Book Review of Berkshire Hathaway Letters to Shareholders by Warren Buffett

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This Book Review of Berkshire Hathaway Letters to Shareholders by Warren Buffett is brought to you from Shep Klinke from the Titans of Investing.

Genre: Business Education & Reference
Author: Warren Buffett
Title: Berkshire Hathaway Letters to Shareholders (Buy the Book)


In 1965, Warren Buffett penned his first annual letter to the shareholders of Berkshire Hathaway. The letter was one page long and dealt with topics that included liquidating the assets of one textile mill and changes in Berkshire’s inventory. In 2012, forty-eight years later, Buffett discusses his 50% purchase of a holding company that will own 100% of H.J. Heinz, paying $4 billion for common stock and another $8 billion for additional preferred shares.

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Along the way, Buffett shares with his stockholders great insight into the reasoning behind every acquisition and major investment made and provides a highly detailed historical account of Berkshire Hathaway’s growth. More importantly, from time to time Buffett will share his views on a number of different topics ranging from market fluctuations to accounting for intangible assets.

These topics are incredibly important because they allow readers a window into Buffett’s mind and provide timeless wisdom that teaches readers how to think, rather than simply what to think. The results speak for themselves: in 1965, a single share of Berkshire Hathaway common stock would have carried a cost of $18. By 2012, that same share would trade for $134,060, compounding at an annual rate of 20.4%.

Comparatively, an $18 investment in the S&P 500 in 1965 would have compounded at an annual rate of 9.4% and been worth $1,343 in 2012. Clearly, Buffett has some knowledge worth sharing. Readers of these letters are provided with an invaluable understanding of how to view markets and companies, which is exceedingly beneficial for passive investors and professionals alike.

Due to his consistent outperformance of the market, Buffett has been dubbed “The Oracle of Omaha” and is widely considered the greatest investor of all time. The knowledge that he lends in his letters, while perhaps not as monetarily beneficial as investing in a few shares of Berkshire back in 1965, is incredibly valuable to any person who wishes to learn the art of investing. This brief will attempt to capture a glimpse of the wisdom provided by Buffett in his forty-eight annual letters.

In this Titans Brief, you will find Warren Buffett’s answers to these questions:

  • What are the characteristics of an ideal investment (company)?
  • How does Berkshire Hathaway create value?
  • How should management issue shares, or repurchase them?
  • How does a company create a sustainable competitive advantage (a “moat”)?
  • What does effective corporate governance look like?

The Brief also provides Buffett’s views on:

  • “Mr. Market” (Your trading partner)
  • Traditional academic theories (Risk, Market efficiency)
  • Proper perspectives on diversification


When Warren Buffett assumed control of Berkshire Hathaway in 1965, it was a small and struggling textile mill with profits of just $125,586 in the year before he took over and a net loss over the preceding ten years. Through Warren Buffett’s annual letters to his shareholders, his readers follow Berkshire’s journey from struggling textile mill to diversified juggernaut with a great amount of detail. It is surreal (and almost humorous) to look at the astounding amount of change that has taken place during his forty-eight years at the helm.

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In the 1965 and 1966 letters, Buffett discusses changes at specific textile mills and refers to common stocks as simply an opportunity to create earnings streams outside of the textile industry “temporarily and indirectly.” Skipping forward to 2012, the reader sees Buffett explain why he is disappointed that Berkshire generated a profit of $24.1 billion.

Along the way, Buffett allows his shareholders tremendous insight not only into the internal affairs of Berkshire, but also into his thoughts on a vast array of material, ranging from corporate governance to dividend policy.

Buffett himself has said that he was “wired at birth to allocate capital,” which is evident not only through his impressive track record, but also through the tremendous amount of wisdom exuded in each of his letters. These forty-eight letters do not provide a magic formula for valuing companies or maximizing profit in the market. Rather, they provide something much more valuable: a mental framework that sets a standard for how a great company should operate and how investors should think and behave in the market.

How does Berkshire Hathaway Create Value?

The insurance operation is the engine that drives Berkshire Hathaway’s profits. Berkshire first entered the insurance industry in 1967 with the acquisition of National Indemnity and National Fire and Marine Insurance Company. Berkshire’s presence in the insurance industry has grown enormously over the years, especially with the acquisition of GEICO at the beginning of 1996 and General Re in 1998.

