Warren Buffett's Annual Letter to Shareholders (2021)

Hey guys, welcome back to the channel. In this video, we're going to be talking through Warren Buffett's 2020 letter to Berkshire Hathaway shareholders. Of course, he writes one of these every single year. There's a bit of an update on what he's thinking about, especially in terms of Berkshire Hathaway. In fact, these are actually a really good wealth of information about Warren Buffett—how he thinks about business and how he thinks about investing. So, if you haven't read one of these before, I would encourage you to sit down, maybe read the 2021; I'll leave it linked down in the description below. But go back and read prior years' annual letters as well because you actually learn a lot about investing and about business from them.

But anyway, in this video, we're going to break down essentially the most important points that came out of the letter. It was quite a long letter, and we'll kind of just discuss them. So with that said, let's get stuck into it.

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As Warren Buffett always does with these letters, he starts out by comparing Berkshire Hathaway's share price performance from all the way back down to 1965. He compares it with the performance of the S&P 500. If you actually have a look over time, as an average annual return, if you're an investor in Berkshire Hathaway, you would have gotten 20%, whereas if you were just invested in the S&P 500 annually, you would have averaged out to just over 10%. So that's pretty crazy—that on average, every year, you're going to just about double the performance of the S&P 500. Not many people—in fact, maybe Buffett is the only person that can boast that sort of performance for that period of time.

If you'd stuck with Berkshire Hathaway since 1965, then overall, you've got a total return of 2.8 million percent! How's that for a return? versus 23,000 if you just stuck with the S&P 500. So this really just shows you that even if you can achieve maybe one, two, three percent better than, say, the S&P 500, better than the market each year, and you can do that consistently, that even just one, two, three percent over what the market can do will add up in the long run, and you will be far, far ahead. So I find that very interesting.

Anyway, next up, Buffett always gives a Berkshire Hathaway update, so we'll talk about that now. Berkshire Hathaway in 2020 earned $42.5 billion, which Buffett breaks down into four main components: $21.9 billion in operating earnings, $4.9 billion in realized capital gains, $26.7 billion from unrealized gains, and then an $11 billion loss from a write-down in the value of a few subsidiaries and affiliate businesses that Berkshire Hathaway owns.

In this part of the letter, Buffett really just highlights that for businesses with stock portfolios on top of their business operations, particularly like Berkshire Hathaway, really the number one metric you need to look at is the operating earnings. And the reason for that is—so that's the money that the business makes through its own business operations. Because unfortunately, it was a few years ago now, the generally accepted accounting principles were changed so that in your earnings number, you also have to include any unrealized gains or losses on investments that you hold, stock investments that you hold.

And I do have to say that I tend to agree with Warren Buffett—that this change in the accounting rules is pretty stupid overall. Because, like, imagine if you yourself had a business and you made—your business made $100,000 in 2019, and then it made a million dollars in 2020. That is pretty remarkable—you've 10x'd your business, which is just ridiculous. But how about your business also holds a stock portfolio? And through large market fluctuations and market volatility, you say made $400,000 unrealized? Of course, you didn't sell anything, but on paper, you made $400,000 in the stock market in 2019. And then, due to market volatility, you lost $500,000 in 2020. You didn't buy or sell anything; you were just holding—just what your positions did over time.

Well, on paper—like, according to these accounting principles, your business went nowhere! You know—$500,000 in 2019, $500,000 in 2020. But really, your business 10x'd itself! So Buffett basically says, "Don't worry about this rule. You know, we're going to hold the stocks for a long period of time, so short-term fluctuations really don't mean anything." And for all these businesses, we treat them as businesses.

A lot of the businesses that they hold in their stock portfolio retain a huge chunk of their earnings, and then, you know, smart management uses that earnings to reinvest it to grow the business, which in the long run grows the value of the company. So it all works out in the end; it's just a silly little rule.

Anyway, moving on, then, in the next section of the letter, Warren Buffett actually talks a little bit about conglomerates and how they ended up having such a bad name. I found this really interesting because this is something that I didn't know about.

He writes here that over time, conglomerates have generally limited themselves to buying businesses in their entirety. That strategy, however, came with two major problems. One was unsolvable. Most of the truly great businesses had no interest in having anyone take them over. Consequently, deal-hungry conglomerates had to focus on so-so companies that lacked important and durable competitive strengths. That was not a great pond in which to fish.

