3 Lessons from Warren Buffettís 2021 Shareholder Letter and How You Can Apply Them to Your
Life
Whatís up guys! Itís Jason here and welcome to my YouTube channel, Company Insight. Today
we go from Company Insight to Warren Buffett Insight! When thinking of advice that you
can implement into your life, Buffettís highly regarded annual letter to shareholders may
seem like an unlikely place to start. Many people are familiar with Buffett for his success
as an investor and his status as one of the wealthiest persons in the world. But few are
aware of the life philosophy and world view of the man behind the renowned holding company,
Berkshire Hathaway. A deep thinker in his own right, Warren Buffettís wisdom and life
advice to everyone (from students, young people to entrepreneurs and retirees), extend beyond
business and investing. In this video Iíll share with you three pieces of advice taken
from the Warren Buffett 2021 annual letter. By the end of this video, youíll be a Buffett
Guru and Warren Buffett's life advice will change your future. Trust me when I say that
you donít need to be an investor to benefit from a lifetime of accumulated wisdom from
the Oracle of Omaha.
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Warren Buffett Advice for 2021 #1 ñ Retained Earnings and the Power of Compounding
The numbers are almost unbelievable. Buffettís investment track record has delivered yearly
performance of 20% from 1965 to 2020. That means if you had invested in 1965, your investment
wouldíve gained over 2.8 million percent! For perspective, the average annual performance
of the S&P 500 was only up 10% yearly over the same time period. The secret formula to
this outsized performance? Retained earnings and the compounding of those earnings.
Retained Earnings
When a company earns a profit, this is a good thing. When a company has retained earnings,
this is even better. This means the company still has money left over to reinvest in its
business. This money is managementís responsibility to put to good use doing things that will
increase shareholder value over the long-term. Generally, this surplus is plowed back in
order to continue growing the business. Retained earnings put to good use is a healthy sign.
Increasing shareholder value can lead to an increased stock price over time, so consequently
savvy investors look to retained earnings as a possible indication of good future prospects.
And retained earnings are necessary for the next part of the formula: compounding.
Compounding
Over the years people have described the idea of compounding as the eighth wonder of the
world. But what is compounding, and why is it so powerful? Simply put, compounding is
an ever-increasing amount being added to what you already have. In the context of finance,
money that compounds is money that grows at an ever-increasing rate so that each time
that money is being put to work, itís able to earn even more each time because the return
you receive helps grow the overall size of your money. If compounding seems confusing,
maybe this analogy will help. Picture a small snowball that starts at the top of a mountain
and begins rolling down to the bottom. It starts small and moves slowly. But as the
snowball travels down the mountain, it becomes larger by picking up more snow as it moves.
And it expands faster as the speed and mass increase. As the snowball grows, so does the
amount of snow thatís able to stick to it. From a company perspective, as its money grows,
so does its ability to utilize that money to accomplish key business objectives. This
is how many decades of compounding transformed Berkshire into such a valuable company for
shareholders and made Buffett one of the worldís wealthiest people in the process. However,
donít be misled: the bulk of Buffettís net-worth came in the later part of his life, not earlier
and this is due to the time that compounding takes.
Compounding Can Be Positive or Negative
The financial definition of compounding is certainly enticing, but thatís only one application.
In relationships, education, careers, or level of experience, positive compounding is the
special ingredient that leads to huge accomplishments. For example, trust between people leads to
more synergy in a relationship because each person doesnít have to spend time questioning
the motives of the other. In education, your prior learning gives you a platform to stand
on and allows you to solve tougher problems with larger payouts. In your career, one way
to define how valuable you are is by the value you add to the lives of other people and compounding
your knowledge is a surefire way to do this. Perhaps most importantly, the magic of compounding
is that once the process is underway, it generates its own momentum and can largely run on autopilot.
