Warren Buffett: How To Understand Annual Reports
Summary
TLDRIn this engaging discussion, Steve Davis and Charlie Munger share their insights on understanding annual reports and investment strategies. They emphasize the importance of transparent management communication, noting that candid discussions about both successes and challenges foster investor confidence. The conversation highlights Coca-Cola's long-term growth potential compared to Pepsi and the value of stock buybacks as a strategic tool for strong companies. They also advocate for independent investor analysis over broker recommendations, showcasing a preference for individual shareholders who align with the company’s values. Overall, the dialogue offers valuable perspectives for investors seeking to navigate the complexities of financial reporting.
Takeaways
- 😀 Understanding annual reports starts with focusing on companies that investors can comprehend.
- 📊 Candid management communication about both successes and challenges is crucial for building trust with investors.
- 📈 High-quality annual reports can provide insights equivalent to conversations with top management, enhancing investment confidence.
- 🔍 Avoiding jargon and using straightforward language in reports can positively influence investor interest.
- 🍹 Long-term growth predictions favor Coca-Cola over Pepsi, indicating confidence in Coca-Cola's market strategies.
- 📚 Recommended readings, such as 'Guns, Germs, and Steel' by Jared Diamond, can offer valuable perspectives on business and decision-making.
- 💰 Share repurchase strategies, even at high price-to-earnings ratios, are viewed as beneficial for long-term shareholder value.
- 🤔 Investors are encouraged to make independent decisions rather than relying solely on broker recommendations.
- 🔔 Management should prioritize transparency by discussing challenges promptly and avoid only presenting positive news.
- 📝 A well-informed investor is more likely to engage with a company and remain committed over the long term.
Q & A
What is the primary focus when evaluating annual reports according to the speakers?
-The primary focus is on finding companies whose reports are understandable and provide candid information about their management and business operations.
How do the speakers feel about the use of jargon in annual reports?
-The speakers believe that the use of standardized jargon can be a turn-off and prefer straightforward, coherent language that communicates the business's true state.
What example do the speakers give of a company with an informative annual report?
-They highlight Coca-Cola's annual report as being particularly informative, stating that it provides insights comparable to a personal conversation with management.
What is the recommended approach for managers regarding bad news?
-Managers are encouraged to communicate bad news immediately and openly, as this fosters trust and understanding with shareholders.
What long-term growth prediction do the speakers make regarding Coca-Cola and Pepsi?
-The speakers predict that Coca-Cola will continue to gain market share compared to Pepsi in the long term.
What book does Charlie Munger recommend, and why?
-Charlie Munger recommends 'Guns, Germs, and Steel' by Jared Diamond for its analytical approach and the way it encourages readers to ask insightful questions.
What do the speakers think about share repurchases by strong companies like Coca-Cola?
-They view share repurchases as a wise use of capital, especially for strong companies, as it can lead to increased ownership and value over time.
What caution do the speakers express regarding stock repurchase programs?
-They caution that not all stock repurchases are well-reasoned and can lead to poor management decisions if done excessively or for the wrong reasons.
How do the speakers perceive individual investors compared to institutional investors?
-They prefer individual investors, believing they are more engaged and understand the impact of investments on their lives better than institutional investors.
What key factor do the speakers believe enhances their investment decisions?
-They believe that having a deep understanding of a company's business operations and being informed by transparent annual reports enhances their investment decisions.
Outlines
📊 Understanding Annual Reports
In this part, Steve Davis shares insights on how to effectively read and understand annual reports. He emphasizes the importance of selecting companies whose reports are comprehensible and well-communicated. Davis highlights that the quality of management's transparency in reporting critical business aspects directly impacts investment decisions. He mentions the Coca-Cola annual report as a prime example of informative documentation, asserting that they made their investment decision based solely on it. Both Davis and Charlie Munger express their disdain for jargon-heavy reports and advocate for candid communication, urging managers to convey bad news promptly to maintain investor trust.
