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Top 5 Lessons from Warren Buffett's Letter to Shareholders - YouTube
Channel: Stephen Spicer, CFP
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Every year, Berkshire Hathaway shareholder
or not, investors from all around the world
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anticipate the Oracle of Omaha's wisdom. Over
the weekend, the annual shareholder letter
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was released and these were my top 5 takeawaysâŠ
--
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Hey there. My name is Stephen Spicer and itâs
my goal to help you invest smarter. And what
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better way to do that, than by learning from
the Master. There was one thing that Buffett
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implied that I didnât really agree with
though⊠Iâll put that into a separate
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video - so be sure to subscribe and hit that
notification bell so you donât miss it!
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Now, if you havenât had a chance yet to
read over the letter yourself - Iâll leave
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a link for you right at the top of the description.
And real quick, if youâre a fan of videos
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like this (where we can learn from wisdom
distilled from the Greats), take a second
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right now and hit that like button - let me
(and YouTube) know that you appreciate the
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work that goes into these videos.
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Without further ado, letâs get to it:
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The first big lesson came from his warning
about screwy accounting practices commonly
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used by many corporations. I think thereâs
a valuable lesson to be learned here from
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the point Buffett is trying to make, but I
also want to come at this from the other side
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as well - provide you with an alternate perspectiveâŠ
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...hereâs what Buffett said - [After talking
about how much money Berkshireâs subsidiaries
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made last year, he explained:]
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When we say âearned,â moreover, we are
describing what remains after all income taxes,
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interest payments, managerial compensation
(whether cash or stock-based), restructuring
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expenses, depreciation, amortization and home-office
overhead.
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That brand of earnings is a far cry from that
frequently touted by Wall Street bankers and
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corporate CEOs. Too often, their presentations
feature âadjusted EBITDA,â a measure that
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redefines âearningsâ to exclude a variety
of all-too-real costs.
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For example, managements sometimes assert
that their companyâs stock-based compensation
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shouldnât be counted as an expense. (What
else could it be â a gift from shareholders?)
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And restructuring expenses? Well, maybe last
yearâs exact rearrangement wonât recur.
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But restructurings of one sort or another
are common in business â Berkshire has gone
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down that road dozens of times, and our shareholders
have always borne the costs of doing so.
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Abraham Lincoln once posed the question: âIf
you call a dogâs tail a leg, how many legs
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does it have?â and then answered his own
query: âFour, because calling a tail a leg
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doesnât make it one.â Abe would have felt
lonely on Wall Street.
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Itâs really easy to get sucked into the
numbers that managements feed you (...or analysts).
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If youâre not aware of this fact that Buffett
details - if you just take what they tell
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you at face value - you CAN get burned.
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So, Buffettâs warning is appropriate and
timely for anyone trying to invest smarter.
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So⊠be aware of that.
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BUT⊠if youâre trying to compare a company
to its peers, then youâll be best served
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if you can get it as close as possible to
an apples-to-apples comparison. To this end,
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an adjusted figure can be entirely practical
and extremely helpful. (If youâd like more
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information on EBITDA - how to calculate it,
what it means - I have a video that Iâll
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link to in the description.)
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But as a simple example of what Iâm talking
about here, as Buffett mentioned, companies
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have different restructuring expenses from
year to year. And yes, although those will
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absolutely come up again, and should be accounted
for by you as the potential investor, theyâre
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not coming up in the same year or to the same
degree for every single company inside a peer
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group. Meaning, if you donât factor them
out for the sake of deriving a comparable
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company analysis, your end result will be
skewed - itâll be inaccurate, wrong. Just
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because the one incurred the higher capital
expenditure this year, that doesnât mean
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it necessarily deserves a lower valuation
today as a result.
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I hope that makes sense. To have a fair comparison
- one upon which you could make an educated
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investment decision - the companies need to
be at the same level. Any expense like those
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would need to be factored out to make this
possible. And you should note: that might
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even require you doing your own âadjustedâ
calculations - you shouldnât assume that
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each company in a particular industry structures
that figure - the one they report as their
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adjusted-EBITDA - in the exact same way.
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AND THEN - if you still really like the stock,
if it does seem to be relatively undervalued
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- THEN, heed Buffettâs council and consider
those additional expenses. Because as he says,
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they are indeed very real expenses that will
ultimately be borne by the shareholder - potentially,
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you.