Beyond that, as conglomerates dipped into this universe of mediocre businesses, they often found themselves required to pay staggering control premiums to snare their quarry. Essentially, they would really have to pay up if they wanted a controlling interest in the company. Aspiring conglomerators knew the answer to this overpayment problem; they simply needed to manufacture a vastly overvalued stock of their own that could be used as currency for pricey acquisitions.

So what they'd end up doing is they would pump their own business's stock as much as possible to try and get the stock, say, trading at three, four, five times the intrinsic value—so horribly overvalued. But then that would make it easier for them to buy these overvalued stocks that they wanted to acquire. Because, you know, say the stock over there that they want to buy is two times overvalued—is that premium for taking the controlling interest? Well, that doesn't really matter because you've just pumped your stock and have made it, you know, three, four, five times what it's actually worth. So it still kind of works out.

Anyway, Warren Buffett writes, "Eventually, of course that party ends as many business emperors are found to have no clothes. Financial history is replete with the names of famous conglomerateers who were initially lionized as business geniuses by journalists, analysts, and investment bankers but whose creations ended up as business junkyards."

Interestingly, Buffett goes on to talk about, you know, really the one reason why Berkshire Hathaway, while it is a conglomerate, has been able to avoid this typical pattern of conglomerates of the past is quite simply because they are okay with having a non-controlling interest in another company. So they're not always looking to—while they—if they find a business they like, they would like to buy the whole thing, but if that just doesn't work out, they are still okay with buying into a company in part—like what they've got with Apple. They own 5.4% of Apple; that's not a controlling interest, but they're very happy to do that because, at the end of the day, they do their due diligence on the management team.

They make sure they're only investing in companies that are managed well. And it really, at the end of the day, if they trust the management team, then having a non-controlling interest is just one less thing to worry about because they don't have to themselves think about, "What are we going to do with this company? How are we going to grow it? Blah, blah, blah." They can just not think about that, leave it up to the management team of that company, and the management team of the company can do that themselves and make that investment worth more and more over time.

So that's Warren Buffett's little word on conglomerates, and actually, I learned something—how they earned such a bad rep, but how Berkshire Hathaway is actually different.

Anyway, the next part of this annual letter was actually Warren Buffett talking about share repurchases, how they work, and why they can be so, so beneficial to shareholders. So in 2020, Berkshire Hathaway themselves cleared 80,998 A shares off of the table, spending $24.7 billion in the process, which was actually a pretty smart strategy.

Because in 2020, especially around that March-April time where the lockdown really gripped on and companies lost a lot of value, Berkshire Hathaway was the same—they lost about a quarter; their share price went down by about 25%. Berkshire Hathaway didn't actually lose 25% of their value; just their share price got shaved about a quarter off the top. So that actually presented them with an opportunity where Warren Buffett thought that the shares were trading cheaply, so it was an effective time to use some of their extra cash to clear shares off the table to benefit their pre-existing shareholders.

Because if you take advantage of a time where your share price is very, very cheap, it means for the same amount of money, you're going to be able to clear more shares off the table. And that really benefits existing shareholders because it means they can sit back and do absolutely nothing, and your actions of dragging your own stock off the table increases their percentage ownership of the company without them having to do anything.

In fact, if you held Berkshire Hathaway shares on New Year's Eve in 2019 and you held onto them through 2020 until New Year's Eve 2020—in that time period, doing nothing at all, overall, you now own 5.2% more of the business than what you did before. So I find that really interesting, and Buffett really hammers home this point by analyzing Berkshire Hathaway's own investment in Apple.

Of course, Apple over the past few years has themselves been doing massive, massive share repurchases. He writes, "Berkshire's investment in Apple vividly illustrates the power of repurchases. We began buying Apple stock late in 2016, and by early July 2018 owned slightly more than one billion Apple shares, split adjusted. When we finished our purchases in mid-2018, Berkshire's general account owned 5.2% of Apple. Our cost for that stake was $36 billion. Since then we’ve enjoyed both regular dividends averaging about $775 million annually and have also, in 2020, pocketed an additional $11 billion by selling a small portion of our position. Now, despite that sale, voila! Berkshire now owns 5.4% of Apple. That increase was costless to us, coming about because Apple continuously repurchased its shares, thereby substantially shrinking the number it now has outstanding.”

