Our annual dose of wit and wisdom from Warren Buffett and Charlie Munger
Today, Berkshire Hathaway released their 2022 shareholder letter. Like a new album dropping for music fanatics, this is an exciting day for business-oriented readers.
This highly anticipated annual letter does not disappoint, and contains the wisdom, optimism, advice, and anecdotes we’ve come to expect from Warren Buffett, the "Oracle of Omaha," and his partner, Charlie Munger.
Here are 4 key takeaways and surprises from this year’s letter:
1. What do wealthy people do with their money?
Interestingly, Buffett begins with an observation about Berkshire’s major shareholders: “Common belief” - especially the more cynical variety - suggests that wealthy people choose to save and invest in hopes of hoarding wealth, maintaining their standard of living upon retirement, and passing assets on to their immediate family. If they're lucky, some meager, leftover funds might make their way to friends or charity. But Buffett says that, in reality, the opposite is true. He observes that most of Berkshire’s individual holders are consistent, long-term investors who live well and, over time, pass a majority of their funds to philanthropic organizations.
“The disposition of money unmasks humans,” Buffett explains. “Charlie and I watch with pleasure the vast flow of Berkshire-generated funds to public needs and, alongside, the infrequency with which our shareholders opt for look-at-me assets and dynasty-building.”
This is an interesting observation in light of our previous discourse on the nature of ambition and its frequent mischaracterization. Critics paint ambitious individuals as contemporary Scrooge McDucks, obsessed with hoarding power and resources, possessed by avarice, and disinterested in benefitting anyone but themselves. In Buffett’s experience, and as evidenced by his own life, this characterization is, at best, an exception, and at worst, a false caricature. For the multitude of Berkshire’s shareholders, “dynasty-building” and the accumulation of “look-at-me assets” are seldom a priority in comparison to benefitting the common good. Most dispense a majority of their capital to philanthropic organizations who, in turn, “redistribute the funds by expenditures intended to improve the lives of a great many people who are unrelated to the original benefactor.”
2. Berkshire’s “Secret Sauce”
Like many issuances before, Buffett’s 2022 shareholder letter reiterates his investment philosophy and Berkshire Hathaway’s “secret sauce:”
I. A disciplined, long-term investment process intended to pick a small number of big winners
II. Faith in the American economy, and
III. Unwavering integrity
I. Pick big winners, avoid big losers, and maintain a long-term view
“Our satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years – and a sometimes-forgotten advantage that favors long-term investors such as Berkshire.”
In what has become an ostensible Warren Buffett slogan, the letter reminds investors that “Charlie and I are not stock-pickers; we are business-pickers.” They aim to “make meaningful investments in businesses with both long-lasting favorable economic characteristics and trustworthy managers.” They hold these investments over the long-term and have little involvement in day-to-day management. Their equity purchases are based on expectations of long-term business performance, “not because we view them as vehicles for adroit purchases and sales.”
Buffett once said “Our favorite holding period is forever.” This approach allows Berkshire to benefit from “the power of compounding” and to minimize the impact of investing misjudgments, so long as they are minor rather than mortal mistakes.
To illustrate, he points to some of Berkshire’s now-famous success stories: their $1.3 billion investment in Coca-Cola in 1994 has ballooned in value to $25 billion; their 1995 purchase of $1.3 billion shares in American Express is now worth $22 billion. He remarks that even if they made a poor investment at that time which flatlined and retained its $1.3 billion value, the big wins would water this down to essentially a rounding error on their balance sheet. “The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders.”
II. Faith in the American Economy
Buffett argues the “most important” ingredient in Berkshire’s secret sauce is “the American Tailwind.” Over his 80 year investment career, he has never seen a time “when it made sense to make a long-term bet against America” and doesn’t see any reason why this would change. “America’s dynamism has made a huge contribution to whatever success Berkshire has achieved… We count on the American Tailwind and, though it has been becalmed from time to time, its propelling force has always returned.”
Accordingly, Buffett dedicates a chunk of real estate in his letter to discuss the magnitude - and willingness - of Berkshire’s tax contributions. During the decade ending in 2021, Berkshire paid $32 billion Berkshire in federal income tax. In a very “ELI5” illustration, Buffett explains that if you stacked $32 billion in $100 bills, the tower of Franklins would be 21 miles high. “At Berkshire,” he concludes, “we hope and expect to pay much more in taxes during the next decade.”
III. The Trust Business
Finally, Buffett reiterates his commitment to maintaining the trust of investors above all. Finance is, in the final analysis, a trust business. Investors entrust their capital to a money manager or advisor in hopes that they will provide optimal returns while maintaining their fiduciary duty. As such, Buffett condemns the manipulation of earnings reports, saying such “Bold imaginative accounting” is “disgusting” and “one of the shames of capitalism.” Berkshire, on the other hand, recounts annual operations and transactions for shareholders in vivid detail. He insists, however, that it is far from required reading:
“There are many Berkshire centimillionaires and, yes, billionaires who have never studied our financial figures. They simply know that Charlie and I – along with our families and close friends – continue to have very significant investments in Berkshire, and they trust us to treat their money as we do our own.”