The key to the value of Berkshire’s insurance subsidiaries is their ability to underwrite profitably.

Berkshire earns large returns from its insurance subsidiaries by investing the money that the company has collected in premiums and has yet to pay out in claims, also known as the “float.” If the insurance companies can underwrite at a profit, the cost of their float (comparable to an interest rate on a loan) is negative, meaning that purchasers of insurance policies are essentially paying Berkshire to hold and invest their money.

This is no easy task; many property and casualty insurers have much difficulty generating an underwriting profit, and the cost of their float can be quite expensive as a result. As of 2012, Berkshire’s float amounts to over $73 billion. Berkshire’s cost-free float, while carried on its books as a liability, has proven to be one of its greatest assets.

Additionally, Berkshire owns over fifty non-insurance subsidiaries in a wide variety of industries including furniture, jewelry, bricks, and many more. Berkshire has a policy of acquiring companies and leaving the existing management in place, which allows Berkshire to be the “destination of choice” for owners who do not wish to see their company levered up and sold for a profit.

Berkshire’s goal is to keep the companies operating exactly as they were before the purchase. As an aid in calculating its intrinsic value, each year Berkshire reports its investments per share and non-insurance subsidiary earnings per share. As of 2012, Berkshire carried investments per share of $113,786 and non-insurance subsidiary earnings per share of $8,085.

Typical Letter Structure

Each letter typically begins with the change in book value over the course of the year. Berkshire has averaged a book value growth rate of 19.7% compounded annually from $19 per share in 1965 to $114,214 per share in 2012. Following these results is usually a discussion of how the change in intrinsic value is the metric that counts, but that book value is a conservative substitute that approximately tracks intrinsic value.

Following this discussion, Buffett spends the majority of each letter detailing the operations of Berkshire’s subsidiary companies as well as the results of its major non-controlling investments. Occasionally, Buffett will choose to include special topics in his letters on whatever topic he feels that his shareholders should be aware.

The content of these topics includes discussion of market fluctuations, risk, investment policy, and more. These “special topics” provide the most valuable insight available in the letters, and will be the focus of this brief hereafter.

On Market Fluctuations

“When investing, pessimism is your friend, euphoria the enemy.” (2008)

In his letters, Buffett often speaks of how investors should respond to fluctuations in market prices. Buffett, a Graham disciple, believes wholeheartedly in the “Mr. Market” concept illustrated in chapter eight of Graham’s The Intelligent Investor.

In this chapter, Graham characterizes the market as a manic-depressive who comes each day to offer prices at which he will buy from and sell to the investor, whichever one the investor chooses. On some days, Mr. Market will offer obscenely low prices to the investor and on others Mr. Market will offer him inexplicably high prices.

The investor can always use Mr. Market to his advantage as long as he understands that Mr. Market’s purpose is to serve him rather than to guide him. When Mr. Market offers high prices, the investor can take advantage by selling to him at a price above intrinsic value, and when he offers low prices, the investor can take advantage by buying from him at prices below intrinsic value.

Thus, volatility actually works in favor of the intelligent investor because increased volatility creates increased opportunity to take advantage of even lower lows and higher highs. By viewing market prices as quotes from a manic-depressive business partner, the investor is now put in a position of power over market prices rather than enslaved by them (a far-too-common occurrence).

Buffett first mentions his philosophy on market fluctuations in his 1974 letter.

He states that Berkshire is “under no pressure to sell securities except at times that we deem advantageous and it is our belief that, over a period of years, the overall portfolio will be worth far more than its cost.” In other words, unless Mr. Market is in a great mood and offers him an exuberantly high price, Buffett will simply choose not to do business with him.

Later in the letter, Buffett also hints at another ingredient necessary to apply the Mr. Market mindset to investing that Graham leaves out of The Intelligent Investor: operating from a position of financial strength and liquidity. In order to use market quotes to his advantage, the investor must not ever be in a position of being forced to sell at any given time.

If the investor does not have enough liquidity to operate outside of the market, he is put at the mercy of market prices when he is forced into selling his assets to create cash-and equities have a nasty habit of being the least valuable when people want to cash them out most (i.e. during times of uncertainty).

