Saturday, March 15, 2014
It's an absurd number: $34.2 billion. That's what the world's best investor earned in 2013. But the number is so large, I doubt most people really understand what it means.
To put this figure in perspective... consider that George Soros – widely considered the greatest trader of all time – made roughly $39 billion over the course of his entire career. The world's best investor produced almost as much wealth last year as the best trader made during his entire career. (See why I believe most people should focus on investing, not trading?)
Or look at it this way... this one investor, the world's greatest investor of all time, produced more wealth than most of the countries in the world produce. (The global median GDP is Jordan, with a $31 billion annual GDP.)
The investor, as I'm sure you've guessed, is Warren Buffett. And the reason everyone makes such a big deal out of his annual letter to shareholders of his holding company Berkshire Hathaway is because he has made more money investing than anyone thought was possible. (He just published the latest letter at www.berkshirehathaway.com.)
How he did it – exactly, step by step – is detailed in his annual letters. And they're free. How many of you have read them? I've read them all at least a dozen times.
I've read the 1983 letter so many times, I can nearly recite it. I would urge all of you to read these letters. They're the ultimate guidebook to long-term investing. The goal of long-term investing is to compound your wealth. Buffett's annual 19% gains (on average) don't seem very impressive in any given year. But over 50 years? That's how you turn $19 per share of book value into $134,973 per share of book value. That's a total gain, over 50 years, of 693,517%.
Buffett was able to compile this incredible track record by doing two things. First, he figured out that certain kinds of companies were far more likely to produce large, compounding returns on capital over the long term. He describes how to identify these businesses in detail in his 1983 letter.
He coined the term "Economic Goodwill" to explain the special characteristic these companies possess. In short, they produce timeless products that the public doesn't merely need or want, but loves. These businesses are able to routinely increase prices, thereby assuring future increases to revenues and profits, without a corresponding increase to the amount of capital they require to operate and grow. This is the "magic" of Berkshire.
Buffett says of his strategy: "Ultimately, business experience, direct and vicarious, produced my present strong preference for businesses that possess large amounts of enduring Goodwill and that utilize a minimum of tangible assets."
Where do you find stocks with these qualities? Buffett answers: "Consumer franchises are a prime source of economic Goodwill."
The best example of this kind of investing from my Investment Advisory newsletter was my December 2007 recommendation of Hershey (HSY). I wrote at the time that it would become the single greatest recommendation of my career, making investors around 400% over 10 years in capital gains.
Hershey is a nearly perfect example of a beloved consumer franchise that utilizes a minimum of tangible assets. It is tremendously capital-efficient. And I don't believe the world's love of chocolate is in danger of receding.
The second part of Buffett's formula for success is a bit harder to mimic. He currently controls insurance companies that own $77.2 billion worth of "float." That money, which equals almost half of Berkshire's net worth, provides Buffett with "cheaper than free" capital that he can use to leverage his investments by around 50%. Rather than having to borrow $77.2 billion to use for margin, Buffett gets his margin for free. In fact, Buffett normally makes an underwriting profit, which means he's paid to use the money. It's an extraordinary situation that I believe has created more than half of Berkshire's wealth.
Unless you're able to take control of an insurance company with disciplined underwriters, it probably isn't possible for you to get your margin for free. On the other hand, our proprietary work on insurance companies in Stansberry Data – a supplemental publication to my Investment Advisory newsletter – can quickly teach readers what a great investment insurance companies can be... as long as they're earning an underwriting profit.
In this way, you can mimic, if not exactly copy, Buffett's strategy. Check out the long-term return on RLI Corp (RLI) as an example of what's possible when you invest with disciplined insurers.
Having pointed out the scope of Buffett's accomplishment... let me share with you two secrets I'm confident no other analyst is going to mention.
First, Buffett isn't doing very well as an investor right now... and he hasn't been in a long time. Until his 2011 letter, Buffett used to disclose his performance in common stocks separately from the overall performance of Berkshire. He did so by showing the compounded annual increase in investments by decade. So in the 1970s, we know that Buffett made roughly 27.5% annually buying stocks. He made roughly 26.3% annually buying stocks in the 1980s. And almost 20.5% annually buying stocks in the 1990s. But between 2000 and 2010... he made only 6.6% buying stocks. Meanwhile, his wholly owned subsidiaries continued to grow earnings by more than 20% annually.
