2010
Click here to read the letter.🧠 Key Takeaways
At the end of the day, the long-term results of the business are what really matter. And if you’re truly a long-term investor with an owner mindset, that’s where your focus should be too.
No theory or investing idea should be treated as set in stone just because it came out of academia or because enough people repeat it. If real-world evidence contradicts the theory, then maybe the theory deserves a second thought.
While leverage can be helpful, it also creates risk. And just like any other form of risk, you’d best not expose yourself to too much of it — and you’d best not think of yourself as somehow special and exempt from its potential pitfalls.
People might think Berkshire is too conservative when times are good, but that conservatism helps protect them during the bad times and gives them the ability to take advantage of the opportunities those bad times create.
✍️ Memorable Quotes
“Yearly figures, it should be noted, are neither to be ignored nor viewed as all-important. The pace of the earth’s movement around the sun is not synchronized with the time required for either investment ideas or operating decisions to bear fruit. At GEICO, for example, we enthusiastically spent $900 million last year on advertising to obtain policyholders who deliver us no immediate profits. If we could spend twice that amount productively, we would happily do so though short-term results would be further penalized. Many large investments at our railroad and utility operations are also made with an eye to payoffs well down the road.”
I think this is a really important point that Warren is making here. What he’s basically saying is that people have a tendency to assign too much value to things that happen within a year’s time (or less).
But really, what is a year other than the time it takes for the earth to revolve around the sun? For some reason — possibly because a year is a nice, round period of time — we treat that arbitrary timeframe as if it should mean something as it relates to businesses and their operations. But in reality, business doesn’t work that way, and we shouldn’t try to force it.
Warren goes on to say that if Berkshire had ample opportunities to invest capital today that might come at the expense of short-term results in favor of greater long-term benefits, they would gladly do so.
At the end of the day, the long-term results of the business are what really matter. And if you’re truly a long-term investor with an owner mindset, that’s where your focus should be too. After all, you’re a shareholder, not a sharerenter.
“John Kenneth Galbraith once slyly observed that economists were most economical with ideas: They made the ones learned in graduate school last a lifetime. University finance departments often behave similarly. Witness the tenacity with which almost all clung to the theory of efficient markets throughout the 1970s and 1980s, dismissively calling powerful facts that refuted it “anomalies.” (I always love explanations of that kind: The Flat Earth Society probably views a ship’s circling of the globe as an annoying, but inconsequential, anomaly.)”
The theories that economists come up with and the ones that come out of universities are sometimes treated as indisputable truths, almost like the laws of physics.
Then those ideas get parroted throughout the investment world, which only perpetuates them and makes them seem even more indisputable because everyone is saying the same thing. After all, if everyone is saying it, it must be true, right?
I think this extends beyond just the theories coming out of academia. There are so many ideas that get regurgitated throughout the industry — especially online — that they eventually become these things people just accept because they hear everyone else saying them (and then parrot them themselves to avoid standing out from the herd).
Things like, “95% of professional money managers can’t beat the market, so just buy the index,” or, “If you’re young, you should be focused on growth.”
Eventually, these become things that people just say. You’re supposed to believe them because everyone else believes them, but very few people ever stop to question whether they’re actually true, why they’re true, or under what circumstances they might not be true.
All of this is to say that no theory or investing idea should be treated as set in stone just because it came out of academia or because enough people repeat it. If real-world evidence contradicts the theory, then maybe the theory deserves a second thought.
“Unquestionably, some people have become very rich through the use of borrowed money. However, that’s also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you’re clever, and your neighbors get envious. But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade - and some relearned in 2008 - any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.”
Leverage and the use of debt is a double-edged sword.
On one hand, it can greatly amplify your returns when the market is working in your favor. And when you experience the wins that come from that, as Warren says, it can be difficult to go back to a more conservative strategy that doesn’t include the use of leverage.
But this is where it gets tricky, and where your previous success (and the potential overconfidence that comes with it) can get you into trouble. Eventually, the market winds will change direction, and if you’re overleveraged when that happens, it can completely take you out of the game.
Ultimately, while leverage can be helpful, it also creates risk. And just like any other form of risk, you’d best not expose yourself to too much of it — and you’d best not think of yourself as somehow special and exempt from its potential pitfalls.
“By being so cautious in respect to leverage, we penalize our returns by a minor amount. Having loads of liquidity, though, lets us sleep well. Moreover, during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival. That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008.”
This is kind of a follow-up to the previous quote. Here, Warren says that while they could potentially generate slightly better returns if they were more open to using leverage, the “sleep well at night” factor is much more important to them, and they get more of that by maintaining plenty of liquidity and using less leverage.
More importantly, this approach allows Berkshire to take advantage of major buying opportunities in the market. During the Great Financial Crisis, when too much leverage was getting everyone else into trouble, Berkshire had the financial capacity to make massive investments at deeply discounted prices.
So all in all, people might think Berkshire is too conservative when times are good, but that conservatism helps protect them during the bad times and gives them the ability to take advantage of the opportunities those bad times create.
Memorable quotes and key takeaways from the 2010 Berkshire Hathaway shareholder letter.