Over the years, Buffett goes on to explain that as a net buyer of stocks, the best thing that can happen is for stock prices to drop, as articulated in his 1977 letter when he states that “we ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term. In fact, if their business experience continues to satisfy us, we welcome lower market prices for stocks we own as an opportunity to acquire even more of a good thing at a competitive price.”

As late as 2011, Buffett continues to harp on investor reaction to market fluctuation, stating that investors who intend to be net buyers of stock and feel comfort in seeing stock prices rise ”resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.”

On Risk

“In stating this opinion, we define risk, using dictionary terms, as ‘the possibility of loss or injury.’” (1993)

As discussed, Buffett does not view volatility as an adequate measure of investment risk. Rather, Buffett feels that real risk is not volatility, but the potential that after-tax receipts from an investment will not result in a gain in purchasing power. Buffett simply defines investing as “forgoing consumption now to have the ability to consume more later.”

Inherently, the risk that the investor runs is that by forgoing consumption now, he may not have the ability to consume more later. Thus, some of the lowest-beta investments (i.e. those made in money-market funds, bonds, mortgages, bank deposits, etc.) that are generally considered to be “riskless” actually carry with them some of the greatest risk of all, because the returns from these instruments often fail to keep pace with inflation, and thus result in a net reduction in purchasing power.

The use of beta as a measure of risk can cause an investor to miss out on great opportunities in the market.

When discussing his purchase of stock in the Washington Post in his 1993 letter, Buffett states that “the academics’ definition of risk is far off the mark, so much so that it produces absurdities. For example, a stock that has dropped very sharply compared to the market-as had the Washington Post when we bought it in 1973-becomes ‘riskier’ at the lower price than it was at a higher price.”

Obviously the stock was riskier at the higher price by Buffett’s definition, but its beta was much higher only after its price dropped (and the risk was largely removed). Buffett efficiently sums up his thoughts on the use of beta as a measure of risk with this line from his 1993 letter: “In [academics’] hunger for a single statistic to measure risk, however, they forget a fundamental principle: It is better to be approximately right than precisely wrong.”

According to Buffett, there are five key criteria necessary to evaluate true risk:

  1. The certainty with which the long-term prospects of the business can be evaluated;
  2. The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;
  3. The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself;
  4. The purchase price of the business;
  5. The levels of taxation and inflation that will be experienced, and that will determine, the degree by which an investor’s purchasing-power return is reduced from his gross return. If these five criteria can be effectively evaluated, the real risk run by an investor will be minimal.

Buffett’s Ideal Company

“We like a business with enduring competitive advantages that is run by able and owner-oriented people. When these attributes exist, and when we can make purchases at sensible prices, it is hard to go wrong.” (1994)

Buffett is not shy when describing what traits he seeks most in a business. In fact, for a number of years, at the end of each letter he would place an advertisement for possible acquisition candidates from his shareholders. Consistently over the years, Buffett stated that businesses in which he would invest possessed the following specific characteristics:

1. Demonstrated consistent earning power

This criterion seems to be another mark of Graham’s influence on Buffett. Graham had his own list of various criteria that had to be met in order to ensure a company’s financial strength, and one of them was consistent strong earning power in the past. Neither Graham nor Buffett place any sort of value on market forecasts, and while past performance is no indication of future success, it is still a far better indicator than any market forecast previously produced.

Buffett goes into a bit more detail on why he is not interested in turn-around situations in his 1979 letter, saying that “Both our operating and investment experience cause us to conclude that ‘turnarounds’ seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price.”

Buffett is not concerned with seeking out bargain prices for average companies that may or may not become winners in the market.

This marks an area where Buffett diverges a bit from Graham, who searched for stocks selling in the market for below the value of their net tangible assets (a practice that makes sense given the context – these stocks were easy to find in 1934, immediately following the Great Depression). Buffett is a proponent of purchasing extraordinary companies at fair prices, rather than average companies at bargain prices.

2. Businesses earning good returns on equity while employing little or no debt

This is a two-pronged approach for assessing the underlying economics of a company. The first prong is that a company must earn strong returns on equity. Buffett favored return on equity over earnings per share as a yardstick to measure managerial effectiveness.

This is because an enlarged capital base from retaining earnings can produce “record” earnings yearly even if management does not employ capital any more effectively than it did in the past. Buffett relates this point nicely in his 1977 letter, when he states that he finds “nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share.