🥤 Long-Term Growth: Coca-Cola vs. Pepsi
In this segment, the discussion shifts to the long-term growth prospects of Coca-Cola compared to Pepsi. Davis expresses confidence that Coca-Cola will continue to outperform Pepsi, illustrating his point with insights from Munger. The importance of maintaining competitive advantages and the effectiveness of management strategies are highlighted as key factors in this prediction. The conversation underscores the value of experience in assessing company prospects and reinforces the rationale behind their investment choices.
💸 Capital Deployment and Stock Buybacks
This part revolves around the strategic considerations of companies like Coca-Cola when buying back their shares. Davis argues that repurchasing shares is often a wise decision for strong companies, citing Coca-Cola's consistent history of share repurchases as a positive practice. He discusses how repurchases have enabled Berkshire Hathaway to increase its stake in Coca-Cola without additional capital outlay. Munger adds that while there can be instances where share buybacks are inappropriate, great companies can successfully buy back stock even at high prices. The discussion also critiques the trend of companies repurchasing shares for the wrong reasons, urging a more judicious approach to capital deployment.
📉 Recommendations and Individual Investors
In this final part, the conversation touches on stock recommendations and the nature of Berkshire Hathaway's shareholder base. Davis explains their preference for individual investors over institutional ones, emphasizing that individuals tend to have a longer-term perspective. He reflects on how little Berkshire Hathaway is recommended in the institutional market due to perceptions of its difficulty in large-scale investments. The discussion emphasizes the emotional and practical impacts of successful investing on individuals' lives, contrasting it with the often short-sighted strategies employed by institutional investors.
Mindmap
Keywords
💡Annual Reports
💡Transparency
💡Investment Strategy
💡Coca-Cola
💡Candid Communication
💡Stock Buybacks
💡Jargon
💡Long-Term Growth
💡Reading Recommendations
💡Individual Investors
Highlights
Steve Davis seeks advice on understanding annual reports and what to focus on.
The importance of transparency and candid communication from management is emphasized.
Investors should seek reports that help them understand the business as if they own it entirely.
Coca-Cola's annual report is cited as an exemplary model of effective communication.
The speakers purchased Coca-Cola stock based on insights from the annual report, not management conversations.
The rejection of standardized jargon in annual reports is highlighted as a negative aspect.
A call for management to share bad news immediately for better investor understanding.
The speakers assume every business has problems that should be transparently communicated.
Munger mentions the importance of reading insightful books beyond standard investment literature.
Charlie Munger recommends 'Guns, Germs, and Steel' for its analytical perspective.
Munger mentions a book on Einstein's commentary as a valuable read for its insights.
The speakers discuss share repurchases and their implications for long-term shareholders.
Coca-Cola's stock repurchase strategy is seen as beneficial, even at high price-to-earnings ratios.
The potential for companies to abuse share repurchase strategies is acknowledged.
The importance of individual investors making informed decisions rather than relying on broker recommendations.
A preference for a committed individual shareholder base over institutional investors is expressed.
