20 Pearls of Wisdom From Warren Buffett’s Last Annual Letter

50 years

Berkshire Hathaway board member Bill Gates calls Warren Buffett’s 2014 annual letter his best ever. Now that’s saying something since Buffett has produced 50 of them, and Gates is not easy to impress.

Truth be told, I love Warren Buffett. I think he’s brilliant, and he just oozes common sense.

So I am fan, and from a fan’s perspective, I want to share 10 pearls of wisdom I gleaned from Buffett’s last letter:

1. Disclose the bad news right up front. “Our bad news comes from our group of five as well and is unrelated to earnings. During the year, BNSF (a railway company) disappointed many of its customers. These shippers depend on us, and service failures can badly hurt their businesses.”

Buffett could have just hidden this information from us. After all, it didn’t affect Berkshire Hathaway’s earnings. I don’t know about you, but I want to work with someone who doesn’t hide things.

This is a great lesson for any manager or employee at any level. You get in trouble when you hide things, not the other way around.

2. A great leader accepts the blame when he doesn’t have to. Buffett easily could have blamed the weather for BNSF’s problems, but he didn’t: “Though weather, which was particularly severe last year, will always cause railroads a variety of operating problems, our responsibility is to do whatever it takes to restore our service to industry-leading levels.”

Every leader at every company can learn from Buffett’s example.

I wish all vendors would act this way, but it doesn’t stop there. Look at what Buffett did next.

3. Great leaders take corrective action. Buffett didn’t hope the weather would be better, or that the bad weather was an aberration. Instead, Berkshire Hathaway took action: “Recently, however, our outsized expenditures are beginning to show results. During the last three months, BNSF’s performance metrics have materially improved from last year’s figures.”

You can’t ask for more as a customer, or as an investor. Transparency and corrective action are such a positive force.

4. Give Others the Credit and be Humble. How many times have we seen the leader take the credit when maybe he should not? Buffett realizes the leader doesn’t need to ask for the credit: “I’m not embarrassed to admit that Heinz is run far better under Alex Behring, Chairman, and Bernardo Hees, CEO, than would be the case if I were in charge.”

That’s the only way to be as a leader. Give others the credit for what goes right and take the blame for everything that goes wrong. Your team will love working for you, and your customers will want to keep working with you.

There’s just one catch: You have to be sincere.

5. Becoming a better businessperson helps you become a better investor and vice versa. Experience counts. Only Buffett would add this beauty to annual report: “In Fred Schwed’s wonderful book, Where Are the Customers’ Yachts?, a Peter Arno cartoon depicts a puzzled Adam looking at an eager Eve, while a caption says, ‘There are certain things that cannot be adequately explained to a virgin either by words or pictures.’”

6. Don’t bet against America. “In my lifetime alone, real per-capita U.S. output has sextupled. My parents could not have dreamed in 1930 of the world their son would see. Though the preachers of pessimism prattle endlessly about America’s problems, I’ve never seen one who wishes to emigrate (though I can think of a few for whom I would happily buy a one-way ticket).”

Buffett is right. Despite all of America’s problems (and there are many), America is still the economic powerhouse of the world.

7. Understand the true economic value of your business. Buffett goes through a detailed analysis of how the insurance business really works, and the intrinsic value the insurance business generates for Berkshire Hathaway. I love the explanation of the importance of “float.”

Any good value investor will tell you that understanding the intrinsic value of a company is a key component of making sound investment decisions.

8. Make sure your investment has enduring value. Buffett likes to own businesses that are going to be around for at least 20 years. He talks about the “moat” around GEICO’s huge cost advantage versus the competition.

9. Be a person of your word, and invest only in people and companies that earn your trust. Trust is everything in business. You believe in someone who discloses everything (#1) and accepts blame (#2). Who would you want to guarantee a multi-billion dollar insurance policy? Warren Buffett.

10. Don’t try and skirt the rules. Buffett states, “It is in the self-interest of governments to treat capital providers in a manner that will ensure the continued flow of funds to essential projects. It is concomitantly in our self-interest to conduct our operations in a way that earns the approval of our regulators and the people they represent.”

When I started writing this, I was going to stop at 10, but there were so many pearls of wisdom in Buffett’s letter, I want to share 10 more:

11. Own your mistakes. Everyone, even the great Warren Buffett, makes mistakes. Successful people own their mistakes and unsuccessful people blame others for their mistakes. Buffett speaks freely about his many “blunders.”

12. Always look for great deals as an investor.  In the letter, Buffet refers to: “[T]he 1974-1975 period, when we sold stocks that were very cheap in order to buy others we believed to be even cheaper.” You have to have great conviction to execute the way Buffett did, but the rewards were – and are – huge!

13. A widely diversified stock portfolio is the best long-term investment. “Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.”

14. Don’t borrow money to invest. “Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur.”

Listen to Buffett’s advice if you are on margin. Please, please, please sell stock to get off margin. You can be wiped out if you are not careful.

15. Spell out exactly what you want. Buffett explains exactly their investment criteria. And, I’m sure Berkshire doesn’t deviate from it:

“Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units);
"Demonstrated consistent earning power (future projections are of no interest to us, nor are 'turnaround' situations);
"Businesses earning good returns on equity while employing little or no debt;
"Management in place (we can’t supply it);
"Simple businesses (if there’s lots of technology, we won’t understand it);
"An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).”

16. Always have a sense of humor. Buffett says, when frustrated about the bad deals he is always pitched, “A line from a country song expresses our feeling about new ventures, turnarounds, or auction-like sales: 'When the phone don’t ring, you’ll know it’s me.'”

17. Don’t let your emotions rule you. It will likely cost you. Buffett explains how he ended up owning Berkshire Hathaway over Berkshire Hathaway’s then owner’s bad behavior:

“Through Seabury’s and my childish behavior – after all, what was an eighth of a point to either of us? – he lost his job, and I found myself with more than 25% of BPL’s capital invested in a terrible business about which I knew very little. I became the dog who caught the car.”

18. It’s okay to change your strategy. Most people think of Buffett as only a value investor, buying companies at bargain prices. That was true until Charlie Munger, his partner, convinced Buffett to change: “The blueprint he gave me was simple: Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.”

Buying wonderful businesses at fair prices is a subtle, but important difference:

Wonderful businesses dominate their segments.
Wonderful businesses stand the test of time.
Wonderful businesses appreciate in value.
Munger’s strategy, implemented by Buffett and Munger, is what built Berkshire Hathaway into the powerhouse it is today.

19. Acquiring companies can be a slippery slope. You have to increase the value of your company if you are acquiring another company: “Too often CEO's seem blind to an elementary reality: The intrinsic value of the shares you give in an acquisition must not be greater than the intrinsic value of the business you receive.”

Remember Buffett’s words of wisdom the next time a company you are an investor in acquires another company.

20. Stock market bubbles will happen from time to time. As Buffett says, “Periodically, financial markets will become divorced from reality – you can count on that.”

I want to add one final 21st pearl of wisdom from Buffett. This one is especially appropriate with the stock market at all time highs, the Case-Shiller Index at an all time high, and the OU Index at an all time high:

21. “More Jimmy Lings will appear. They will look and sound authoritative. The press will hang on their every word. Bankers will fight for their business. What they are saying will recently have “worked.” Their early followers will be feeling very clever. Our suggestion: Whatever their line, never forget that 2+2 will always equal 4. And when someone tells you how old-fashioned that math is - zip up your wallet, take a vacation and come back in a few years to buy stocks at cheap prices.”

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