After all, even a dormant savings account will produce steadily rising interest earnings each year because of compounding.” On top of employing capital at high rates of return, Buffett requires that companies operate from a position of low leverage. When an investor intends to invest over the long term, he must be assured that the companies in which he invests will continue to operate over the long term as well.

The best way to ensure this is to invest in companies employing low levels of leverage and enough financial strength to weather inevitable storms down the road. The combination of employing capital at high rates of return and operating with little or no leverage allows the long-term investor to feel reasonably confident about the underlying economics of the business.

3. Outstanding, shareholder-oriented management already in place

Management is consistently one of the most discussed topics in Buffett’s letters. Buffett often states that he has two major standards by which he evaluates his management. First, managers must be shareholder-oriented. The highest praise that he can bestow upon his managers is that they “unfailingly think like owners.”

This is consistent with Buffett’s view of Berkshire not as a corporation, but as a partnership in which he and Charlie Munger are managing partners, with shareholders as owner-partners. Thus, Buffett and Munger do not view Berkshire to be the owner of the assets, but as a “conduit through which shareholders own the assets.”

Second, he asks that each of his managers run their business as if it were the only asset in their possession.

Indeed, it is not uncommon for Berkshire’s managers to work well into old age simply because of their love for their business. If these two criteria are satisfied, Buffett feels that his managers are doing their jobs and will praise them for it in the annual letter. Additionally, in Buffett’s early letters, readers are able to see firsthand how he operates as a manager of a small company himself.

Early on, readers see that Buffett is very candid in his communication with his shareholders and that he does not shy away from discussing both his triumphs and failures. When he presents financial statements on a pro forma basis, he does so to reveal truth to his shareholders, rather than display the statements as if nothing bad had happened to the company.

His decisions are made with the intention of maximizing long term shareholder value, and he openly discusses risks associated with his decisions. His views on the tone and content of his correspondence are summarized in his 1979 letter, when he explains to his shareholders that he does not “expect a public relations document when our operating managers tell us what is going on, and we don’t feel you should receive such a document.”

Buffett’s attitude on management, while simple, has produced outstanding results at many of Berkshire’s subsidiary companies. As long as Berkshire’s managers continue to think like owners and manage their companies as if the companies are the only assets that they own, Berkshire shareholders can be confident that these outstanding results are likely to continue.

4. A durable competitive advantage (a “Moat”)

In medieval times, moats were constructed around castles as a defense system against outside threats and forces. The wider the moat was, the more effective it was for repelling attacks and protecting those inside the walls of the castle.

Much in the same way, a durable competitive advantage can protect a business and its returns on invested capital from the threat of competition and lessen the impact of other outside forces that can cripple average businesses. Buffett encourages “moat-widening” actions from his operating managers and actively seeks to invest in businesses possessing a durable competitive advantage, such as Coca-Cola and Gillette.

As a long term investor, the durability of a competitive advantage is a key concern to Buffett. The standard of durability has served Buffett well over the years, keeping him out of the tech bubble in the late 1990s because the standard inherently eliminates companies in industries prone to rapid change.

Additionally, Buffett states that the criterion of durability eliminates businesses whose success depends on having a great manager. While a great manager is a tremendous asset to a company, when the company’s success is tied to his/her presence, any competitive advantage created simply cannot be durable by nature.

The purpose of the durable competitive advantage is not to boost growth or expected future earnings, but rather to ensure that a company’s current level of profitability can be maintained in the future through adverse events that may occur along the way. This is why Buffett characterizes them as “moats” and why they are such an integral part of his long term investment decisions.

Two other criteria that Buffett specifies but does not go into much detail about are the need for a simple business and the ability to pay a fair price.

Buffett prefers simple businesses for one primary (and major) reason: it is much easier to make accurate estimates about the future prospects of simple companies than for more complex companies. Buffett provides the following example: “If only one key variable is key to a decision, and the variable has a 90% chance of going your way, the chance for a successful outcome is obviously 90%.

But if ten independent variables need to break favorably for a positive result, and each has a 90% probability of success, the likelihood of having a winner is only 35%.” Regarding price, Buffett (unfortunately) does not provide much insight into how he values companies, except that his basis for business valuation can be traced back to Aesop, who once said, “A bird in the hand is worth two in the bush.”

