As the markets enter another volatile season, investing in fundamentally sound businesses is back in vogue. At least, if one follows Fin-Twitter. And who better to learn from than the venerable Warren Buffett and his value hunting specialist business, Berkshire Hathaway?

Berkshire Hathaway recently released its chairman’s letter to shareholders. Every year millions of investors wait to get a handful of investment lessons directly from the investment guru Warren Buffett

After all, his track record is impeccable – the share price of Berkshire Hathaway has outperformed S&P 500 index returns by a wide margin since 1965 – returning 20.1% on a CAGR basis.

Here are the key takeaways of the 2021 letter from the chairman of Berkshire Hathaway:

Stay liquid 

Buffett pointed out that he and Charlie Munger (Vice-chairman of Berkshire Hathaway) pledge never to let the cash hoard sink below $ 30bn. “We want your company to be financially impregnable and never dependent on the kindness of strangers or even that of friends. Both of us like to sleep soundly”, the letter mentioned. 

Similarly, retail investors need to apportion a part of their investments in liquid assets to take care of contingencies. For example, to sleep peacefully, anywhere from six to twelve months of one’s earnings should be parked in liquid funds. 

Not stock-pickers, but business-pickers 

“After my initial plunge, I always kept at least 80% of my net worth in equities. My favoured status throughout that period was 100% – and still is”. To reap the full benefit of the equity asset class, Buffett stayed out of the effort to time the market. 

“Our goal is to have meaningful investments in businesses with durable economic advantages and a first-class CEO”, he mentioned. “Charlie and I are not stock-pickers; we are business pickers”.

Warren Buffett

In other words, Berkshire Hathaway makes long-term investments in businesses rather than speculating on its share price movements.

From the Berkshire equity portfolio, it is clear that the business quality has been the focus more than diversification. In addition to its controlling stakes in insurers, railroads and utilities, it also holds parts of Apple, Bank of America, American Express, Coca Cola and Kraft Heinz. 

Focus on value 

Berkshire Hathaway held about $ 140 bn in cash and cash equivalents which was much more than their minimum threshold of $ 30 bn. “Prices of equities remain elevated, and so the landscape there has been unfavourable for deploying large chunks of capital”, mentioned the letter.

According to Buffett, low long-term interest rates have pushed the prices of all productive assets up, including stocks and real estate.

With little value in the market, he decided to repurchase Berkshire shares and thereby create value for its shareholders. Buybacks reduce the number of shares freely trading (as the buy-back shares are extinguished) and thereby increase the stake of shareholders in the company. 

“When the price/value equation is right, share repurchases (or buyback) is the easiest and most certain way to increase shareholder wealth”.

Warren Buffett

Grab the opportunity

Besides, its insurance business, Apple and BHE (Berkshire Hathaway Energy) account for a considerable chunk of Berkshire’s value, mentions the letter. Interestingly, one of its four giants – BNSF, was bought when the markets ditched its stock after seeing disappointing earnings. Post its third-quarter results, the share price of BNSF, one of America’s largest freight railroads, was down 10% in 2009, and Buffett made a $ 26 bn bid. Since then, the company has reported a record $ 6 bn in profit last year.

During the Global Financial Crisis of 2008, Buffett threw Goldman Sachs a $ 5 bn lifeline in exchange for equity. In 2011 when the bank redeemed the shares, a $3.7 bn in profit was booked.

Track the fundamentals

“Speaking less politely, I would say that bull markets breed bloviated bull,” said the letter. The letter mentioned that the earnings are often subject to deceptive adjustments to make the stock look attractive in today’s world. For instance, a company might report one-time gains in revenues and show it as an income earned in the ordinary course of business or change its depreciation policy to cover up poor results. 

No matter how much technology advances, the financial metrics for analysis remain the same. Buffett emphasised that he preferred an old-fashioned way of calculating earnings – after interest, taxes, depreciation, amortisation, and compensation. 

Takeaways

The 2021 Berkshire letter has a strong message for equity investors – stick to the basics and don’t view stocks as vehicles for timely market moves.