By JohnCoumarianos
Warren Buffett’s 50th annual Berkshire Hathaway shareholder letter
included technical discussions about the insurance industry and other
businesses Berkshire owns, but as usual it also contained some important
lessons for individual investors, including:
1. A stock is a business, not a piece of paper
First,
although it seems banal to say, a stock is an ownership unit of a
business. Early in the letter Buffett remarks about Berkshire’s
BRK.A, +0.87%
BRK.B, -0.04%
intrinsic value, saying that
computing intrinsic value of a business isn’t an exact science. But
Buffett mentions earnings per share and quality of management as
touchstones. The latter will presumably maintain profitability and not
waste money.
The lesson for investors is that a
stock represents the value of a business’s future earnings. You should own it
for that reason, and not because you think you can capitalize on its short-term
gyrations, which generally have nothing to do with its business value.
Although they can be crazy in the
short term, stock prices are ultimately governed by the profits their
underlying businesses generate, and you should treat them that way. (Buffett
doesn’t say it in this context, but he has said in the past that market
craziness can be a good thing for those who can calculate intrinsic value
coolly. Price gyrations provide opportunities to buy at unreasonably low prices
and sell at unreasonably high prices.)
2. Stocks serve as inflation
protection over the long haul
Buffett remarks that from 1964
through 2014, the S&P 500 SPX, +0.12% , including dividends,
generated a return of more than 11,000%. Over that same period of time, the
U.S. dollar DXY, +0.51% lost 87% of its purchasing
power, meaning it now costs $1 to buy what in 1965 cost 13¢.
Investors should remember that U.S.
stocks didn’t do well in the 1970s, when inflation was rocketing. But Buffett
is clearly correct in arguing that stocks certainly improved the purchasing
power of their owners over the half-century period from 1964.
Finally, although stocks may not be
priced to deliver outstanding returns at any given moment, Buffett adds the
phrase “bought over time” when talking about accumulating stocks. Investors
should take that to mean regular periodic investments in stocks will likely
turn out fine over a multi-decade period.
3. Volatility is not risk
Investors must tolerate far greater
volatility in stocks than in securities tied to U.S. currency. But it’s clear
that securities tied to the value of U.S. currency have presented truer risk to
one’s financial well-being over the past half-century.
If you need money for a home
purchase or to fund tuition payments over the next few years, then short-term
bonds and cash are required. Stocks’ volatility VIX, -1.34% makes them inappropriate for
short-term goals.
But if you have a long time frame
and can make regular investments, then the risk to your financial well-being is
in not owning stocks. So if you’re relatively young, and you’re contributing to
a 401(k), for example, you’ll do yourself a favor in old age by making
contributions to stocks now and periodically through your life.
4. Keep a multi-decade time horizon
Buffett thinks long-term. And that’s
not simply because this year’s letter marks the
50th anniversary of his having taken control of Berkshire. Being able to have a
longer time horizon allows you to tolerate the volatility that stocks
necessarily present, and reap the inflation-beating rewards they deliver.
5. Keep an eye on fees, and use
index funds
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