The Berkshire Hathaway 2022 annual report was released on Saturday, February 25th. In every annual report, there is a Chairman's letter written by Warren Buffett. The Chairman's letter is where Warren shares his insights and wisdom about Berkshire Hathaway, investing, and life in general, which I deeply believe we can all learn a tremendous amount from.
With Warren turning 93 in August and his long-time business partner, Charlie Munger, who turned 99 on January 1st of this year, their combined intelligence is astounding. There is a lot of noise and distractions in the world we live in today. Through it all, time and time again, Warren and Charlie provide us with advice and lessons that are simple, brilliant, and unmatched.
Needless to say, if you haven’t read this year’s Chairman’s letter, I highly recommend you do. For now, I would like to take this opportunity to highlight a few of the lessons that I took away from the letter along with lessons I have learned from Warren and Charlie over the years. I would like to focus on four main topics including the power of compounding, dividend increases, share buybacks and retained earnings.
Power of Compounding
Warren Buffett’s mentor, Benjamin Graham, has said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” The market can ebb and flow daily due to investor emotions, current news, reported earnings and much more however, over the long term, the market reflects the growth and overall strength of companies.
Charlie Munger went on to say, “If you keep making something more valuable, then some wise person is going to notice it and start to buy.” Well, Warren and Charlie did just that. They made something that continues to increase in value in every which way through the creation and growth of Berkshire Hathaway.
To put Berkshire’s growth into perspective, the company’s per-share market value has compounded annually at 19.8% since 1965 compared to a 9.9% annual percentage change in the S&P 500. Early shareholders have been rewarded and have benefited from the growth of Berkshire Hathaway tremendously.
The key is to buy great quality companies and hold onto them for a very long time. As Warren mentioned: “make meaningful investments in businesses with both long-lasting favorable economic characteristics and trustworthy managers.” Warren has invested in companies that are well run and provide services and products that we need in our daily lives. As strong dividend paying companies grow over time, investors can benefit from the appreciation of capital and the growing dividend income.
Warren purchases stocks based on his expectations of their long-term business performance. He does not use investments as vehicles to make skillful purchases and sales in attempt to achieve a gain. In the words of Warren: “Charlie and I are not stock pickers; we are business pickers.”
Warren admits that in 58 years of managing Berkshire, the majority of his capital-allocation decisions have been no better than so-so. Warren stated: “Our extensive collection of businesses currently consists of a few enterprises that have truly extraordinary economics, many that enjoy very good economic characteristics, and a large group that are marginal.”
Investing in strong companies with decent but not extraordinary growth comes with its benefits. Although you may not always greatly benefit from remarkable capital gains, being able to reinvest dividends back into the company at a low-cost base allows you to own more shares thus resulting in greater dividend income. The compounding effect continues to snowball as dividends are reinvested, more shares are acquired, a higher dividend income is achieved, and the market value of the investments increase over time. It is not about timing the market, it is about how long you are in the market for.
“The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders. And, yes, it helps to start early and live into your 90s as well.” – Warren Buffett
Dividend Increases
Warren highlighted the significance of holding onto strong dividend paying companies for the long term which he tributes to as his ‘secret sauce.’ Dividends are a portion of a company’s earnings that are returned to shareholders, most commonly in the form of a quarterly payment of cash.
In 1994, Berkshire Hathaway completed its seven-year purchase of 400 million shares of Coca-Cola that the conglomerate still owns to this day. Their total cost was $1.3 billion and in the year the purchase was complete Berkshire Hathaway received a cash dividend of $75 million. Fast forward to 2022, the annual dividend Berkshire Hathaway received from Coca-Cola had increased to $704 million. Growth occurred consistently every year and it was “just as certain as birthdays” as Warren stated.
You can see by this example, by buying a strong dividend paying stock and holding onto it for the long term, you can be rewarded with growing cash flow. In addition to the growing dividends, the stock also brought gains in stock prices. At year-end of 2022, Berkshire’s Coke investment was valued at $25 billion. That is an unrealized capital gain of $23.7 billion. All that was required of Warren and Charlie was to hold onto the growing stock and cash the dividend cheques when they came in.
American Express was another wonderful purchase of Berkshire Hathaway that has a similar story. Berkshire purchased Amex in 1995 at a cost of $1.3 billion. The annual dividends from this investment has grown from $41 million in 1995 to $302 million in 2022. Those dividend cheques also seem highly likely to increase if history continues to repeat itself. In addition to the growth in dividend income, Berkshire’s investment in Amex has a capital gain of $20.7 billion. Both Coca Cola and Amex now account for approximately 5% of Berkshire’s net worth, similar to its weighting in the mid-1990s.