Buffett states that if you can answer three questions it is possible to ascertain the value of the “bush.” First, how certain is it that there are indeed birds in the bush? Second, when will they emerge and how many will there be? Finally, what is the risk-free interest rate?

The answers to these three questions will allow the investor to rank all of his possible investments in different “bushes.” According to Buffett, “Aesop’s investment axiom, thus expanded and converted into dollars, is immutable. It applies to outlays for farms, oil royalties, bonds, stocks, lottery tickets, and manufacturing plants.

And neither the advent of the steam engine, the harnessing of electricity nor the creation of the automobile changed the formula one iota- nor will the Internet. Just insert the correct numbers, and you can rank the attractiveness of all possible uses of capital throughout the universe.” Both of these criteria are of vital importance to Buffett’s investment decision-making, but regrettably he does not go into a great deal of detail on either subject.

Berkshire Investment Policy

“Our goal is more modest: we simply attempt to be fearful when others are greedy and greedy when others are fearful.” (1986)

Buffett’s investment policy at Berkshire Hathaway can be broken into two primary distinctive qualities: concentrated holdings and minimal activity.

With regard to his policy of concentrating his holdings, Buffett states that he feels that his risk is actually reduced by investing in companies with which he is familiar and fairly certain of their long term prospects. He shuns the idea that diversification limits risk because often it requires that investors move money away from winning stocks and into companies with which they are unfamiliar.

To illustrate this point in his 1996 letter, Buffet uses a sports analogy: “To suggest that this investor should sell off its portions of his most successful investments simply because they have come to dominate his portfolio is akin to suggesting that the Bulls trade Michael Jordan because he has become so important to the team.” In relation to his policy of concentrating holdings, Buffett frequently quotes Mae West who has said, “Too much of a good thing can be wonderful.”

Buffett is a strong advocate of buying and holding equities for long periods of time, with minimal levels of activity (especially selling). In his 1983 letter, he states his distaste for highly active investing, saying, “One of the ironies of the stock market is the emphasis on activity.

Brokers, using terms such as ‘marketable’ and ‘liquidity’, sing the praises of companies with high share turnover (those who cannot fill your pocket will confidently fill your ear). But investors should understand that what is good for the croupier is not good for the customer. A hyperactive stock market is the pickpocket of enterprise.”

He goes on to state that, as opposed to Adam Smith’s “invisible hand,” hyperactive markets act like an “invisible foot,” tripping up and slowing down a progressing economy. In later letters, he sets forth an in-depth example of how much frictional trading costs can eat away at investing returns. Buffett humorously (but accurately) describes his investment style in his 1990 letter, when he says that “lethargy bordering on sloth remains the cornerstone of our investment style.”

Buffett staunchly opposes hyperactive trading due to the frictional costs associated with it that can eat away at investment returns, and advocates buying and holding investments for the long term. He openly states that for investments in truly great companies, his favorite holding period is forever.

On Dividend Policy

We test the wisdom of retained earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained.” (1983)

Central to Buffett’s thesis on dividend policy is the concept that not all retained earnings are equal.

Buffett contends that the true value of retained earnings lies in how effectively managers can employ them. If a manager is able to employ all of company earnings internally at a high rate of return that will create over $1 of market value for every $1 retained, managers should do so.

Conversely, if a manager cannot create over $1 of market value for every $1 retained, he has a duty to his shareholders to distribute his earnings to them so that they may earn a higher rate of return elsewhere. Effectively, some retained earnings are worth more than 100 cents on the dollar, while some are worth considerably less.

Managers should structure their dividend policy so that they retain only the earnings that can be reinvested at a high enough rate of return to create over $1 of market value and distribute the remaining earnings as dividends.

However, many managers follow a rigid dividend policy in which they can be forced to distribute earnings that could be reinvested at a high rate of return or retain earnings that should be distributed because they cannot be reinvested at a high enough rate of return.

While this approach may be simpler and more predictable, Buffett contends that if serious thought is not put into which earnings should be retained and which should be distributed, shareholders are hurt because they are not earning an optimal (manimum) rate of return. Retained earnings can be worth considerably more or less than 100 cents on the dollar, and managers should adopt dividend policies that reflect that fact.