Buffett's poor investing has made a substantial impact on his company. In four of the last five years (2009-2013), Berkshire Hathaway's book value failed to keep pace with the S&P 500. And last year, Buffett's underperformance of the market was substantial – the S&P beat him by 14.2%. As a result, for the first time in Buffett's entire career, Berkshire has now underperformed the market over a five-year period.
Buffett had long maintained that beating the market over each five-year rolling period was the true test of his management of the company. After all, he'd previously argued, if investors can do better owning a low-cost mutual fund, then why should they pay him to run Berkshire? In 2012, Buffett warned that this winning streak would likely come to an end if the S&P had a good year in 2013. And he boldly promised not to change his performance standards:
So when this year's letter came out... I was eager to see if Buffett would address this issue. Surprisingly, given his reputation for candor, the five-year performance chart that had been featured in the front pages of so many recent annual letters was missing.
Instead, Buffett was now judging his performance against the S&P over a six-year period, instead of five...
Buffett frequently warns that Berkshire's future investment performance can't match its historic rates of growth because of its size. Size is certainly an impediment to performance. But it's not an impossible hurdle. You can see this clearly when you realize that Buffett is still earning more than 20% a year in the businesses he controls.
Where he has fallen down is simply in the stocks he has purchased. For example, even though he described the markets in 2009 and 2010 as being "the perfect environment" for investors, the stocks he bought – mainly IBM (2009) and Bank of America (2010) – are not the kind of businesses that brought Berkshire so much prosperity in the 1970s, 1980s, and 1990s.
Both stocks have underperformed the S&P since his purchase. IBM is clearly involved in technology – a space Buffett has decried his entire career as being inappropriate for long-term investors. And Bank of America clearly requires massive amounts of capital for growth.
You might think my criticism of Buffett’s performance in common stocks is sour grapes. After all, he's the greatest investor who ever lived. I'm merely a scribbler working out of an old house in Baltimore. But think about this for a second...
Buffett spent more than $20 billion on IBM and Bank of America convertible bonds. That's the largest investment he has ever made – by a huge margin. Putting so much capital into these businesses that don't fit the model he pioneered simply doesn't make sense. Something's up at Berkshire. What could it be?
One last secret. Bloomberg recently broke the story that Buffett now holds less than 20% of Berkshire's portfolio in bonds. The allocation had fallen to around 15% by the end of last year. Since 2009 (when I began warning about the "End of America" scenario of soaring inflation and the collapse of the U.S. dollar as the world's reserve currency), Buffett has always been stridently warning about an imminent collapse in bonds.
In his 2009 letter, Buffett warned:
And in his 2010 letter, he warned again:
As you can see, Buffett states publicly that he doesn't favor "currency-based" investments, like bonds. And is there a currency-based investment he likes least of all? We believe so.
Our research shows that Buffett now holds nearly 70% of Berkshire's bond portfolio in non-U.S. sovereign debt. The amount of foreign bonds in Berkshire's portfolio has been increasing, almost linearly, since the late 1990s.
You're free to draw your own conclusions. But... what I can see is that Buffett is moving large amounts of his assets into extremely safe equities and operating companies. Buffett has been buying electric utilities, railroads, and the biggest banks. These companies don't match his preference for capital-efficient businesses, nor can they give Berkshire an S&P-beating performance over the long term. But...
They will survive even a decade-long global crisis. Seeking safety at all cost, Buffett even spent $10 billion on IBM, a fortress-like tech stock. Meanwhile, Buffett is doing everything he can to get out of the U.S. dollar, selling nearly all of his U.S. bonds.
The world's greatest investor looks like he's "battening down the hatches." Don't say you haven't been warned...
In my recent presentation at the Stansberry Society event in Miami Beach, I updated my End of America thesis – my belief the U.S. dollar will lose its place as the world's reserve currency.
In my Investment Advisory newsletter, I show my subscribers how to protect their wealth against the devaluation of the dollar. To get started with your four-month risk-free trial – which comes with access to all of my monthly issues and special reports – click here to learn about a subscription to Stansberry's Investment Advisory.
Date Range:3/6/2014 to 3/13/2014
Date Range:3/6/2014 to 3/13/2014