As it relates to Berkshire’s investments, he adds that they are “understanding about business mistakes,” but their “tolerance for personal misconduct is zero.”
3. Creative Destruction
Buffett sneaks a bit of macroeconomic education into this year’s letter. He describes Berkshire’s investment record: there are “a few enterprises that have truly extraordinary economics, many that enjoy very good economic characteristics, and a large group that are marginal.” Naturally, there were also investments in certain businesses that subsequently “died,” often unpredictably, which is a feature rather than a bug in a Capitalist economy.
In 1942, Austrian economist Joseph Schumpeter coined the term “creative destruction:”
"...the process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”
“Capitalism has two sides,” explains Buffett. On one hand, most businesses fail, creating “an ever-growing pile of losers” with products or services that nobody wants. On the other hand, it produces a small number of extraordinarily successful, innovative enterprises that deliver new and improved goods and services. Creative destruction occurs as these businesses continue to grow, innovate, reduce prices, and expand offerings, and in the process, make other organizations obsolete. While this produces short-term downsides, the pattern theoretically paves the way for innovation and the creation of long-term value, and provides a net benefit to the consumer and society.
Inevitably, the process creates winners and losers, and investors like Buffett have to be vigilant in identifying the former and avoiding the latter. True to form, Buffett is forthcoming that he has “made many mistakes.” But he explains that such “Disappointments are inevitable” and that Berkshire - like the economy at large - has benefitted more than suffered from the results of creative destruction.
4. The Wit and Wisdom of Charlie Munger
It would not be a stretch to claim that in hundreds of thousands of people will read some version of Buffett’s latest shareholder letter. Knowing this, Buffett concludes his letter sharing some of the wit and wisdom of his partner, Charlie Munger. Buffett not only admires the man’s thinking (and “zingers”), but surely believes the world could use more people who think like Charlie.
Here are a few standout quotes:
“Early on, write your desired obituary – and then behave accordingly.”
Given this blog’s focus on professional development, this quote is of special interest. This advice is deceptively simple, but an incredibly powerful tool to improve one’s personal and professional life. What Munger suggests is actually a common and powerful psychological exercise called "future self-visualization" or "future self-authoring.” This approach combines the methods of industrial-organizational goal setting and narrative therapy. It entails envisioning the legacy you would like to leave behind - either by creating a detailed mental image of one’s ideal future self or by writing something like an obituary or retirement speech - and mining that narrative for insight around your own values, goals, and ideal future self.
Unsurprisingly, Munger is right on the money here. Such exercises are shown to consistently improve objective markers of mental health and well-being, increase self-awareness, enhance performance, and promote a sense of purpose and direction (references: 1, 2, 3).
“You can learn a lot from dead people. Read of the deceased you admire and detest.”
Havelock Ellis once observed that "Every man of genius is a stranger and a pilgrim on the earth, unlike other men, seeing everything as it were at a different angle.” This is an apt description of Charlie Munger. Munger is famous for his dedication to learning, the quality of his thinking, and his worldly wisdom, not to mention his extraordinary business savvy. He draws powerful mental models from an array of disciplines and thinkers which he applies to his own life and business. He emphasizes a “first principles” approach, stays ahead of the curve, and is quick to recognize when a misjudgment calls for a change in thinking. “You have to keep learning if you want to become a great investor,” he explains. “When the world changes, you must change.”
“Patience can be learned. Having a long attention span and the ability to concentrate on one thing for a long time is a huge advantage.”
Buffett and Charlie are both known for spending massive amounts of time simply thinking. Unlike most business leaders, Buffett keeps his calendar largely free of meetings and reads for six hours a day. He understands how to maximize his impact and play to his strengths: thinking strategically, concentrating deeply on key challenges and opportunities, exercising patience and avoiding the urge to jump on any “good” opportunity that arises, and making a small number of precise, well-informed, highly valuable decisions.
Here’s Buffett, alongside Bill Gates, explaining more:
“A string of wonderful numbers times zero will always equal zero. Don’t count on getting rich twice.”
This is sage business advice disguised as simple arithmetic. For Buffett and Munger, their strategy of picking a small number of big winners only works if they concurrently avoid big, irreversible mistakes. This is as true for you and me as it is for a professional investor. Just as Buffett observed that "It takes 20 years to build a reputation and five minutes to ruin it," one can ruin 20 years of professional or business success with one terrible, hasty decision.
“There is no such thing as a 100% sure thing,” Munger explains. In addition to promoting Berkshire's strategy of picking your shots carefully, he also warns against the use of leverage and debt as they can amplify the downside of any judgmental error with possibly dire results.
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