Sunday Times 28 May 2017
The 1988 comedy classic, Dirty Rotten Scoundrels, featured Lady Fanny of Omaha. This is the first time I can recall being aware of the existence of Nebraska’s largest city. More recently Omaha has been familiar to me as the home of the world’s best known and arguably most successful investor, Warren Buffett.
Earlier this month, myself and 40,000 other Buffett acolytes squeezed into the Century Link Center in Omaha to attend the AGM of Buffett’s investment vehicle, Berkshire Hathaway. The format is a Q&A. Buffett and Charlie Munger (the 93 year old Vice Chairman) sit alone together on a stage flanked by 3 analysts on one side, 3 media reporters on the other and the Board of Berkshire, which includes Bill Gates, out front.
In a video that opens the meeting Buffett makes a point of including footage from his testimony to the Senate over the Salomon Brother’s affair. He invested in the business in 1987 and had to intervene in 1991 and step on to the board owing to legal issues around fake bids at US government bond auctions. At that hearing he assures the Senate committee that the staff at Salomon was warned “Lose money for the firm and I will be understanding. Lose even a shred of reputation for the firm and I will be ruthless”.
This approach to business ethics and governance permeates the discussion that takes place during the day. He concludes that many lessons were learned from the Salomon affair. One of which is that acting immediately in relation to problems (legal or otherwise) is an absolute imperative. The problem grows exponentially in the absence of action. “An ounce of prevention is worth a pound of cure. And a pound of cure implemented early, is worth a tonne of cure delayed”.
Before the Q&A kicked off, Buffett singled out the founder of Vanguard, Jack Bogle (yet another billionaire!), for special mention. Investors the world over, Buffett said, have been done a great service by Bogle, as he was responsible for putting billions of dollars back into their pockets due to Vanguards relentless pursuit of costs. An interesting juxtaposition as Buffett is the world’s poster-boy for active management and Vanguard is the pioneer of passive and now the 2nd largest fund management company in the world.
Over the course of the day, there were lots of discussion points, but one of the more interesting was in relation to Technology and Berkshire’s patchy track record. Berkshire is the 7th most valuable company in the world, but four of the 6 companies ahead of it are Technology stocks; Apple, Microsoft, Amazon and Facebook.
Buffett was very candid on having missed out on the likes of Amazon. “We blew it. We were smart enough to see it, but we just didn’t execute“.
Recently Berkshire has taken a sizeable stake in Apple and this comes on the back of a largely unsuccessful foray with IBM, which Berkshire first invested in six years ago.
But Buffett gives himself a pass on this one recognising that you can’t get them all right. A quick glance at his track record will affirm that it’s not the frequency with which you are right that counts, it’s by how much.
Buffett’s annual letter to shareholders shows the year by year performance of Berkshire Hathaway shares relative to the company’s book value, and the performance of the S&P 500 with dividends included. It’s a remarkable fifty two year track record.
A quick tabulation will show that there were seventeen years when Buffett’s return was below that of the market including eleven negative years.
Thus, for some 33% of the time there were annual disappointments, when Buffett returned less than the S&P500. But remember, over this period in aggregate the gain was 1,972,595% or 20.9% per annum, more than double the annualised return of the market.
Two critical observations of the numbers: first, if one of the world’s best long-term investors can deliver disappointment one third of the time, we should not hold ourselves or those that invest on our behalf to a higher standard.
Secondly, the power of compounding is writ large in Berkshire shareholder returns. Buffett has managed to more than double the annual return delivered by the S&P500 from 1965-2016. The US stock market’s 9.7% p.a. over this 52 year period has delivered a tidy return on investment equating to 127 times the original capital, turning $1,000 in to $127,170. Not bad, until you see what Buffett’s return has generated. Berkshire’s 20.9% p.a. return does not give you double the 127 times original investment. Through the magic of compounding it gives you more than 127 squared (i.e. 127 x 127!)
Buffett has turned $1,000 in to over $19 million. As Charlie Munger says of compounding, try not to get in its way!
Warning: Past Performance is not a reliable guide to future performance
Gary Connolly is Managing Director of iCubed, an investment consulting company providing investment support to financial advisers and chairman of the valueinstitiute.org. He can be contacted at firstname.lastname@example.org. iCubed Training, Research and Consulting, trading as iCubed, is regulated by the Central Bank of Ireland.