It’s that time of year again when the Oracle of Omaha writes to his shareholders. As always, there’s much wisdom in those pages.
Critics gotta criticize, and when you’re as successful in your undertakings as Warren Buffett, they’re going to look for anything they can find. This year, having combed through Buffett’s annual letter to his Berkshire Hathaway shareholders, Fortune noted that S&P 500 returns beat Buffett’s over the last five years–but not the past six.
Who gives a flying frijole? Buffett has proven himself one of the greatest investors of all time and someone who understands business like few people can. He gets the basics, the flourishes, and the twists. On an off year in 2013, Berkshire Hathaway pulled in 23 percent growth in pretax profits. It’s even more remarkable because Buffett typically holds companies for extended periods of time and is the head of a conglomerate, which, given the history of disasters that have often plagued such entities, makes it additionally impressive.
So, forget about reading the Berkshire Hathaway results for gotchas. Let’s take a look at some sound business advice that comes from watching what someone does, not just listening to what he says.
1. Know your company’s intrinsic value.
People focus far too often on the external measures of a company’s value. They look at stock price or the valuation derived from looking at the prices venture capitalists pay for a given percentage of a company. Forget all that, because those are ephemeral measures. Here’s how Buffett thinks of it:
Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.
The calculation can be complicated and can change with interest rates or cash-flow projections. But Buffett’s definition offers reasonable guidance. Calculating the intrinsic value is an excellent exercise. When you have a sense of the company’s real worth, you have a context in which to consider investments, deals, and strategic decisions. Just be careful of the inherent danger of believing your own hype: Look at all the tech companies that twist accounting metrics into pretzels to pretend that they’re profitable when they aren’t.
2. Build business templates.
Ask most businesspeople about templates and they’ll mention word-processing documents and spreadsheets. Buffett talks about a partnership template. He has built a new methodical approach to large acquisitions. The specific details are immaterial for an entrepreneur, who isn’t buying a company like NV Energy or a big chunk of H.J. Heinz. What is important is the idea of developing repeatable processes. Major deals are always unique, and then they all have common characteristics. Know how to achieve what you need, and you have far more energy available to consider the quirks.
3. Know the difference between types of growth.
Many companies are anxious to grow at a breakneck pace. Even large companies will buy other large companies for their revenue. But in a way that’s just trading one block of money for another. It can be a wash. Buffett says he doesn’t want Berkshire Hathaway to simply grow, but to grow per-share results. Even though your business is probably private, that’s a good way to think about it. Are you just bulking up, or are you becoming proportionately more successful?
4. Invest in management.
An important reason for Buffett’s success is that Berkshire Hathaway only invests in companies if they have strong management. Otherwise, you only subsidize a badly working business. Get the best management you can in your company from people who really know how to run marketing, sales, supply chain, customer service, manufacturing, finance, and any other silos. While providing strategy, let the people who know how to do the work actually do it. Buffett admits that two people working for him handle $7 billion portfolios with returns far outperforming his. Better to have them work for you than compete with you.
5. Use your money effectively.
Buffett wrote about the money that Berkshire Hathaway doesn’t own but that it can use to its benefit. The idea of float is well known in certain types of businesses, particularly low-margin ones like groceries and distributors. There’s the difference between when you get paid and when you pay. Some grocery chains make a significant percentage of their profit on the float made available by being a cash business that has terms from its vendors. Effective use of money can also mean passing on your bonuses or compensation and using the cash to strengthen the weaker parts of your operation. Invest in people and capital smartly. As Buffett wrote, « it’s better to have a partial interest in the Hope diamond than to own all of a rhinestone. »
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