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On Some Lessons From Buffett’s Annual Letter

Warren Buffett’s annual letter to Berkshire Hathaway (BRK) shareholders was released over the weekend. Readers will find plenty of investing lessons among the twenty-three pages. Warren began this letter as he begins each letter, by stating Berkshire’s change in per-share book value:

Our gain in net worth during 2005 was $5.6 billion, which increased the per-share book value of both our Class A and Class B stock by 6.4%. Over the last 41 years, (that is, since present management took over) book value has grown from $19 to $59,377, a rate of 21.5% compounded annually.

Some may wonder why Buffett opens by announcing the change in per-share book value rather than the earnings per share number. Over long periods of time, the change in per-share book value should nicely approximate the returns to owners. You may remember that, in my analysis of Energizer Holdings, I applauded the company for reporting comprehensive income within the income statement. Although a company’s net income is often referred to as its bottom line, net income is, in fact, a (sub)component of comprehensive income. Energizer Holdings (ENR) literally reports comprehensive income as its bottom line.

FASB merely requires that “an enterprise shall display total comprehensive income and its components in a financial statement that is displayed with the same prominence as other financial statements that constitute a full set of financial statements”. Unfortunately, despite the lack of attention paid to it by investors, the statement of changes in stockholders’ equity is considered “a financial statement that constitutes a full set of financial statements”.

Therefore, comprehensive income can be reported in a statement many investors either do not review or do not understand. Alternatively, a company may choose to report comprehensive income in a separate Statement of Comprehensive Income. This, of course, baffles many investors, who think they are reading a second copy of the income statement. After all, what is comprehensive income? Isn’t the net income number reported in a (traditional) income statement a comprehensive number?

No. The widely reported earnings per share number is not comprehensive. That isn’t to say the EPS number isn’t important. It is very important. In fact, for certain businesses, it may be the most useful figure for evaluating a going concern. This is especially true if the investor is only looking at the financials for a single year. A single year’s comprehensive income may actually be less representative of a business’ performance than a single year’s EPS number (both can be pretty unrepresentative).Remember, the earnings per share number does not tell you how much wealth was actually created (or destroyed). You need to look to the comprehensive income number to find that information.

Essentially, Buffett is reporting Berkshire’s earnings in that opening line. He is simply using a more comprehensive income figure. He’s saying here’s how much wealth we created, and here’s how much capital it took to create that wealth. When he writes “Our gain in net worth during 2006 was $5.6 billion, which …

Suggested Link: Enough Whining For “Guidance”

Nearly all the investment pundits are blaming the recent decline in Google’s share price on the company’s refusal to provide guidance. But, one very familiar name isn’t. Today, former Wall Street internet analyst Henry Blodget writes: “I respect Google for not giving guidance, a practice that often reduces analysts to Excel-savvy parrots.”

Google (GOOG) has been mentioned surprisingly often on this blog, considering its lofty price. But, I don’t believe I’ve ever mentioned Henry Blodget before – and until today, I thought I never would. However, I find myself in complete agreement with the author of Internet Outsider.

I would love to write about other things besides Google, because it’s not a topic that’s likely to help you make a good investment. Later today, I will post an analysis of Pacific Sunwear (PSUN), a much better bet for investors, and a stock that’s more in keeping with my own value investing proclivities. However, I just couldn’t let the Google gaffe pass without writing anything about it.

Many of you already know the facts. If you don’t know them, I’m really not the one to tell you; I don’t pay much attention to Google and I don’t pay any attention to communications with analysts. So, for those that don’t know the facts, just Google “Google gaffe”.

I’m suggesting this link to Mr. Blodget’s post, because I reached the tipping point this morning, when I heard one analyst say a public company has a duty to instill confidence among investors. I’m paraphrasing here, I doubt he used the word “instill”. But, one hopes that confidence is the sort of thing that can only be earned gradually; so, instill would be the right word.

Obviously, I believe no such duty exists. Managers are not (or at least ought not to be) responsible for marketing shares. They have no duty to ensure a current owner rips off a future owner by dumping his shares at the highest price.A good management has the same two primary duties as a good agent.

Management has a duty to act on behalf of owners in exercising delegated powers (primarily those required for day-to-day business operations) and a duty to report back on its activities. Management does not have any duty to facilitate sales of stock on advantageous terms. Now, you could argue that the issue of confidence is larger than I’m making it out to be – that it goes beyond simply keeping the stock price up. However, I haven’t yet heard anyone argue that there is a lack of confidence among anyone but investors. In fact, this issue has nothing to do with Google’s business, which is management’s responsibility. The selling of shares is the investor’s responsibility.

I submitted this link to Fat Pitch News. So, if you like Mr. Blodget’s post, please bid it up over at Fat Pitch News so others will get a chance to read it as well (if enough people vote for the link, it will …

Google Price Target: $16,578.90

Regular readers of this blog will immediately recognize this headline is a joke. For the rest of you, I was kind of hoping the ninety cents part would give it away.

If you’re reading this because you’re interested in what I have to say about Google (GOOG), you can stop now. I’m not going to say anything interesting about Google. Rather, I’m going to say something (that I hope is) very interesting about the wonders of compounding.

