Chairman and CEO of Berkshire Hathaway, Warren Buffett, released his annual letter to shareholders last week. People in the investment world would know that this annual letter summarises Berkshire’s financial performance for 2019 and usually contains nuggets of investing wisdom. The letter was so influential that before the advent of the Internet, professional money managers owned 1 share of Berkshire Hathaway just to receive a copy of the annual letter. Now, we have the benefit of reading about Buffett’s thoughts through the wonders of the Internet.
Berkshire Hathaway’s annual letters to shareholders can be found here.
The 2019 edition of the letter sees Buffett talk about the power of retained earnings and the state of Corporate Governance in the world, among other anecdotes. A little light on investment lessons, but an enjoyable read nonetheless.
This is not an investment website if we don’t kay-poh Buffett’s holdings a little bit. Not much changes in the individual counters with Visa replacing USG Corporation. Nothing too surprising, typical Buffett portfolio.
The power of retained earnings
Buffett took some time to illustrate the power of retained earnings through the words of economists Edgar Lawrence Smith and John Maynard Keynes.
Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back into the business. Thus there is an element of compound interest (Keynes’ italics) operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders.
This reiterates a point that I think investors sometimes ignore. A common question at company AGMs is about raising dividends and increasing earnings payout. I get that, who doesn’t love to get paid?
The inherent issue with this strategy is two fold:
- Companies that pay a large percentage of their earnings out as dividends do not retain much capital to grow their business. As such, these companies usually experience stagnant to slow growth.
- As a result of this, the responsibility falls on the investor to compound their investment by reinvesting the dividend in identified opportunities. Something that I think not all investors want to spend time on.
Investing in good growth companies solves this. Company management is able to take the cash flows the business generates to reinvest to grow the business. Sure you don’t get as much income, but you don’t have to do anything other than to stay invested.
Moral of the story – don’t fear investing in good growth companies.
On the state of Corporate Governance
Corporate Governance is an area that I’m interested in. I have regularly pointed out Governance issues in the past (Tesla and KORE). As such, I am glad that Buffett took some time to call out the Corporate Governance issues found in companies.
Here’s a summary of the issues highlighted:
- Female representation on Boards remain abysmal
- Acquisition proposals are often doctored to favour the CEO’s stand. (Buffett hilariously suggested bringing in advisors to pitch for and against an acquisition. The winning side receives 10x the token sum paid to the loser)
- Compromised Board Independence due to Director’s compensation.
- This is due to the prevalence of “non-wealthy directors”, directors who is actually beholden to their Director’s compensation.
- “Non-wealthy” Independent directors tend to be yes-men who provide poor oversight over the CEOs that they oversee. This is so that they can retain their plump director roles and the compensation that comes with the position.
I’m a bit of a feminist when it comes to Company management and Board composition. It’s because I find that women executives often bring a different and more considered perspective. However, we’re still a long way to go to seeing more female representation on company boards.
The point on director’s compensation is particularly interesting to me, as I’ve not thought about it that way. Something to pay attention to going forward.