On Stock Issuance, Splits, and Repurchases

“We will try to avoid policies that attract buyers with a short-term focus on our stock price and try to follow policies that attract informed long-term investors focusing on business values.” (1983)

Buffett only contemplates issuing additional shares of stock as part of an acquisition (and even in this instance, only grudgingly). In this event, the key question to Buffett is whether he can receive as much intrinsic business value as he gives. He views a stock-for-stock transaction to be a case in which both companies are making a partial sale of themselves.

In this case, if stocks are traded based on market price, shareholders of the company with the more overvalued stock will ultimately benefit at the expense of shareholders of the other company (similar to the benefits of trading with an overvalued currency).

Buffett seeks to alleviate this issue by trading stocks based on intrinsic value rather than market value.

In his view, many times the company being purchased will sell for full intrinsic value anyway, so the purchasing company must be sure to pay with an equal amount of intrinsic value on its end. Buffet touches on this fact in his 2009 letter, in which he says, “In more than fifty years of board memberships, however, never have I heard the investment bankers (or management!) discuss the true value of what is being given.

Buffett also believes that rather than being worried about how dilutive a merger can be in terms of per share earnings, what really counts is whether a merger is dilutive or anti-dilutive in terms of intrinsic business value. This emphasis on trading equal amounts of intrinsic business value ensures that neither party in any of Berkshire’s acquisitions will be taken advantage of, and is ultimately the most fair basis upon which to make a stock-for-stock transaction.

Buffett refuses to split Berkshire stock, which would explain why Berkshire Class A shares currently trade for over $160,000 in the market.

Buffett is often asked why he does not split the stock to make it more affordable and accessible for a larger number of people. His response is that he is attempting to attract a certain class of buyers, and that splitting the stock to make it sell more cheaply would ultimately lead to a decrease in the quality of ownership of Berkshire.

Buffett desires shareholders who intend to hold Berkshire stock for the long term, and lowering the price of Berkshire stock to make it more tradable would inherently bring in a more trigger-happy brand of owner who is more than happy to jump in and out of Berkshire stock as he/she pleases. In his 1983 letter, Buffett makes exactly this point, saying, “Were we to split the stock or take other actions focusing on stock price rather than business value, we would attract an entering class of buyers inferior to the exiting class of sellers.”

Making Berkshire stock more tradable would inevitably lead to more trading, and more trading would lead to fewer long-term investors. Buffett does not wish to see this happen, and thus refuses to split Berkshire stock. Buffett has two criteria that must be met for share repurchases to become advisable for a business.

First, the company must have available funds (cash on hand plus sensible borrowing capacity). Secondly, the firm’s stock must be trading below intrinsic value in the market. When these two criteria are met, Buffett is a strong proponent of corporate share repurchases. In his 2012 letter, Buffett reaffirms these sentiments by saying, “Indeed, disciplined repurchases are the surest way to use funds intelligently. t’s hard to go wrong when you’re buying dollar bills for 80 cents or less.”

Buffett views share repurchases as an extremely effective means for increasing shareholder value.

Some argue that share repurchases serve as a means for managers to artificially boost per share earnings, but the fact of the matter is that as long as Buffett’s conditions are met, repurchases provide shareholders with a very real economic benefit with little to no downside.

Additionally, managers conducting share repurchases demonstrate their shareholder-oriented mindset that Buffett values so highly. Under the right circumstances, there is very little that a manager can do to benefit his/her shareholders more than repurchasing undervalued shares.

On Efficient Markets

“Observing correctly that the market was frequently efficient, they went on to conclude that it was always efficient. The difference between these propositions is night and day.” (1988)

Buffett strongly opposes the idea that stock prices always reflect all publicly available information. While he does admit that the market is often efficient, Buffett believes that inefficiencies exist in the market that can be exploited through careful analysis.

In his 1988 letter, he backs up his position using his own investing career.

Speaking on a 63-year record built at Graham-Newman Corp., Buffett Partnership, and Berkshire Hathaway during which he averaged an unleveraged annual return of over 20%, he states that his experiences provide a fair test.

The three organizations traded hundreds of different securities over the 63-year period, the results have not been skewed by a few fortunate experiences, he never had to dig for obscure facts or develop keen insights about products or managements, and his positions were held in a clearly identified universe (they were not selected by hindsight).