Warren Buffett’s annual letter to shareholders was released today; I’ll write a lot more about it tomorrow. For now, I’m just going to pull out one little nugget:

Between December 31, 1899 and December 31, 1999, to give a really long-term example, the Dow rose from 66 to 11,497 (Guess what annual growth rate is required to produce this result; the surprising answer is at the end of this section.)

I knew what Warren was up to, and had some idea of the historical growth rate for the Dow, so I guessed 6%.

Here’s the answer to the question posted at the beginning of this section: To get very specific the Dow increased from 65.73 to 11,497.12 in the 20th century, and that amounts to a gain of 5.3% compounded annually. (Investors would also have received dividends, of course). To achieve an equal rate of gain in the 21st century, the Dow will have to rise by December 31, 2099 to – brace yourself – precisely 2,011,011.23. But I’m willing to settle for 2,000,000; six years into this century, the Dow has gained not at all.

I wish I could tell you that my guess was close. But, it wasn’t even in the right ballpark. The difference between a 5.3% annual gain and a 6% annual gain may look relatively small. In fact, the difference is not small. If, during the 20th century, the Dow had achieved a gain of 6% compounded annually rather than a gain of 5.3% compounded annually, on the eve of Y2K, the index would have been sitting at 22,302.33.

The rallying cry of the bubble years would have been Dow 20,000. And what of Dow 10,000? The index would have added its fifth figure in 1987. That’s right, if the Dow had achieved a gain of 6% compounded annually during the 20th century, the index would have broken the 10,000 mark while the Berlin Wall was still standing.

Over a century, that extra 0.7% really adds up. I recently wrote an email to a member of my family who had just had her first child. You would think that blathering on as I do here each day, I would have a sea of investing advice to offer. In fact, I provided only a single drop: Time trumps money.

If you want to have more money than you will ever need, your best bet is to find a few places where you can deploy large sums of money that will earn good returns for …

News Item: Pacific Sunwear

On Wednesday, shares of mall based specialty retailer Pacific Sunwear (PSUN), the company that operates PacSun stores, fell sharply on news that sales for the quarter were about $2.5 million less than analysts had expected. The earnings per share number matched analyst estimates.

Pacific Sunwear’s same store sales fell by 3.1% in February. Analysts expected a rise of 1.4% in same store sales. Generally speaking, teen retailers reported poorer same store sales in February than Wall Street had expected. Of course, Pacific Sunwear did not simply fail to grow same store sales as quickly as expected; the company actually saw same store sales decline for the month.

Pacific Sunwear now trades at about fourteen times earnings. The company has long been the one teen retailer I would like to own – at the right price. At today’s price, PSUN is the best bargain among well known American retailers. Expect a more detailed discussion of the company within the next few days.

Note: When discussing Pacific Sunwear (PSUN), all uses of the term “Pacific Sunwear” will be references to the company; all uses of the term “PacSun” will be references to the skate and surf themed chain. This practice is intended to avoid confusion as to whether a particular statement applies to the PacSun chain alone or to the PacSun, d.e.m.o., (and soon) One Thousand Steps chains collectively.…

Suggested Link: Fat Pitch News

Some of you may have noticed a recent addition to the Gannon On Investing site. On the right side of your screen, you will see a “News” box subtitled “Fat Pitch News”. Within that box, you will find the top five value investing headlines courtesy of Fat Pitch News. These are clickable links that will take you to the brand new Fat Pitch News. From there, you can click on the headline (in the green header) and be taken directly to the story.

I’m really excited about Fat Pitch News. It’s a great opportunity for value investing blog readers and value investing bloggers alike. The service will only be as good as those who frequent it. The easiest way to support (and enjoy) Fat Pitch News is simply to check out the submitted links and vote for those you like best.

Of course, there is another way you can help. If you really want to do a great service for your fellow blog readers, you can submit any interesting links you run across. As more stories are submitted to Fat Pitch News and more votes are cast for those stories, the service will improve dramatically. Fat Pitch News will be a tailor made financial daily of sorts. Imagine the front page of the Wall Street Journal filled only with the value investing news you’re interested in. With your help, that’s exactly what Fat Pitch News will become.

I encourage everyone to check out the headlines on the right side of your screen. Click through the headlines; then, read, vote, discuss, etc. Before you do that, I want to make a few things clear about this service. Fat Pitch News is part of the Fat Pitch Financials site. It is not part of the Gannon On Investing site. Therefore, when you click these headlines you’ll be going off-site. I don’t mind, because I know they’ll always be plenty for you to come back for.

As I see it, if you’re interested enough in value investing to click on the Fat Pitch News headlines, you’re probably interested enough to find your way back to this site. Still, you should know that these links will not load Fat Pitch News in another window. They will take you off-site. If you’re enjoying my site and haven’t bookmarked it yet, you really should. Once you’ve bookmarked this site, you won’t need to worry about following links to other great sites like Fat Pitch News.

The first time you click a headline you might get a little confused, because you’ll be thrown right into things. That’s why I suggest you first read this description of Fat Pitch News taken directly from the Fat Pitch Financials homepage:

Today is the launch of Fat Pitch News, a new service provided by Fat Pitch Financials. Fat Pitch News is a community driven value investing news site. You can submit links to investment articles, “bid” up stories to the front page by clicking on the green up