Transcripts
okay zone
two hello I'm Steve Davis from San
Francisco I'd like your advice on how to
understand annual reports what you look
for what's important what's not
important and what you've learned over
the years from Reading thousands of
reports thank you well we've read a lot
of reports I will tell you that
and we uh well we start by looking at
the reports of companies that we think
we can understand so we hope to find we
hope to be reading reports and I and I
do read hundreds of them every year we
hope to be reading reports of businesses
that are understandable to us and then
we
see from that report whether the
management is telling us about the
things that we would want to know about
if we owned 100% of the company and when
we find a management that does tell us
about those things and that is candid in
the same way that a manager of a
subsidiary would be candid with us and
talks in life anguage that we can
understand it it definitely improves our
feeling about about investing in such a
business and and the it it definitely
improves our feeling about about
investing in such a business and and the
reverse uh turns us off to some extent
so if we read a bunch of public
relations gobble
leuk it has some effect toward a
business we want to understand the
business better when we get through with
the annual report than when we picked it
up and that is not difficult for a manag
to do if they want to do it if they
don't want to do it you know we we think
that is a
factor uh and whether we want to be
their Partners over a 10 10 year period
or so but we've learned a lot from
annual reports for example I would say
that uh the cocacola annual report over
the last good many years been an
enormously informative document I mean I
can't I I can't think of any way if I
had had a conversation with Roberto
voicea or now Doug ivester and they were
telling me about the business they would
not be telling me more than than than
than I get from reading that annual
report we bought that stock based on on
an annual report we did not B buy it
based on any conversation of any kind
with the top management of Coca-Cola
before we bought our interest we simply
bought it on based on reading the annual
report plus our knowledge of how the
business worked
Charlie yeah I do think the if you've
got a standardized bunch of popular
jargon that looks like it came out of
the same consult for him I I do think
it's a big turn
off that's not to say that some of the
Consulting mantras aren't right but
uh I think there's a lot that for sort
of candid simple coherent
Pros a lot to be said for
it almost every business has problems
and we just assume the manager would
tell us about them uh we would we would
like that in the businesses we run in
fact one of the things we we give very
little advice to our managers but one
thing we always do say is to tell us the
bad news immediately and and I don't see
why that isn't a good advice for the the
manager of a public company uh uh over
time you know I'm I'm positive it's the
best you know I'm I'm positive it's the
best policy but but uh a lot of compan
they they're dying just to pump out what
they think is good news all the time and
they they have this attitude that you
know that you've got to buy buch of
animals out there to be fed and that
they're going to feed them what they
want to eat all the time and over time
the animals learn uh so it's we we try
to stay away from businesses like that
what you seldom see in an annual report
is a sentence like this this is a very
serious problem and we haven't quite
figured out yet how to how to handle
it but believe me that is an accurate
statement much of the time
all right zone
three I'm L dks and I live I'm L dks I
live in the area and I would like to
know what your prediction is for
Coca-Cola's longterm growth versus Pepsi
cola's recent efforts to increase the
competitiveness with Coke
yeah
uh long term I would expect Coke to
continue to gain versus
[Laughter]
Pepsi what has he been doing while I was
gone what' you say
Charlie I knew I I knew I was taking a
what was a question I said that long
term I expected Coke to continue to gain
versus Pepsi oh well it's those kind of
insights is why we why we keep him on
the job year after
year Zone
one I'm Ben null and I'm from
Minneapolis and uh first I just wanted
to thank you for providing your uh past
annual letters to the shareholders and
Mr Munger for providing your speech to
The Graduate students at uh the USC a
couple years ago um drawn a lot of
insights from that not only in investing
but also in my uh day job as a as a
business manager and I'm wondering if
you can help me with my summer reading
list and uh provide some additional
suggestions for reading in the fields of
investing and management other than the
standards of Graham Fisher so
forth Charlie
yeah I have uh recently read a new book
twice which I very seldom do and that
book is Guns Germs and Steel by Jared
diamond and uh it's a marvelous book and
the the way the guy's mind works would
be useful in business he's got a mind
that is always asking why why why why
and he's very good at coming up with
answers I would say it's the best work
of its kind I have ever
read I read a little easier book
uh recently I I I'm not even sure of the
title I I don't pay much attention to
titles when I get into the books but it
it's something to the effect of the
quotable Einstein I mean it's it's it's
all it's a lot of his commentary over
the years and it's great
reading the firm OD theum was with the
book but that isn't the exact title
either it it's the story of the of the
uh discovery of the answer on that that
that's a very interesting book one of
our shareholders from Sweden gave me a
copy of that when I was in New York and
I've enjoyed it Zone