--
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My second big takeaway from the letter is
how serious Buffett is about repurchasing
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Berkshire shares. Itâs kind of exciting.
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He said:
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It is likely that â over time â Berkshire
will be a significant repurchaser of its shares,
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transactions that will take place at prices
above book value but below our estimate of
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intrinsic value.
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Clear enough. But that was just the first
time of several that he either mentions or
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alludes to this happening in the future. And
obviously - with the news last year about
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them changing the way that process works for
Berkshire - we already had an idea this was
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coming. But this letter really drives it home.
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Aside from the mentions, he took time to express
caution with the way it would be done - referencing
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the carelessness with which many corporations
use buybacks to boost share price.
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On top of that, he gave a couple very detailed
examples of how this has worked in his favor
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in the past. You know, warming shareholders
up to the idea.
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He talked about how in the late 70âs they
originally purchased enough GEICO shares to
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own â
of the company. And how, over time,
that third grew to œ without Berkshire spending
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a dime. You guessed it - it was through the
magic of GEICO buying back its own shares.
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He provides another example with American
Express. He explains:
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All of our major holdings enjoy excellent
economics, and most use a portion of their
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retained earnings to repurchase their shares.
We very much like that: If Charlie and I think
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an investeeâs stock is underpriced, we rejoice
when management employs some of its earnings
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to increase Berkshireâs ownership percentage.
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Hereâs one example⊠Berkshireâs holdings
of American Express have remained unchanged
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over the past eight years. Meanwhile, our
ownership increased from 12.6% to 17.9% because
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of repurchases made by the company. Last year,
Berkshireâs portion of the $6.9 billion
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earned by American Express was $1.2 billion,
about 96% of the $1.3 billion we paid for
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our stake in the company. When earnings increase
and shares outstanding decrease, owners â over
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time â usually do well.
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Some great lessons in there about the proper
way for management and shareholders to view
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buybacks. And something to definitely look
forward to in the future.
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--
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The third big lesson slash takeaway is one
that particularly resonated with me. Part
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of my modus operandi is to help people invest
smarter - to help them be prepared no matter
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what happens. Most investors arenât invested
this way - they arenât (even psychologically)
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prepared for something to happen that (maybe)
hasnât ever happened beforeâŠ
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In fact, most investment advisors - most professionals
- fall short from this perspective. Itâs
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one of the main reasons I left my industry
career years ago. Itâs one of the driving
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themes of my book STOP INVESTING LIKE THEY
TELL YOUâŠ
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That you should be prepared - come what may.
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And although Buffett and I might do that differently,
itâs refreshing to hear him acknowledge
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this reality that so many stock-and-bond-only
advocates (and âexpertsâ) conveniently
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ignore.
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He captures the sentiment in his observations
about the future possibilities for Berkshireâs
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insurance subsidiaries when he says:
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A major catastrophe that will dwarf hurricanes
Katrina and Michael will occur â perhaps
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tomorrow, perhaps many decades from now. âThe
Big Oneâ may come from a traditional source,
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such as a hurricane or earthquake, or it may
be a total surprise involving, say, a cyber
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attack having disastrous consequences beyond
anything insurers now contemplate. When such
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a megacatastrophe strikes, we will get our
share of the losses and they will be big â very
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big.
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Buffett is acknowledging the reality that
some catastrophe that has never before been
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experienced - whether itâs tomorrow or decades
from now - that it WILL happen.
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And heâs prepared. After explaining the
specifics of how Berkshire is prepared (with
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its significant portfolio of cash equivalents),
he emphasizes:
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Berkshire will forever remain a financial
fortress. In managing, I will make expensive
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mistakes of commission and will also miss
many opportunities, some of which should have
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been obvious to me. At times, our stock will
tumble as investors flee from equities. But
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I will never risk getting caught short of
cash.
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I wanna give you one final thought (of Buffettâs)
on the subject. (Just as Nassim Taleb does
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in his inspiring book FOOLED BY RANDOMNESS,)
in this part of the Letter, Buffett draws
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the comparison to Russian Roulette - which
you should keep in mind because Iâll be
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referencing it again in the next video about
where I disagree with Buffett.