So overall, they've received on average $775 million worth of dividends per year, and they've sold some of their stock—they've basically sold $11 billion of their position—and even after all that, they've still got a larger percentage ownership in the company than what they had just a few years ago. That, if you ask me, is absolutely genius.

But anyway, let's move on. That's share repurchases. The next part of the annual, or the annual letter to Berkshire Hathaway shareholders is about their stock portfolio—what investments have they been making in stocks themselves where they haven't been able to buy the whole business outright?

Now, you can have a look; I'll chuck the chart up. They actually put up their largest 15 positions, but they do it alphabetically. So they're in alphabetical order. What I actually did is I went through, and I reorganized this table and I listed them in terms of percentage return over time, total return.

Okay, and if you do that, have a look at some of these monsters: Moody's Corporation—they—that cost them—their whole position cost them $248 million. The current market value at the end of 2020 was $7.16 billion, so they've made a 2,787% return over that time. You see BYD—that's actually one that's really taken off for them over the last year or so. They invested $232 million; now current market value $5.9 billion. So 2,441% return. Coca-Cola—$1.3 billion in, and it's currently worth $22 billion. American Express—$1.3 billion in, and it's currently worth $18.3 billion, so another 1,324% return.

So you can see this really—this is some really phenomenal investments. But I think the one thing that really this graph, this chart here, this table highlights to me is something that Warren Buffett gets quoted—he says this sort of stuff all the time. I'm not sure of the exact quote, but he's essentially saying that over the course of your life, you really don't need that many great investments to become very, very rich. I mean, even you have a look at these top 15 positions—there are some which have actually gone down—negative 0.1%, negative 0.2%, negative 0.3%, but really the bulk of Berkshire Hathaway's success in their stock portfolio has been in four stocks—in Moody's, BYD, Coca-Cola, and American Express.

And this to me perfectly highlights that you really don't need—all you have to do is find one real—one or two really great stocks each decade to do phenomenally well as an investor. And I think that's something we, as long-term investors, should always remember. We don't need to be making 15, 20, 30 investments every year; we would do much better if we just took our time, really researched everything in depth, and only put the bulk of our money towards the best investments that we can possibly find, even if it means we have to wait five to ten years to find one.

So I find that very, very interesting. Anyway, let's move on. Oh, actually, before we move on, I actually figured out how much money would you have if you just sunk a thousand dollars into these top four positions in Buffett's portfolio when Warren Buffett invested in them. So what would you do as just a retail investor? You sunk a thousand dollars into each, so obviously you would have invested $4,000. And if you’ve done that when Warren Buffett sunk the money into these companies, you would have right now $85,000—$85 grand! Wow! That's pretty remarkable. You know, if there's any situation out there where I can give $4,000, and at some time in the future, I’ll get $85,000, I'm going to take that deal!

Anyway, let's move on. The next part of the letter was just American success stories—was basically Warren Buffett talking about the successful businesses that grew in the American environment that Berkshire ended up taking over and owning themselves and adding to their family of businesses.

I'm going to skip over that because it's really just a collection of stories—still very interesting, so I encourage you to read it yourself. And he also talked about—really, he classifies there's five owners, I suppose—five buckets of owners of Berkshire Hathaway, which I found interesting.

The first one is Warren Buffett because he owns a hell of a lot of stock in Berkshire Hathaway. Then the second bucket is the ETFs that own Berkshire. Then the third is the managed funds. Then the fourth group is the individual investors that are just looking for the best place to put their money—that may come in and out of Berkshire Hathaway, you know, as they find better deals in the market.

And then the fifth group, which Warren Buffett talks about—Warren Buffett describes these people as the million-plus individual investors who simply trust us to represent their interests, whatever the future may bring. They have joined us with no intent to leave, adopting a mindset similar to that held by our original partners." And Buffett basically just writes a bit of a love letter to these kind of people because you and I think it's really nice—in a way, it's kind of refreshing to see it; it shows you what sort of CEO Warren Buffett is.

Warren Buffett is the CEO that genuinely cares about how well his investors do. He's not just someone that, "Oh yeah, you know, I'm just in it for myself. I just want all the money. Oh, the investors, the shareholders—I don't care as long as I'm getting my bonus." He's not one of those people at all. And I think this is probably a big reason why Berkshire Hathaway has become so successful over time—because he genuinely believes—he genuinely cares for the people that own it. Not everyone. I'm sure he cares much less about just the money managers, institutional investors, or ETFs to own it. But the people that have actually trusted him to grow their money and have stuck with Berkshire Hathaway for the long run, I think that really is what kind of spurs him on and keeps him going because he's made these people into millionaires, if not billionaires, seriously.

So, it's just refreshing knowing that, you know, there are still some companies out there where the CEO actually gives a [ __ ]—actually cares about the long-term shareholders. And, of course, that is such an integral part of all long-term investing—is finding that management team that cares about long-term shareholders.

And then lastly, the last little bit here is Warren Buffett actually just noting a bit of an interesting fact about Berkshire Hathaway's fixed assets. He actually says, "Recently I learned a fact about our company that I never suspected. Berkshire Hathaway owns American-based property, plant, and equipment—the sort of assets that make up the business infrastructure of our country—with a gap valuation exceeding the amount owned by any other U.S. company. Berkshire's depreciated cost of these domestic fixed assets is $154 billion. Next in line on the list is AT&T with property, plant, and equipment of $127 billion."

That in itself is a really interesting statistic that Berkshire Hathaway owns the most staff or the highest valued fixed assets, you know, infrastructure and so on—more so than any other U.S. company, which I find ridiculous. However, have a listen—this is a bit of an investing lesson here from Warren Buffett.

He says, "Our leadership in fixed asset ownership I should add does not in itself signal an investment triumph. The best results occur at companies that require minimal assets to conduct high-margin businesses and offer goods or services that will expand their sales volume with only minor needs for additional capital."

So although he says it's very interesting that Berkshire Hathaway has all these fixed assets, really what you want to find in a business as an investor is—you want to find a business that doesn't need much money to get up and going—it can generate a very high margin. So they keep a high percentage of the revenue that they generate, and then in order to achieve that scalability—in order to increase that sales volume—that in itself doesn't take very much money at all.

So what he's really saying here is the key for us to find really great businesses is to find something that can scale up and make more and more and more money with very small incremental costs of that expansion, I suppose. So I guess, really, the most standout example of those sort of businesses in today's environment is software companies and/or any business that runs pretty much solely on the internet.

So we're thinking like Facebook, the social medias, that sort of thing; or, you know, software companies like Adobe where, you know, they don't have to make a new Photoshop every single time they make a sale. They just keep the program running, and that's very high-margin, and it can be repeatedly bought because it's obviously just a program on the cloud, on the internet, I suppose.

So anyway, that kind of wraps up the main different sections of Warren Buffett's annual shareholder letter. The last thing is about the annual meeting, which this year is going to be on May the 1st, and it's going to be between 1:30 and 5 p.m. So interestingly, also this year, the Berkshire Hathaway annual meeting is going to be in Los Angeles, and Warren Buffett is going to be there. Making his return is going to be Charlie Munger. Buffett is essentially relocating the annual meeting to come to Charlie, which is pretty cool.

So it’s going to be Warren Buffett, Charlie Munger, and then they've also got Jain, who runs the insurance business, and Greg Abel, who runs—I'm pretty sure he just runs Berkshire Hathaway Energy. I might run the railroad business, but I don't know.

Anyway, so it's going to be good; you got all four of them, including Warren and Charlie, which is going to be fantastic. So I have to make sure we tune in on May the 1st, and that will be broadcast by Yahoo Finance as well. So watch out for that because it will be on Yahoo Finance's YouTube channel. So make sure you follow them because it's always packed full of investing nuggets and lessons to be learned in those meetings.

So anyway, guys, that is it for this video. If you did enjoy it or if you found it useful, leave a like on it; I certainly appreciate it. And comment down below, what did you think of the annual letter if you read it? I would definitely encourage you to read it—links down in the description below, so check it out if you would like.

But that will just about do me for today. If you would like to know kind of a step-by-step process as to Warren Buffett's strategy, the strategy that I myself follow with my own investing, then check out Introduction to Stock Analysis, which is a course on Profitful, which is my own business, which is linked down in the description below. But that will just about do me for today, guys. Like, subscribe, do all the good things, and I'll see you guys in the next video.

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