7 yes um Bill Amman from New York uh
there is there a price at which it's
inappropriate for a company use its
capital buyb its
stock give me that again example
Coca-Cola at 40p is that a smart place
for Coke to deploy Capital well it it
sounds like a very high price when you
name it in terms of a PE to buy back the
uh stock at at uh uh that sort of number
but I would say
this uh Coca-Cola's been
around what 12 years now and uh
uh there are very few times in that 112
years if any when it would have not have
been smart for Coca-Cola to be
repurchasing its shares Coca-Cola is
probably in my
view among businesses that I can
understand it's the best large business
in the world I mean it it is a fantastic
business and uh we love it when coch
repurchases shares and our interest goes
up we owned 6.3% % of Coca-Cola in 1988
when we bought in we
actually increased that a little bit a
few years later but if they had not
repurchased shares we probably would own
about 6.7% or 6.8% of coke now as it is
we own a little over
8% uh through
repurchases uh there are going to be
about a billion 8 ounce servings of coke
sold around the world or Coca-Cola
products sold around the world
today uh 8% of that is 80 million and
6.8% is 68 million so they're 12 million
extra servings for the account of
birkshire Hathaway being sold around the
world and they're making a little over a
penny of serving so you know that that
gets me kind of
excited
and I I I think it all I can tell you is
I approve of of coke repurchasing shares
I'd lot rather have them repurchasing
shares at at at 15 times earnings but
but uh when I look at other ways to use
capital I still think it's a very it's a
very good use of capital and maybe the
day will come when they can buy it at 20
times earnings and if they can I hope
they go out and borrow a lot of money to
buy a ton of it at those prices and uh I
think we will be better off 20 years
from now if cop follows a consistent
repurchase uh approach I do not think
that is true for many companies I mean I
think that repurchases have become in
Vogue and done for a lot of silly
reasons and uh so I I I I don't think
everybody's repurchase of shares uh is
well reasoned at
all uh you know we see
companies that issue options by the ton
and then they repurchase shares much
higher you
know I started reading about Investments
when I was six and I think the first
thing that I read was you know Buy Low
sell high but these companies through
their options you know they they sell
low and then they buy high and they
they've got a different formula than I
was taught uh so there a number that we
don't approve of it when when we had
when we own stock in a wonderful
business uh we we we we like the idea of
repurchases even at prices that uh that
may give you nose bleeds uh it it
generally turns out to be a pretty good
policy Charlie well I think the answer
is that in any company the stock could
get to a price so high it would be
folish for the corporation to repurchase
its shares sure
and you can even get into gross abuse uh
before the crash the insole utilities
were madly buying their own shares as a
way of promoting the stock higher it was
like a giant Ponzi scheme at the end uh
so there's all kinds of excess that's
possible but the really great companies
that buy a high price earnings rate
that's that can be wise
our interest in Geico went from 33% to
50% without us laying out a dime because
Geico was repurchasing it shares and uh
uh we benefited substantially but we
benefited a lot more obviously when
prices were were lower I mean we would
we would our interest in the Washington
Post company's gone from nine and a
fraction percent to 17 and a fraction
percent over the years without us buying
a single share um but the post or Coke
or any number number of companies don't
get the bargain in repurchasing now that
that they used to uh we still think it's
probably the best best use of money in
many cases the question about
recommending the stock we we've very
seldom had stock recommendations over
the years as I think back to 1965 I I uh
I can't think of a lot of brokerage
reports that have recommended burer that
I I I'm not looking for any you know
reports at all we we are not to have
Berkshire sell at the highest possible
price and we're not looking for to try
and attract people to birkshire who are
buying stocks because somebody else
recommends them to them we we we prefer
people who who figure out for themselves
why they want they themselves want to
buy burshire because they're much more
likely to stick around if they enter the
restaurant because they decide it's the
restaurant they want to eat at than if
somebody has touted them on it and
that's that's our approach so we uh we
do nothing to encourage but I think even
if we did we probably wouldn't generate
a lot of recommendations it's it's not a
great stock to get rich on if you're a
broker yeah I think the
[Applause]
reason I think the one of the main
reasons why it's so little recommended
in the institutional Market is that it's
perceived as hard to buy in
quantity wait we prefer we we've got
some good institutions as holders one
that's run by a very good friend of ours
but frankly it's more fun for us to have
a bunch of individual shareholders I
mean you see it it translates if there's
money made it translates into changes in
people's lives and not some change in
somebody's performance figure for one
quarter and we think that individuals
are much more likely to join us with the
idea of staying with us uh for as long
as we stay around and and you know
that's the way we look at the business
very few institutions look at
Investments that way and and frankly we
think they're often less rational
holders than we get with individuals
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