As of 31 December 2022, Berkshire’s common stock investments are worth US$ 308.8 billion, which is a 24.7% decrease from US$ 350.7 billion at end-2021. For 2022, there is no stockholdings breakdown offered in its latest annual report. In Berkshire’s view, such short-term capital gains and losses are ‘meaningless’, due to value investing principles practiced by Warren Buffett and Charlie Munger.
Source: Warren Buffett’s Letter 2022
For this edition, Warren Buffett wrote briefly about the ‘secret sauce’ which has taken Berkshire’s portfolio to where it is today. As such, in this write-up, I would dive deep into his ‘secret sauce’ to extract meaningful investing lessons that we all could apply to building and maintaining our own portfolios.
Example #1: Coca-Cola
In August 1994 – yes, 1994 – Berkshire completed its seven-year purchase of the 400 million shares of Coca-Cola we now own. The total cost was $1.3 billion – then a very meaningful sum at Berkshire.
The cash dividend we received from Coke in 1994 was $75 million. By 2022, the dividend had increased to $704 million. Growth occurred every year, just as certain as birthdays. All Charlie and I were required to do was cash Coke’s quarterly dividend checks. We expect that those checks are highly likely to grow.
3 quick points from this example.
1. In 1994, Berkshire’s dividend yield from Coca-Cola was 5.77%, which may not be ‘impressive’ to some who are looking for impressive double-digit returns per annum. But, that is okay. This is because better investments tend not to be with those that promise initial fast and huge gains. The ones that could yield 10+% in dividends per year may not be (often are not) better investments than ones like Coca-Cola. So beyond initial returns, it is practical to emphasize on the business qualities (fundamentals) when investing.
Dividend Yield (1994)
= Dividends Received / Investment Cost x 100%
= US$ 75 million / S$ 1.3 billion x 100%
2. By 2022, Berkshire’s dividend yield from Coca-Cola is 54.15%. This is the fruit, the end-product for holding onto Coca-Cola over the long-term. The key to earn increasing dividends lies in Coca-Cola’s business growth for the long run. Here, I charted 3 graphs of Coca-Cola’s financial results after Berkshire’s investments in the company:
a. Net Income (1994-2022)
b. Operating Cash Flows (1994-2022)
c. Dividends Paid (1994-2022)
Dividend Yield (2022)
= Dividends Received / Investment Cost x 100%
= US$ 704 million / S$ 1.3 billion x 100%
3. For Buffett and Munger, all they did after investing in Coca-Cola is to ‘Deposit Quarterly Dividend Checks’ and nothing else. You would not find them, thinking about disposing off Coca-Cola shares, during recessions, downturns and market crashes. In 1994-2022, Buffett and Munger have stayed invested with Coca-Cola throughout many crises such as:
a. Dotcom bubble in late 1990s.
b. Global financial crisis in 2008.
c. European debt crisis.
d. COVID-19 in 2020/21.
e. Ongoing Ukraine-Russia War
Therefore, the essence is – As long as the stock is income-productive, there isn’t a need to sell off the stock (business). Now, let’s look at the next example:
Example #2: American Express (AMEX)
American Express is much the same story. Berkshire’s purchases of Amex were essentially completed in 1995 and, coincidentally, also cost $1.3 billion. Annual dividends received from this investment have grown from $41 million to $302 million. Those checks, too, seem highly likely to increase.
2 quick points:
1. The key word here is ‘same story’. This means – ‘making sound investments in fundamentally strong companies is a formula that is highly replicable.’ Investing successfully in the long-term is about skills and systems.
2. In 1995, Berkshire’s dividend yield from AMEX was 3.15%, not that ‘stunning’ for most. But by 2022, its dividend yield had increased to 23.23%. So, if we look at AMEX’s financial results after 1995:
We can see a similar pattern of growth in net income, operating cash flows, and dividend payments in 1994-2022. Also, we can see that Buffett and Munger had held onto AMEX’s shares throughout major crises as stated above. So, I guessed the secret sauce that Buffett is referring to is on:
a. Fundamental quality of the businesses.
b. Staying invested and allowing the businesses to grow over time.
Example #3: High-Grade 30-Year Bond
These dividend gains, though pleasing, are far from spectacular. But they bring with them important gains in stock prices. At year end, our Coke investment was valued at $25 billion while Amex was recorded at $22 billion. Each holding now accounts for roughly 5% of Berkshire’s net worth, akin to its weighting long ago.
Assume, for a moment, I had made a similarly-sized investment mistake in the 1990s, one that flat-lined and simply retained its $1.3 billion value in 2022. (An example would be a high-grade 30-year bond.) That disappointing investment would now represent an insignificant 0.3% of Berkshire’s net worth and would be delivering to us an unchanged $80 million or so of annual income.
The third US$ 1.3 billion investment Berkshire made was into a 30-year bond. A bond is a form of debt and thus, couldn’t expand in intrinsic value unlike stocks, which are businesses that are expandable and scalable over time. This is how in the long-term, Berkshire’s investments in Coca-Cola and AMEX had expanded in value to US$ 25 billion and US$ 22 billion, while the 30-year bond has remained at US$ 1.3 billion in value.
I likened a 30-year bond as a typology of ‘fixed deposit’. I’m not advocating that stocks are better than FDs as both serve different purposes. FDs or bonds could be okay if one wishes to stash aside some emergency funds. That, I understand.
But, is it practical to hoard excess cash in FDs for 30 years?
Now that, I believe, is debatable.
The lesson for investors: The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders. And, yes, it helps to start early and live into your 90s as well.
I guessed his context is – ‘Over Buffett’s 80+ years of investing, there are several stocks that he invested which had attained exceptional successes and they have contributed significantly to his wealth (and as well as long-term shareholders of Berkshire). These are notably his Coca-Cola and AMEX. Gains from these stocks, I believe, had far exceeded any losses that he incurred due to mistakes’.
Personally, as one who is of the latter generation, I’m privileged to learn, reflect and gain valuable insights from his vast investing experiences. As such, I tend to adopt what worked for him and avoid what failed him when investing. By doing so, I have been able to replicate winners and avoid losses better as I stepped on his shoulders. Hopefully, some ‘winners’ that I own could ‘work wonders’ in the long-term and thus, contribute to my personal wealth.
Here is the link to get a copy of Warren Buffett’s letter for 2022.