Over these same 63 years, the average market return was just under 10%, including dividends. Over this period, an average market return would have grown a $1,000 investment to $405,000 if all income had been reinvested. The 20% average return produced by Buffett over this period would have grown a $1,000 original investment to $97 million.

In Buffet’s words, “That strikes us as a statistically-significant differential that might, conceivably, arouse one’s curiosity.”

He goes on to state that he is actually grateful to the academics professing the Efficient Market Hypothesis as gospel, saying, “In any sort of a contest – financial, mental, or physical – it’s an enormous advantage to have opponents who have been taught that it’s useless to even try.”

Buffett also states that a strictly contrarian approach is equally foolish-“What’s required is thinking rather than polling.” Buffett’s personal track record serves as strong opposition to the Efficient Market Hypothesis, and proves that with sound analysis and a strong mental framework, abnormal returns can be generated consistently in the market.

On Corporate Governance

“The bottom line for our directors: You win, they win big; you lose, they lose big. Our approach might be called owner-capitalism. We know of no better way to engender true independence.” (2003)

In his later letters, Buffett begins to closely examine corporate governance. At this point, Buffett has seen many CEO’s taking various actions that hurt their shareholders, including reckless acquisition and employing questionable accounting practices.

The board of directors is intended to hold the CEO accountable for his actions, but too often CEO’s are never challenged by their boards. In his 1993 letter, Buffett lays out the three “boardroom situations” in great detail.

The first, and most common, boardroom situation is one where there is no controlling shareholder.

In this situation, Buffett argues, the board must act as if there is a single “absentee owner.” The board should attempt to further this owner’s long-term interests to the best of its ability. If board members lack either integrity or the ability to think independently, the directors can actually do a great deal of harm to shareholders.

If a functional board is in place, and it is dealing with “mediocre or worse” management, it has a responsibility to the absentee shareholder to change that management. Additionally, when able but greedy managers begin to “dip too deeply into shareholders’ pockets, directors must slap their hands.”

The second situation is what exists at Berkshire Hathaway, where the majority shareholder also runs the business.

In this situation, there is little that a director can do to affect change besides persuading the owner/manager towards his/her point of view. If a manager is incompetent or greedy, there is little that a director can do to quell the issue.

The third situation is most advantageous to directors. In this case, the corporation has a controlling owner not involved in management. When this happens, directors who are not content with the quality of management or fear that management is becoming too greedy can go directly to the owner and report their dissatisfaction. If the owner agrees, change will take place.

Buffett also questions the cry for “independent” board members. In his mind, the best directors are those who have their interests best aligned with shareholders. In fact, being a major, long-term shareholder is one of the primary qualities that Buffett takes into account when searching for directors.

Buffett states that the best place to find true independence-“the willingness to challenge a forceful CEO when something is wrong or foolish”-is among people whose interests are aligned with shareholders. Additionally, many “independent” directors depend on fees as a major component of their income.

These directors are incentivized to stay on the board, which often means choosing not to offend a CEO or fellow directors so that his popularity with management can remain strong and he can continue to collect directors’ fees.


“Rule Number 1: Never lose money. Rule Number 2: Never forget Rule Number 1.” – Warren Buffett

Clearly, these letters serve a far greater purpose than simply the ability to follow the activities of Berkshire Hathaway on a yearly basis. Indeed, these letters can at times provide a window into the mind of a man who is widely considered to be the greatest investor of all time.

What readers of these letters gain is far more than a list of rules for successful investing in the market.

Readers gain a framework for how to view risk, markets, and investing, as well as an understanding of how truly great businesses should operate. Buffett makes it clear that investing is far from a science and that there is much more to being a successful investor than being the smartest person in the room.

A combination of traits is required, including an understanding of true risk and market fluctuations. Above all, readers see the “Oracle of Omaha” at work each year, shaping an investing career that may not ever be replicated. would like to thank the Titans of Investing for allowing us to publish this content. Titans is a student organization founded by Britt Harris. Learn more about the organization and the man behind it by clicking either of these links.

Britt always taught us Titans that Wisdom is Cheap, and principal can find treasure troves of the good stuff in books. We hope only will also express their thanks to the Titans if the book review brought wisdom into their lives.

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