This is the twenty-fourth in a series of blog posts that will analyze / summarize Warren Buffett's shareholder letters from 1977-2015. For all of the prior shareholder letters, see here.
The 2000 letter weighs in at 13,320 words, an 8% increase from 12,340 words the prior year. Berkshire's gain in net worth during 2000 was just $3.96 billion, or 6.5% of beginning 2000 net worth.
FROM BERKSHIRE TO BYRNE TO BEZOS BACK TO BUFFETT
Buffett mentions in the 2000 letter that he needed to find a new CEO for Berkshire Hathaway subsidiary Fechheimer Brothers, a uniform manufacturer. What he doesn't mention is that the exiting CEO was Dr. Patrick Byrne, now CEO of Overstock.com and famous in the investing community for his Sith Lord rant against short sellers in 2005. A contemporaneous Fortune article about Byrne from 2000 contains a few interesting details worth mentioning here. First, Byrne says that Buffett gave him the following investing advice when he was 13...
"There was no one calling balls and strikes, and I could take as many pitches as I wanted," recalls Byrne, who got to know Buffett because his father was a colleague and friend of the legendary investor's. Buffett's advice was simple: "Every year or two, the perfect pitch comes along, and you swing from the heels." But few people have the courage to do that, Buffett explained. "Most people just try to bunt." [emphasis added]
A second interesting detail included in the Fortune story was Byrne's prediction that Overstock 'will make more money in the next five years than Amazon'. Well, yours truly is far too lazy to retrospectively fact check that prediction; however, it is worth mentioning that Amazon's market cap today is almost precisely 1,000X that of Overstock.com, or $430 billion for AMZN versus $434 million for OSTK.
Finally, the Fortune article states that 'some [people] felt Byrne was "too quick on the trigger," as a former Fechheimer executive puts it. Certainly, Byrne's tenure didn't lack for drama: He once challenged union leaders to a fistfight to resolve a labor dispute. No one volunteered, and the union later backed down.'
Meanwhile, Jeff Bezos' most remarked-on personality trait seems to be his consistent uproarious laughter. Perhaps there's a lesson in there somewhere. [By the way, just about a week ago Bezos became the world's 2nd richest person, surpassing...you guessed it - Warren Buffett.]
SUPERIORITY OF CONCENTRATED LONG-TERM PORTFOLIOS
In our discussion of the 1999 letter, we noted how concentrated Berkshire's portfolio was, with the top 5 holdings constituting nearly 80% of Berkshire's overall portfolio. The 2000 letter again evidences why concentration yields better [albeit lumpier] results, at least in the hands of a skilled capital allocator like Buffett. As of 12/31/2000, Berkshire's top 5 holdings had a basis equal to just 35.6% of the overall company portfolio basis, or $3.7 billion out of a total basis of $10.4 billion. Yet the top 5 holdings were responsible for 90% of the overall company portfolio's unrealized capital gains, or $24.4 billion out of a total capital gains of $27.2 billion. If one divides Berkshire's equity portfolio into [A] a top-5 portfolio and [B] an 'everything else' portfolio, as of year-end 2000 the former would have registered an overall unrealized gain of 559%, while the latter would have registered an overall unrealized gain of 42%, in each case excluding dividends. This seems to us to be statistically significant. Of course, this is backward-looking and somewhat self-selecting; in other words, the smartest investments will naturally become a larger and larger percentage of the portfolio over time. However, it shows why Buffett says that his preferred holding period is 'forever'. Just imagine if Buffett had sold out of the Washington Post after it had tripled from his original basis, on the theory that 'one should sell a 3-bagger to lock in gains' or some other flimsy justification for selling--he would then have missed out on an ensuing 33-bagger. Often the best decision is simply to do nothing.
AESOP AND THE 'INEFFICIENT BUSH THEORY'
Buffett goes on to discuss Aesop, who he says laid out the 'formula for valuing all assets that are purchased for financial gain'. This 'formula' is of course the proverb that 'A bird in the hand is worth two in the bush'. Confused? Buffett explains as follows...
