Good Afternoon Income Investors!
Last week, Buffett released his annual letter to shareholders, it is available here. For me, it is required reading each year. The wisdom that Buffett has is a level of wisdom I aspire to reach someday. For the Market Outlook, I want to highlight some of the comments Buffett made that spoke to me and my thoughts on them.
Ignore The Noise
"The Dow Jones Industrial Average fell below 100 on that fateful day in 1942 when I “pulled the trigger.” I was down about $5 by the time school was out. Soon, things turned around and now that index hovers around 38,000. America has been a terrific country for investors. All they have needed to do is sit quietly, listening to no one."
Warren Buffett bought into the stock market in March 1942, and has been in it ever since. He has held through some very tough times and some very large swings, but did not sell everything and try to time it. Patience is perhaps the most difficult part of investing for most.
On Stock Market Movements
After noting the "worse-than-useless" net-income number required by GAAP, Buffett discussed Berkshire's preferred metric for operating earnings. He wrote:
"It is more than silly, however, to make judgments about Berkshire’s investment value based on “earnings” that incorporate the capricious day-by-day and, yes, even year-by-year movements of the stock market. As Ben Graham taught me, “In the short run the market acts as a voting machine; in the long run it becomes a weighing machine.""
Whenever you are using any number to analyze a business, it is crucial to know what that number is telling you and then identify whether or not it is relevant. In the case of Berkshire Hathaway (BRK.B), a very large amount of its GAAP "net income" is attributable to price movements in its stock portfolio. Since those are unrealized gains or losses, and gains or losses that might never be realized, it distorts the true earnings of BRK. The actual cash flow that the company is earning.
This is very important to keep in mind. For income investors like us, the priority is a metric that measures cash flow and closely represents the amount the company could pay in dividends.
For our own portfolios, we should think the same way. The core tenet of the Income Method is to evaluate your portfolio like a business. Focus on the "operating earnings", the cash that is coming into your portfolio minus expenses.
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