For example, Buffettís track record has had down years as well. He is candid when speaking
of his mistakes, most recently Berkshireís $11 billion write down of their $37 billion
investment in Precision Castparts. Despite this, the size of his losses has not eclipsed
the magnitude of his gains. Consequently, his average performance has been double that
of the S&P 500 but this can only be noticed over a long enough period of time. The results
of any one year donít tell you much about the direction.
It is important to remember that compounding can be both positive and negative. An example
of this can be your physical health. Good health leads to better health and longevity,
whereas poor health contributes to worse health which makes an already bad situation worse.
As weíve seen in previous videos, a companyís health is not static and changes over time.
Lastly, the ideas of retained earnings and compounding are both long-term. It takes time
to work up to a point where you can retain earnings, and compounding is a process that
leads to success over the course of years, not weeks or months. When good outcomes compound,
the results can be staggering. Sometimes too much of a good thing is wonderful.
Warren Buffett Advice for 2021 #2 ñ Overdiversification Leads to Mediocrity
Weíve all been told that we should diversify. In investing this is evidenced by owning more
than one stock and in life by being a ìwell-rounded individual.î Diversification drastically
cuts down the risk of negative outcomes by spreading out the risk. Whether itís a financial
investment youíre contemplating or a life path youíre considering, you ultimately donít
know what will happen. But just as mimicking the index gives you the same results as the
index, trying to do too many things in life strains your resources. Buffett has said in
the past that he likes to put all his eggs in one basket and then watches that basket
very closely. In our personal lives, achieving outsized results in a particular area is linked
to how deep we go into learning it, and this takes time. In Inc. magazine, entrepreneur
Randi Zuckerberg, said that the entrepreneurís dilemma is maintaining friendships, building
a great company, spending time with family, staying fit, and getting sleep. Oh, and you
can only pick three of those things. This is a great segue into the next section, where
we take a look at the paradox
of choices.
The Upside of Constraints
Unlimited options. That seems like a good thing at first. Perhaps this is true in theory,
but consider this. If you have unlimited choices, then how do you decide what to do and what
about when things get difficult? If you have unlimited choices you could switch to something
else, but then you would miss out on a potential learning opportunity. Part of achieving the
hard-won knowledge that pays off later when compounding is by doing the right challenging
things. Dropping one activity in favor of another the moment it becomes hard all but
guarantees the kind of learning that is characterized by the phrase ìa mile wide but an inch deep.î
Constraints are limiting, but they can also be clarifying. This is because many of the
things that are presented to us in life are now framed in a way that makes it seem like
the outcomes we want can always be had on our own terms and in unlimited quantities.
The more sobering truth is that we do not have unlimited options and time. Trying to
do everything usually ends in accomplishing nothing. There are times when it is better
to say no than yes, especially if you know that what is being offered to you doesnít
fit your criteria. Berkshire has a sizable portfolio of businesses where some are fully
controlled and others only partially. Despite the portfolio size however, most of Berkshireís
value is concentrated in just four companies. These four companies have powered Berkshireís
growth and financial results for years, with the insurance business being the cornerstone.
The advice to take away here is not that diversification is bad or that you shouldnít do it. Since
you donít know exactly what will or wonít work, it makes sense to experiment and try
different things. As you get feedback from these experiments, pay close attention to
the results. Do more of what works and less of what doesnít. And if nothing seems to
work, keep experimenting until you find something that does. Some of us know right away what
we want to do, while for others it takes more time. Once you have your opportunity in sight,
go all in and see what happens. If it doesnít work, you can always try something else. In
my Company Man video, we learned that Mike most likely had other YouTube channels in
the past that he tried out, specifically the movie and basketball channels. The channel
that took off was Company Man, and he has stuck with it regularly since 2017. Trying
many things makes sense as a discovery strategy in the beginning, but trying to go through
your whole life in a constant state of keeping your options open will preclude success.
Warren Buffett Advice for 2021 #3 ñ Patiently Waiting for Opportunity
Over the last several years, Berkshire has run into a frustrating yet interesting problem.