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He explains:
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We use debt sparingly. Many managers, it should
be noted, will disagree with this policy,
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arguing that significant debt juices the returns
for equity owners. And these more venturesome
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CEOs will be right most of the time. At rare
and unpredictable intervals, however, credit
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vanishes and debt becomes financially fatal.
A Russian Roulette equation â usually win,
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occasionally die â may make financial sense
for someone who gets a piece of a companyâs
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upside but does not share in its downside.
But that strategy would be madness for Berkshire.
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Rational people donât risk what they have
and need for what they donât have and donât
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need.
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Awesome!
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I canât tell you what will happen or exactly
when it might happen, because itâll be unexpected
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and very well may have never happened before.
But Iâll be prepared as best I can for it.
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Itâs so good to get that vibe from the Man
himself as well.
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--
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The fourth lesson - one that you might find
heartening ...or discouraging - is when Buffett
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said:
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Prices are sky-high for businesses possessing
decent long-term prospects.
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So, for all of you struggling to find the
next steal of a company⊠keep that in mind:
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Buffett is struggling too. There arenât
always deals. And when you have strict standards
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like he does - the standards that have helped
him achieve the success heâs had - when
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the market in general is elevated like thisâŠ
you just come up empty handed. It happens.
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And that brings to mind an important point:
if you havenât been investing for very long,
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you should really take special note of Buffettâs
observation and remember that your gauge for
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- your experience with - valuing companies
is limited to the time that youâve been
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doing it⊠thatâs true for everyone. ...but,
in this case, according to Buffett, youâre
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doing it during a time when itâs just very
difficult to find a good company on sale - itâs
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surely not as often as you see or hear hyped
around all the timeâŠ
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Something may seem âfairâ or âundervaluedâ
by todayâs standards, but that doesnât
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tell you the complete story. You need a broader
perspective - like what Buffett has with most
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of his 88 years on this Earth being spent
actively studying companies.
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So, be patient. Itâs okay. Donât lower
your standards. Youâre not just collecting
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a ticker symbol with the hopes that theyâll
be some Greater Fool to buy it from you later
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at a higher price. Thatâs not investing.
Buffett explains:
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Charlie and I do not view the $172.8 billion
detailed above as a collection of ticker symbols
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â a financial dalliance to be terminated
because of downgrades by âthe Street,â
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expected Federal Reserve actions, possible
political developments, forecasts by economists
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or whatever else might be the subject du jour.
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What we see in our holdings, rather, is an
assembly of companies that we partly own and
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that, on a weighted basis, are earning about
20% on the net tangible equity capital required
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to run their businesses. These companies,
also, earn their profits without employing
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excessive levels of debt.
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Those are his high standards, and today, prices
are just too high for him to meet those standards
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very often. And heâs okay with that. You
can be too.
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--
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My fifth takeaway here was not so much as
lesson as - I thought - a brilliant way of
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framing the issue of corporate taxes.
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Iâll just let Buffett explain:
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Begin with an economic reality: Like it or
not, the U.S. Government âownsâ an interest
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in Berkshireâs earnings of a size determined
by Congress. In effect, our countryâs Treasury
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Department holds a special class of our stock
â call this holding the AA shares â that
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receives large âdividendsâ (that is, tax
payments) from Berkshire. In 2017, as in many
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years before, the corporate tax rate was 35%,
which meant that the Treasury was doing very
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well with its AA shares. Indeed, the Treasuryâs
âstock,â which was paying nothing when
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we took over in 1965, had evolved into a holding
that delivered billions of dollars annually
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to the federal government.
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Heâs using this as a way of explaining why
the tax cut from 35% to 21% benefited the
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A and B shareholders so dramatically in 2018.
And, of course, that goes the other way as
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well as taxes increase in the future.
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I just appreciate the simple way Buffett framed
this complicated issue.
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--
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So, those were my five biggest takeaways from
the Letter. Which do you find most helpful?
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Let us know in the comments. And if I didnât
mention your favorite part of the Letter,
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I hope youâll share that too.
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Now, as I mentioned earlier, there was one
big issue I had with what Buffett said - Iâll
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dive into that one for you in the next video.
So, donât forget to subscribe and click
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the bell!
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Iâll see you there! Take care.
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