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2011 Shareholder Letter

Published on 25 February 2020

· Value Investing

The original 2011 Shareholder letter can be found here (https://www.berkshirehathaway.com/letters/2011ltr.pdf)

You are buying a business

As always, WB reminds everyone that you should view any new investments as though you are buying the whole company, and make your calculations as such. If you are not willing to buy the whole company (if you have the money), then you shouldn't even buy one stock.

We view these holdings as partnership interests in wonderful businesses, not as marketable securities to be bought or sold based on their near-term prospects.

Focus on Intrinsic Business Value

As always, WB advocates focusing on Intrinsic Business Value, and uses the S&P500 as a benchmark. Again, he acknowledges that there's no single way to accurately determine the intrinsic value at any point in time, but at Berkshire (unlike many other companies), the book value serves a pretty good proxy (albeit still rough) to the intrinsic value.

This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values. That’s because the amount by which Berkshire’s intrinsic value exceeds book value does not swing wildly from year to year, though it increases in most years. Over time, the
divergence will likely become ever more substantial in absolute terms, remaining reasonably steady, however, on a percentage basis as both the numerator and denominator of the business-value/book-value equation increase.

Share Repurchases

In this year, Berkshire did a small amount of share repurchase, and in this letter, WB elaborates on his criteria for doing so. As with all value-investing, you want to get a good deal, so it makes sense to only do share repurchases when the stock market has undervalued your stock.

Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.

Applying this to ourselves as individual investors means that we should only invest money that we don't need in the short run (have 6 months of emergency funds etc).

Very interestingly, and perhaps this speaks volumes about WB's character, is that WB feels bad when he's doing share repurchases because it means that he's buying out a portion of shareholders, who may think that the stock is overpriced, but if WB's buying it, that means WB thinks it's underpriced. Of course, shareholders may be selling for various reasons (they need the money, they want to invest in something else etc), but WB feels that since they are partner, it's his responsibility to inform them his view of the intrinsic value of the stock.

Charlie and I have mixed emotions when Berkshire shares sell well below intrinsic value. We like making money for continuing shareholders, and there is no surer way to do that than by buying an asset – our own stock – that we know to be worth at least x for less than that – for .9x, .8x or even lower. (As one of our directors says, it’s like shooting fish in a barrel, after the barrel has been drained and the fish have quit flopping.) Nevertheless, we don’t enjoy cashing out partners at a discount, even though our doing so may give the selling shareholders a slightly higher price than they would receive if our bid was absent. When we are buying, therefore, we want those exiting partners to be fully informed about the value of the assets they are selling.

We are net buyers of businesses in the long run

One important aspect of investing is getting the emotional fortitude to go against the crowd. WB, over many decades of investing, has acquired the ability to think independently and not listen to the crowd.

The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.

This is such an important emotion to get correctly, but too few people can, simply because it's just unnatural to feel happy when your stock price keeps dropping like a stone. Even though in normal everyday life, we are generally happy when prices of goods and services drop like a stone.

What Is Investing?

Many people get into investing to make money - absolutely correct. If you're buying stocks because you like the company but doesn't care if it makes money, it's probably called charity, and not investing. We give up our excess cash now, in the hopes that we can get more money back in the future - that's 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.

A corollary: Risk

Of course, no discussion on investing can come without a concept of risk. Unfortunately for the past few decades, academics have focused on using Beta (a measure of volatility) as a proxy for risk - which is simply not logical, especially when it's quite clear that volatility in the stock price may or may not be caused by underlying business fundamentals. Mispricings happen so often, that it's quite absurd to say that the stock price takes into account all necessary information about the future.

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.

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