Mistakes fade away; winners can forever blossom. — Warren Buffett
Warren Buffett, Berkshire Hathaway’s CEO and Chairman, writes an annual letter to provide shareholders with an owner’s manual for the company and never fails to contain tremendous insights. Buffett has a unique gift for explaining complex investing topics in a digestible format. More about the long-term track record later, but Berkshire produced arguably the most remarkable extended performance for investors ever recorded. Even over a shorter period, Berkshire has significantly outperformed the S&P 500. As a rough proxy for the growth of the company’s intrinsic value, the book value growth has also far outstripped the appreciation of the S&P 500.
While Buffett’s letter offers countless lessons, this article will distill his annual missive into three timeless insights.
Lesson 1: Owning a business is superior to cash.
Berkshire shareholders can rest assured that we will forever deploy a substantial majority of their money in equities – mostly American equities although many of these will have international operations of significance. Berkshire will never prefer ownership of cash-equivalent assets over the ownership of good businesses, whether controlled or only partially owned. – Warren Buffett
While much ink has been spilled about Berkshire Hathaway’s $334 billion cash hoard, Buffett noted that considering the substantial size of its wholly owned subsidiaries, most of Berkshire’s investments remain in equities. To quote Buffett directly, “Despite what some commentators currently view as an extraordinary cash position at Berkshire, the great majority of your money remains in equities. That preference won’t change. While our ownership in marketable equities moved downward last year from $354 billion to $272 billion, the value of our non-quoted controlled equities increased somewhat and remains far greater than the value of the marketable portfolio.”
While his comments are accurate, the cash levels relative to Berkshire’s asset size are at an all-time high as far back as Bloomberg data exists. Using Berkshire’s market capitalization and some other minor adjustments as a proxy to capture the value of its wholly owned companies, cash levels are high but below mid-2005.
Buffett makes the case that holding cash or bonds is not a good protection against inflation, as “Paper money can see its value evaporate if fiscal folly prevails. In some countries, this reckless practice has become habitual, and, in our country’s short history, the U.S. has come close to the edge. Fixed-coupon bonds provide no protection against runaway currency.”
Instead, he notes that good businesses with pricing power can adapt to inflation by saying, “Businesses, as well as individuals with desired talents, however, will usually find a way to cope with monetary instability as long as their goods or services are desired by the country’s citizenry.”
Long-term historical data returns across asset classes from 1928 to 2023 show that business ownership via stocks provided the highest annualized returns on both a nominal and real basis. These real, after-inflation returns are essential to maintaining and growing purchasing power. Buffett’s preference for owning good companies rather than cash becomes clear when one compares stock returns to cash equivalent assets, which has provided a more consistent but lower nominal return but has had a barely positive after-inflation return. Once taxes and expenses are considered, cash holdings, though more stable, have eroded purchasing power over time.
He also explained the secret of owning stocks when he said, “Understandably, really outstanding businesses are very seldom offered in their entirety, but small fractions of these gems can be purchased Monday through Friday on Wall Street and, very occasionally, they sell at bargain prices.”
It seems Buffett’s relatively large cash holding can be attributed to a lack of “compelling” opportunities. Buffett notes, “We are impartial in our choice of equity vehicles, investing in either variety based upon where we can best deploy your (and my family’s) savings. Often, nothing looks compelling; very infrequently, we find ourselves knee-deep in…
Read More: 3 Timeless Investment Lessons From Warren Buffett’s Annual Letter