To flesh out this principle, you must answer only three questions. How certain are you that there are indeed birds in the bush? When will they emerge and how many will there be? What is the risk-free interest rate (which we consider to be the yield on long-term U.S. bonds)? If you can answer these three questions, you will know the maximum value of the bush--and the maximum number of the birds you now possess that should be offered for it. And, of course, don’t literally think birds. Think dollars.
Aesop’s investment axiom, thus expanded and converted into dollars, is immutable. It applies to outlays for farms, oil royalties, bonds, stocks, lottery tickets, and manufacturing plants. And neither the advent of the steam engine, the harnessing of electricity nor the creation of the automobile changed the formula one iota--nor will the Internet. Just insert the correct numbers, and you can rank the attractiveness of all possible uses of capital throughout the universe.
Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business. Indeed, growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years. Market commentators and investment managers who glibly refer to "growth" and "value" styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component--usually a plus, sometimes a minus--in the value equation.
Alas, though Aesop’s proposition and the third variable--that is, interest rates--are simple, plugging in numbers for the other two variables is a difficult task. Using precise numbers is, in fact, foolish; working with a range of possibilities is the better approach.
Usually, the range must be so wide that no useful conclusion can be reached. Occasionally, though, even very conservative estimates about the future emergence of birds reveal that the price quoted is startlingly low in relation to value. (Let’s call this phenomenon the IBT--Inefficient Bush Theory.) To be sure, an investor needs some general understanding of business economics as well as the ability to think independently to reach a well-founded positive conclusion. But the investor does not need brilliance nor blinding insights.
At the other extreme, there are many times when the most brilliant of investors can’t muster a conviction about the birds to emerge, not even when a very broad range of estimates is employed. This kind of uncertainty frequently occurs when new businesses and rapidly changing industries are under examination. In cases of this sort, any capital commitment must be labeled speculative.
Now, speculation--in which the focus is not on what an asset will produce but rather on what the next fellow will pay for it--is neither illegal, immoral nor un-American. But it is not a game in which Charlie and I wish to play. We bring nothing to the party, so why should we expect to take anything home?
The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities--that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future--will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands. [emphases added]
Note the remark that sometimes 'the most brilliant of investors can’t muster a conviction about the birds to emerge, not even when a very broad range of estimates is employed', which 'frequently occurs when new businesses and rapidly changing industries are under examination'. Investors in this scenario, Buffett says, are speculating, not investing--instead of examining the bush to see how many birds are inside, they are trying to guess what other investors will think about the bush tomorrow.
This brings to mind a certain electric car company named for a famous early 20th century inventor, now sporting a market capitalization of approximately $47,000,000,000, despite consistently running at a GAAP net loss and burning through hundreds of millions of dollars [the negative bird burn rate, or NBBR] every quarter. Now 47,000,000,000 birds is a heck of a lot of birds, if you ask us. Assuming the bush won't be gushing birds anytime soon [in the next 5 years or so], an investor purchasing at the current valuation will need, say, 5 billion birds to emerge from that bush every 365 days a decade from now in order to justify today's outlay of funds. That would equate to approximately 13.7 million birds emerging every day in 2027. Needless to say, there aren't too many bushes around that hemorrhage birds at that rate, but investors currently view this particular bush/company as THE ONE. We asked a random guy on the street what he thought about the whole thing [i.e., the current NBBR, the 47B bird valuation, etc., for this company]--his reaction said it all...
Well put, sir.
For the record, in 2000 Berkshire's stock appreciated 27%, outperforming the S&P 500 by 36%, the Yankees beat the Mets 4-1 in the World Series, the Ravens topped the Giants 34-7 in Super Bowl XXXV and on March 26th Good Ole Pootie Poot won election as President of Russia. Next up, 2001, a year we will never forget.