Thursday, January 20, 2011

Buffett: Investment-Oriented Shareholders - Berkshire Shareholder Letter Highlights

From Warren Buffett's 1985 Berkshire Hathaway (BRKashareholder letter:

"Historically, Berkshire shares have sold modestly below intrinsic business value. With the price there, purchasers could be certain (as long as they did not experience a widening of this discount) that their personal investment experience would at least equal the financial experience of the business. But recently the discount has disappeared, and occasionally a modest premium has prevailed.

The elimination of the discount means that Berkshire's market value increased even faster than business value (which, itself, grew at a pleasing pace). That was good news for any owner holding while that move took place, but it is bad news for the new or prospective owner. If the financial experience of new owners of Berkshire is merely to match the future financial experience of the company, any premium of market value over intrinsic business value that they pay must be maintained.

Management cannot determine market prices, although it can, by its disclosures and policies, encourage rational behavior by market participants. My own preference, as perhaps you'd guess, is for a market price that consistently approximates business value. Given that relationship, all owners prosper precisely as the business prospers during their period of ownership. Wild swings in market prices far above and below business value do not change the final gains for owners in aggregate; in the end, investor gains must equal business gains. But long periods of substantial undervaluation and/or overvaluation will cause the gains of the business to be inequitably distributed among various owners, with the investment result of any given owner largely depending upon how lucky, shrewd, or foolish he happens to be.

Over the long term there has been a more consistent relationship between Berkshire's market value and business value than has existed for any other publicly-traded equity with which I am familiar. This is a tribute to you. Because you have been rational, interested, and investment-oriented, the market price for Berkshire stock has almost always been sensible. This unusual result has been achieved by a shareholder group with unusual demographics: virtually all of our shareholders are individuals, not institutions. No other public company our size can claim the same.

You might think that institutions, with their large staffs of highly-paid and experienced investment professionals, would be a force for stability and reason in financial markets. They are not: stocks heavily owned and constantly monitored by institutions have often been among the most inappropriately valued."

Some stocks, more than others, obviously tend to attract what John Bogle calls "rent-a-stock" oriented speculators instead of long-term owners. All other things being equal, a stock predominantly held by renters will swing far above and below approximate business value more often than a stock dominated by investment-oriented owners.

Consider the shareholder demographics of a company like Pepsi (PEP) to that of Salesforce.com (CRM). Which of those two companies would you bet is going to have a larger speculative premium or discount to intrinsic business value at any point in time?*

The fact that the average holding period of stocks is now measured in months instead of years just means the swings above and below business value are likely to be larger than ever. 

Adam

Long BRKb and PEP

Related post: Buffett on High Quality Ownership

* In the mid to late 1990s even Berkshire Hathaway's stock was selling well above intrinsic business value so no company is immune to this.
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