt mean that prices will fall. Markets can remain irrational for a very long time, and it's not helpful for anyone to try to predict when they will rise or when they will fall.
Prices are high for both businesses and stocks. That does not mean that the prices of either will fall -- we have absolutely no view on that matter...
Wait for the right pitch
Again, in this letter, WB repeats his point about waiting for the right pitch. If we follow the 4 key principles, we just have to wait for the right price to come around.
In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his "best" cell, he knew, would allow him to bat .400; reaching for balls in his "worst" spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors.
If they are in the strike zone at all, the business "pitches" we now see are just catching the lower outside corner. If we swing, we will be locked into low returns. But if we let all of today's balls go by, there can be no assurance that the next ones we see will be more to our liking. Perhaps the attractive prices of the past were the aberrations, not the full prices of today. Unlike Ted, we can't be called out if we resist three pitches that are barely in the strike zone; nevertheless, just standing there, day after day, with my bat on my shoulder is not my idea of fun.
Value-Investing Mindset: Happy when prices fall
In this letter, WB mentions his oft-quoted mantra that as investors who are looking for an attractive price to acquire good businesses, we should be happy when prices fall.
If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
A similar attitude, as business owner, should be that we are happy when we get the opportunity to buy businesses at ever-lowering prices.
Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices