Thoughts on Buffett’s Annual Letter

Like many other investing pigs, March 1st is when I feed at the trough of Warren Buffett.  His annual letter to shareholders is and always has been one of the best reads of the year.  There’s more education in his past letters than most finance texts around.  You can read the full 2013 letter here.  I don’t have anything I could possibly contribute to the letter, but I do, like any good little piggy, have my own opinions on some items:

First, you’ll notice that Buffett’s firm, by his own measure of book value, has underperformed the S&P 500 in 4 of the last 5 years.  I’ll eat my own cooking here and refrain from reading into that too much (since I don’t think Berkshire should be compared apples to apples with the S&P), but it’s interesting to note that the lag has become quite substantial.  Is Berkshire losing its shine or has it simply turned into a different animal altogether?  I have always thought Berkshire was a different animal so comps to the S&P were always unfair, but the current Berkshire is different than the old Berkshire.  Part of me wonders if Berkshire wouldn’t be better off it was broken up into two parts – a growth component with its smaller more growth oriented business and its larger more stable “income and preservation of capital” type components….

I thought this quote was interesting:

“That’s why our 2012 decision to authorize the repurchase of shares at 120% of book value made sense. Purchases at that level benefit continuing shareholders because per-share intrinsic value exceeds that percentage of book value by a meaningful amount. We did not purchase shares during 2013, however, because the stock price did not descend to the 120% level. If it does, we will be aggressive.”

Buffett never liked buying his own stock, but I do wonder if we haven’t reached a point where he is simply having trouble allocating such a huge amount of capital.  Dividends and buybacks often come from firms in saturated markets who have experienced huge growth already.  I wonder if Berkshire isn’t becoming too much of its own “elephant”….

As I’ve stated elsewhere, I am always intrigued by Buffett’s confidence in the macro perspective of the USA (making specific forecasts about the long-term), understanding full well that the “foundation” of his bets are the US economy, while also trying to convince his readers that macro doesn’t matter.  He reiterates this view again in this letter.  Does anyone really think we’d be reading letters from Warren Buffett if he’d been born in Greece in 1930, built up this huge firm and then suffered through the 90% collapse in stock prices that occurred during the last 5 years?   I think the macro has been extremely important in Buffett’s story.  Much more so than he lets on.

Buffett likes to say that you should focus on individual firms by viewing these purchases as though you’re buying into a business and not just a stock certificate.  That’s great, except for the fact that the secondary markets are so saturated with people doing the same thing that you’re highly unlikely to be able to uncover that value better than the army of high frequency computers and PhD mathematicians that now sit on trading desks in search of the same thing.  For the average person, treating the secondary market as a place where you “invest” is highly misguided.  Indeed, the best investment you’ll ever make is on the primary market in yourself.  Or perhaps you’ll start a company or make real investments in companies on primary markets.  But I find the modern chase for “alpha” on secondary markets through picking individual shares to be a game that provides most of us with no competitive advantage.  Hence, my preference for treating secondary market transactions as allocations of saving and not “investing”.

That said, his general optimism and rational perspective is welcome in a financial world that loves to obsess over the next big “crisis”.  Buffett says:

“A climate of fear is your friend when investing; a euphoric world is your enemy.”

Berkshire’s an amazing company.  By itself it holds 8 1/2 Fortune 500 companies….Wow.



Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.
Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • Cullen Roche

    oops. Wrong quote at the bottom.

    ” A climate of fear is your friend when investing; a euphoric world is your enemy.”

  • SS

    Good thoughts. I didn’t enjoy this year’s letter as much as I’ve enjoyed past ones. Still a great read though.

  • Anonymous

    “Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.”

  • Cullen Roche
  • HankB

    CR, I really like how you think about markets here with the distinction between primary markets and secondary markets. But doesn’t this mean you’re just trying to skin the cat with a different approach? Doesn’t it just mean you’re trying to outperform the market by picking macro themes?

  • Cullen Roche

    I think I am just working from a rational foundation based on operational understandings. I take the view that picking stocks on a secondary market like the NYSE is a losers game in most cases. It can’t be done in any size or scale for prolonged periods of time because the competition is just too much. Besides, what most of us do on a secondary market shouldn’t be thought of as “investing” in the first place. We’re allocating our savings on a secondary market. The place where you make real “investments” (spending, not consumed, for future production) is on the primary markets. You invest in yourself. You invest in a company you start or a company you actually provide funding for. You are MUCH more likely to find a competitive advantage there.

    As for the secondary markets, my approach is simple. I say allocate your savings with two goals:

    1) Protect against permanent loss.
    2) Protect against purchasing power loss.

    If you can construct a portfolio that does this with moderately high risk adjusted returns then you’ve achieved the same thing Buffett has in his goals (saying he will underperform the market in good years, but protect from the downside in bad years), but you’ve avoided the mess of picking stocks and getting your priorities backwards. In other words, you’ve constructed a more grounded and rational process. And most importantly, you’ll make investments in the things that actually matter rather than thinking you’re designing something similar to Berkshire Hathaway by picking stocks. This approach is best implemented using macro principles in my opinion so the macro matters contrary to Buffett’s opinion.

    I work from an operational perspective by understanding things. So this is how I view these things….

  • AnonymousOne

    “By his own measure of book value, has underperformed the S&P 500 in 4 of the last 5 years…the lag has become quite substantial”

    Why wouldn’t an “activist investor” take a position to help unlock some of that value?

  • JWG

    Over the last five years Uncle Warren got bailed out via Wells Fargo, became politically active and took his eye off the ball. He stopped channeling his inner Charlie Munger and has become the Democrats’ favorite big money guy (after George Soros). Crony capitalism and the law of large numbers have put some rust on his armor.

  • Johnny Evers

    Those principals are boilerplate — don’t lose money, beat inflation. I know you probably can’t share your portfolio specifics, but why lead people to believe your approach is better if you won’t share it.
    A lot of this is vague — ‘use macro principals,’ ‘avoid the mess of picking stocks,’ or just jargon – ‘moderately high risk adjusted returns.’
    Also I don’t think Buffett ever had the goal of underperforming the market in good years but protecting your portfolio in down years. That’s just wholesaler patter. Buffett wants to buy good stuff and grow his money. Period. What’s made him a great investor is that he believes if he makes the right moves he doesn’t have to compromise.
    And his micro *is* macro. If a company is making money and looks like it will keep making money, and is on sale relative to its peers, he’s going to buy it. He doesn’t need to make guesses about the future.

  • Cullen Roche

    Did you read the letter (such as the part where he specifically states that he expects Berkshire to underperform in good years and outperform in bad years)?

    You claim he doesn’t have to “guess” about the future, because he’s picking stocks. As if “guessing” about the macro is any different than “guessing” about the micro. Just because his story sounds cute and makes sense to you doesn’t mean it doesn’t involve guessing or forecasting. It’s just a different form of forecasting. Buffett forecasts the micro and sells the story to his followers all the while telling people that macro forecasts are a waste (while also telling most people to buy index funds because the USA will continue to do great – the ultimate macro forecast). You really think he’s not making forecasts? There are so many contradictions in his views on these matters….

    Also, I didn’t say my approach was “better”. I said it was based on sound principles and a well grounded process.

    Lastly, I am not sure why you’re so antagonistic about everything I write. It doesn’t contribute much to the conversation. If you think my principles are wrong then tell me why. Explain to the board why my principles are wrong. Constantly criticizing them without actually contributing anything is just a waste of time….

  • Frederick

    Cullen, have you read this paper on Buffett’s performance? They state that his outperformance is mostly leverage:,%20Kabiller%20and%20Pedersen.pdf

    But Buffett’s companies weren’t always large cap firms. If he’s been underperforming lately it’s probably because of the size of his company. So I wonder, if he’s just using 1.6:1 leverage and the early years of his outperformance were due to being a smaller firm then that could account for almost all of his historical outperformance.


  • Cullen Roche

    I did read that paper but it’s been a long time. I think Buffett’s Alpha is the result of a very innovative firm structure and process. What Buffett does is more akin to what I call real “investing”. Ie, he provides capital on primary markets in most cases and has a real competitive advantage when he makes those investments. And when he makes secondary market purchases he often gets deals that other people can’t get (such as the GS and GE deals). He’s running a totally different animal than what most people do when they buy stocks. That’s the genius behind Berkshire.

  • Greg


    One part of your post stood out to me for some reason

    “Part of me wonders if Berkshire wouldn’t be better off it was broken up into two parts – a growth component with its smaller more growth oriented business and its larger more stable “income and preservation of capital” type components….”

    Given that many economists seem eager to evaluate our macro economy as if it were a very large firm, might it not be true of ourselves (The USA) that we need a growth oriented part AND a preservation and income part. I suspect that most everyone thinks we should be all growth all the time but maybe more consideration can be given to how we can apply the truths in the sentence I lifted to our own macro analysis.

  • Stephen

    I have often thought that one could view an investment as separate from speculation by considering how much of the outcome is within one’s personal control.

  • Johnny Evers

    I’m not antagonistic.
    I’m challenging you to be specific about your proposals and methods.
    You talk a lot about macro, but offered no specifics beyond ‘we’re muddling through’ and ‘I don’t anticipate a recession in the near future.’
    What Buffet is selling is pretty clear — it’s all there in his fund. If you are going to challenge somebody’s strategy (his product, if you will), I think it behooves you to be more specific than saying your approach is based on ‘sound principles and a well grounded process.’
    Buffet is forecasting the micro. He believes that no matter what happens in the markets and the economy, people will shave and buy Coke and need insurance. Sometimes he’s wrong, as I think he was with newspapers, but usually he’s right, and much as I dislike the man and the system that allows him to make more money than he does create value, his approach has paid off for his clients.

  • Steve W


    I suspect Cullen would be happy to offer more specifics and be less “vague” if you pay for his services and research through his Orcam site/firm.

    Cullen’s Pragcap site has been a great resource and forum for us all to learn more about economics, our monetary system, and macro concepts. I hope he keeps the site going for many years, but I also respect his desire to build a business — and that’s what Orcam is about.

  • Cullen Roche

    Okay. Let’s start over then.

    I specified why I don’t think stock picking is the most beneficial approach. I think it’s simply becoming too competitive on secondary markets so I advocate stock picking on primary markets. You don’t seriously think you can find value better than a computer algorithm that’s designed to search for it all day, do you? Or the army of PhDs now sitting on trading desks? Or every Ivy League graduate? These people and machines spend their whole day searching for value and arbing it out of the market. Do you really think you can compete with that?

    And I am someone who was once a very successful stock picker. I ran a stock specific strategy for years and made quite a bit of money doing it. But I realized that it wasn’t scalable or sustainable because the market is changing. Information is so readily available and so quick to disseminate in secondary markets that it’s very hard to find a competitive advantage.

    But you’re missing the broader point here. I am not demeaning Buffett’s approach. In fact, I am praising it. The more important point is that what Buffett does isn’t nearly as simple as what you discuss. He’s not just buying value stocks on secondary markets. He’s involved in a much more complex process. It’s a process I respect and have tremendous appreciation for. But it’s not the process that’s commonly discussed in the media. This “value” view of Buffett is highly misleading. This is a man running a highly levereaged strategy similar to a covered call writing strategy with very important elements of diversification and real “investment” involved (more akin to private equity). The media makes him out to be this simple little stock picker on the secondary markets. It’s a big myth.

  • Cullen Roche

    I am just guessing that BRK has two diffferent types of shareholders – the ones who have become accustomed to market beating returns and the ones who just like the stability of the company. I could be wrong, but if this is the case then there’s a sound argument for breaking up its pieces and extracting the value from the growth side of the business. An activist investor could probably have a field day going into BRK and busting her up….

  • Johnny Evers

    Fair enough.
    In my mind, the efficient market theory has been discredited by the market events of the past 10 years.
    And any notion that Ivy League grads and PhDs have any special insight was also discredited in the financial crash. They have more Information, yes; wisdom, no.

  • Cullen Roche

    Yes, but it has nothing to do with EMH. In fact, the reason why the stock market is so hard to predict is precisely the opposite. It’s the fact that there are so many diverse and erroneous ideas competing that it is incredibly difficult to predict. EMH implies that prices are “right” because the market’s participants are rational. I say prices are wrong, but they’re wrong because the market’s participants are flawed and irrational. And predicting the madness of the crowd is difficult precisely because its madness is so widespread. The market’s much easier to predict when there are only a few irrational fools believing they’re right. But when the entire crowd thinks its right the market might just never come around to your view even if it’s “right”. And that’s why the secondary market is so hard to predict….

  • Stephen

    Buffett is an incredible businessman ,but size is as much a constraint for him as it is for a fund manager.
    Moreover, in truth I have always been a little bit more impressed by his shadow ,Munger.

  • Nils

    People always like to draw the line just so that they can call whatever they are doing in the markets “investment”. It’s completely arbitrary.