It canít find enough deals that fit its investment criteria. This is due to the investment saying:
size is the enemy of performance. When a company has a war chest of cash, the investments it
needs to make must be large to deliver meaningful results. Simply taking a position in common
stock is no longer the best approach and is the reason why Berkshire has shifted to buying
entire companies. Now letís take a look at how Buffett approaches this situation. Warren
says deals are hard to find, but think about the subtext of his statement. It isnít that
deals are hard to find; in fact, quite the opposite. There are plenty of deals everywhere!
But Buffett isnít looking for just any deal. Heís looking for the right ones, the ones
that fit his criteria. And while he is patiently waiting on the right pitch, he is still increasing
value for his shareholders.
Stock Buybacks and Increasing Shareholder Value While Patiently Waiting
Buffett says many CEOs will intentionally do as much as they can get away with to inflate
their own companyís share price to use that to make an attractive offer to a competitor.
But stop and think about the implications. If a company artificially inflates its stock
price over the short term and then uses it to overpay for another company just to show
growth, real value has not been added anywhere. In the longer term, the results can spell
trouble. As investors realize that future prospects are not lining up with managementís
decisions, the companyís intrinsic value can be negatively impacted.
If you think Buffett forgot about shareholders with his lack of deal making, here are some
interesting stats. Berkshire is still hard at work increasing shareholder value even
without buying new companies. In 2020, Berkshire repurchased 80,998 of their class ìAî shares
to the tune of $24.7 billion. Instead of buying back stock when the stock is overvalued, Berkshire
buys back only when it believes its stock is undervalued, a practice that falls in line
with Buffettís views on investing and only buying when the price is right. This decision
has increased shareholder ownership in Berkshireís portfolio of companies by 5.2%. It also had
a positive trickle-down effect into Berkshireís Apple investment. Berkshireís stake in Apple
had been 5.2% when the company finished building its position in July 2018. Due to Appleís
recent stock buyback initiative, that position increased slightly to 5.4% at an additional
cost of zero. Shareholders benefited once again and now own 10% more shares of Apple
than they did before.
The Price of Patience is Criticism
Investors have frequently criticized Berkshire for either underperforming or barely outperforming
the market over the last several years. The critics think that it is their responsibility
to spend Berkshireís money, but their shortsighted view fails to grasp one of the key elements
of Buffettís strategy: cash plus courage in a crisis is priceless.
The saying you just heard is another quotable line from Buffett. It underscores Buffettís
insistence to only buy good deals, and there is nothing like a crisis to suddenly generate
a wide selection of possible deals. This strategy was utilized during the 2008 financial crisis
and paid off handsomely when many otherwise sound companies found themselves in distressed
positions in need of emergency investment. What advice can individuals learn from this?
I think the biggest takeaway is patience. Waiting for the right opportunity in life
is hard because in the moment, it can seem like every opportunity is the right opportunity.
If you know what you want, you can more easily say no to things that donít fit your parameters,
like Berkshire does with its deal making. But similar to Berkshire, saying no to something
doesnít mean sitting back and doing nothing. Instead, youíre using this time to prepare;
to develop and refine your skills. This may take the form of stockpiling cash if youíre
Buffett or practicing your craft. This kind of preparation greatly increases your chances
of success when the right opportunity comes, allowing you to strike with a clarity of purpose
and will.
Conclusion
And that brings us to today. I hope you have found these 3 pieces of advice from Warren
Buffettís 2021 annual shareholder letter to be useful. I wanted to present them to
you because I believe there are parallels between his decisions as an investor and how
individuals can approach making choices in their personal lives. We all want to make
good choices with good outcomes, but of course this is easier said than done. Hopefully,
this video shows you that while the future may be unknowable, there are different ways
for you to think about it and prepare for it so that you can increase your likelihood
for success and to be rich.
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stay tuned for another episode of Company Insight next week.