Oct 12, 2018
A Summary and Commentary of Warren Buffett’s “2018 Letter to the Shareholders”
Written By: Nate Williams
Each year Warren Buffett, the greatest investor the world has ever known, writes a letter to the shareholders of his company, Berkshire Hathaway.
This letter has become somewhat of a “secret scroll” for investors and business geeks alike, with Mr. Buffett pouring out wisdom and wit in his typical style of brutal honesty. I have been reading this annual letter for years and recommend it to you if we share this interest.
(Last year, I summarized Buffett’s 2017 letter on this blog, which you can read here: https://practicefinancialgroup.com/investment-optimism/).
For those of you who want the summarized version of this year’s letter applied to doctors, keep reading….
Should I Open a Second Practice?
Speaking on the difficulty to find good business acquisition deals in 2017, including what he describes as a “purchasing frenzy,” Buffett writes:
“Why the purchasing frenzy? In part, it’s because the CEO job self-selects for “can-do” types. If Wall Street analysts or board members urge that brand of CEO to consider possible acquisitions, it’s a bit like telling your ripening teenager to be sure to have a normal sex life.
Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.”
This statement, I believe, applies directly to the multi-practice craze happening in America right now with dentists buying additional practice locations. I wrote against this business move for the vast majority of dentists (https://practicefinancialgroup.com/multi-practice-model-epidemic-dentistry/), and the article was found and republished on Dental Town by Howard Farran.
The can-do type of CEO Buffett describes applies directly to so many doctors, who, after having success in their own practice think, “Gosh, this is easy. And if I’m doing this well with one practice, imagine how well I’d do with two or three…?”
He also mentions the supporting cast in this decision; for dentists, this consists of very encouraging bankers, equipment reps, lawyers, accountants, real estate professionals—basically anyone who knows and works for the doctor stand to profit off the acquisition.
Should I Borrow More Money to Acquire More?
Admitting that his company could have made even more money over the years by using debt as leverage to purchase more assets, Buffett writes:
“Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need.”
“The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.”
This wisdom applies, however, to more than just debt itself. Just today, for example, I helped a client out of a trap to purchase a second practice and fold it into his already thriving practice (the purchase price was over $1M when all he was hoping to get were a few cash-paying patients). The decision to walk away came down to Buffett’s principle of “it is insane to risk what we have and need in order to obtain what we don’t need.”
How Do You View the Investments You Own?
For years we have attempted to help clients look past the “number on the computer screen” to see what they truly own in their investment accounts. On this topic, Buffett shares these thoughts:
“Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of the media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well…In America, equity investors have the wind at their back.”
At PFG, our clients don’t own large holdings of individual stocks, but shares of mutual funds owning hundreds of stocks. Nevertheless, the fact that you own shares of real companies applies—do you see your investments as a number on a screen, or a chart, or a ticker symbol? Or do you see through to what you really own – interests in the greatest companies in the world? And to take this thought even further, like Buffett, do you see yourself as a partner with these companies with the important job of providing capital for which they can use to operate their businesses?
Are You Ready for the Periodic Market “Corrections” that will Happen?
“Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure long-term growth in value. For the last 53 years, the company has built value by reinvesting its earnings and letting compound interest work its magic. Year by year, we have moved forward. Yet Berkshire shares have suffered four truly major dips. Here are the gory details:
This table offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.
In the next 53 years our shares (and others) will experience declines resembling those in the table. No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow.
When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt. That’s the time to heed these lines from Kipling’s If:
‘If you can keep your head when all about you are losing theirs…
If you can wait and not be tired by waiting…
If you can think – and not make thoughts your aim…
If you can trust yourself when all men doubt you…
Yours is the Earth and everything that’s in it.'”
This reminder of some of the major market crashes of the past are sobering and important for us to acknowledge. To reiterate Buffett’s warning: “No one can tell you when these will happen.” There is no warning. Here are some questions for you to ask and answer:
- Are you financially able to withstand major market declines, including the potential declines to your business operations?
- Are you emotionally and mentally prepared for these declines and the fear frenzy that will rule the air waves?
- Are you clear on what to do during major market declines? (Answer: Stay the course, keep investing, and perhaps increase your investment contributions.)
- Do you have the correct asset allocation for you that you can stick with in times of rain or shine? (Remember, when it comes to short-term market performance, there is no reliable 10-day weather forecast.)
During the inevitable booms and busts that the market will deliver over the coming decades, keep this advice from Buffett handy:
“What investors then need…is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period – or even to look foolish – is also essential.”
To read Buffett’s 2018 annual letter in its entirety, visit: http://www.berkshirehathaway.com/letters/letters.html.