Warren took a moment to depict what the impact would have been if he instead made a similarly-sized investment mistake in the 1990s. If he had made an investment that flatlined and retained its value of $1.3 billion in 2022 (an example would be a high-grade 30-year bond), the disappointing investment would now represent an insignificant 0.3% of Berkshire’s net worth. The investment however, would still be generating an unchanged $80 million or so of annual income.
In 2021, Berkshire Hathaway received an astounding amount of dividend income of approximately $3.8 billion. To put that into perspective, Berkshire received $10.4 million a day in the form of dividends. The dividends of the strong collection of companies Berkshire owns are not only growing but they can be reinvested to allow their investments to further compound.
Share Buybacks
Berkshire Hathaway repurchased 1.2% of the company’s outstanding shares in 2022. Buying back shares at great prices resulted in a direct increase to the shareholders’ interest in the company and their unique collection of businesses.
As Warren said: “The math isn’t complicated: When the share count goes down, your interest in our many businesses goes up. Every small bit helps if repurchases are made at value-accretive prices.”
Furthermore, when the companies that Berkshire owns repurchases their stock, it increases Berkshire’s ownership without any cost to Berkshire. Apple and American Express who are both significant investees of Berkshire Hathaway, repurchased shares in 2022 thus increasing Berkshire’s ownership and ultimately benefiting Berkshire shareholders.
Warren emphasized that value-accretive repurchases benefits all owners in every respect. He made a parallel to an example of three shareholders of a local auto dealership, one of whom manages the business. If one of the passive owners wishes to sell his interest back into the company at an attractive price to the two continuing shareholders, everyone benefits. The two remaining shareholders received a greater portion of the business for a great price.
“When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).” – Warren Buffett
Retained Earnings
Berkshire Hathaway retains their earnings by putting their revenue back into the company. This allows the conglomerate to make further investments in companies they already own or to acquire a part or entirety of additional businesses. Retained earnings benefit both the company and their shareholders due to the growth of their investments.
Retained earnings are not only important for a company, but they are also essential in the compounding of personal finances of individuals. By taking your income and earnings and investing it, your portfolio continues to grow and accelerates the compounding. The most important company you run is yourself. As Charlie Munger has said: “A great company keeps working after you are not; a mediocre company won’t do that.” Throughout your working years, it is important to save and build a life that you will be able to maintain throughout retirement. If you were to consistently save and invest in companies that provide you with growing dividend income, you can use the dividend income to live off of in retirement.
Ode to Charlie Munger
Warren Buffett finished off the letter with an ode to Charlie Munger by compiling a list of lessons that Charlie has shared previously, many coming from a recent podcast. Charlie is known for his short, concise, and funny assertions. I would like to share a few of the lessons that resonated with me:
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The world is full of foolish gamblers, and they will not do as well as the patient investor.
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Warren and I don’t focus on the froth of the market. We seek out good long-term investments and stubbornly hold them for a long time.
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Patience can be learned. Having a long attention span and the ability to concentrate on one thing for a long time is a huge advantage.
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You don’t however, need to own a lot of things in order to get rich.
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If you don’t see the world the way it is, its like judging something through a distorted lens.
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All I want to know is where I’m going to die, so I’ll never go there. And a related thought: Early on, write your desired obituary – and then behave accordingly.
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If you don’t care whether you are rational or not, you won’t work on it. Then you will stay irrational and get lousy results.
2023 Annual Shareholder Meeting
Warren Buffett and Charlie Munger will be taking the stage again in Omaha, Nebraska on Saturday, May 6th for the 2023 Annual Shareholders Meeting. They will be accompanied in the morning by Ajit Jain, who handles the insurance operations, and Greg Abel, who is in charge of all other operations.
It is one of the most exciting times of the year as I always look forward to hear what they have to say. This year, I will be making the drive down to Omaha to attend the meeting in person. I will be sure to share my thoughts and lessons I learned when I return however, I highly encourage you to tune in since it is always a treat to listen to Warren and Charlie share their wisdom.
If you would like to listen, the Berkshire Hathaway Q&A session will be broadcasted on CNBC at 10:15am EST. Visit the following link for the livestream: 2023 Berkshire Hathaway Annual Shareholders Meeting (cnbc.com).
"How will you replace your current income in retirement?"™ - Jim Seyers