3 Valuable Insights Gained Through Warren Buffett's 2017 Annual Shareholder Letter.

In Warren Buffett's 2017 annual shareholder letter I have gained these following 3 insights:

Insight #1: High Valuations Are Posing as a Problem to Berkshire Hathaway’s Acquisition Growth Strategy.

In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price.

The last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.

Buffett thinks there are 2 major factors that are causing this overvaluation within markets. The first is the desire of most CEOs to rule the largest company possible:

Why the purchasing frenzy? In part, it’s because the CEO job self-selects for “can do” types. If Wall Street analysts or board members urge that brand of CEO to consider possible acquisitions, it’s a bit like telling your ripening teenager to be sure to have a normal sex life.

Warren Buffet also believes that low-interest rates played a role. Buffett writes the following about the role of low-interest rates on higher asset prices:

The ample availability of extraordinarily cheap debt in 2017 further fueled purchase activity. After all, even a high-priced deal will usually boost per-share earnings if it is debt-financed. At Berkshire, in contrast, we evaluate acquisitions on an all-equity basis, knowing that our taste for overall debt is very low and that to assign a large portion of our debt to any individual business would generally be fallacious. We also never factor in, nor do we often find, synergies.

This is gold.

Despite our recent drought of acquisitions, Charlie and I believe that from time to time Berkshire will have opportunities to make very large purchases. In the meantime, we will stick with our simple guideline: The less the prudence with which other conduct their affairs, the greater the prudence with which we must conduct our own.

Insight #2: Berkshire Is Not Immune to Price Declines.

Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure long term growth in value. For the last 53 years, the company has built value by investing its earnings and letting compound interest work its magic. Year by year, we have moved forward. Yet Berkshire shares have suffered four truly major dips…

In the next 53 years our shares (and others) will experience declines resembling those in the table. No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow.

Does this quote imply that Buffett believes there will be a market correction on the way?

Anyways this quote is a reminder of the dangers of borrowed money to purchase marketable securities.

Insight #3: Equities are the best investment for building wealth over the long run.

Originally, Protégé and I each funded our portion of the ultimate $1 million prize by purchasing $500,000 face amount of zero-coupon U.S. Treasury bonds (sometimes called “strips”). These bonds cost each of us $318,250 – a bit less than 64¢ on the dollar – with the $500,000 payable in ten years.

As the name implies, the bonds we acquired paid no interest, but (because of the discount at which they were purchased) delivered a 4.56% annual return if held to maturity. Protégé and I originally intended to do no more than tally the annual returns and distribute $1 million to the winning charity when the bonds matured late in 2017.

After our purchase, however, some very strange things took place in the bond market. By November 2012, our bonds – now with about five years to go before they matured – were selling for 95.7% of their face value. At that price, their annual yield to maturity was less than 1%. Or, to be precise, .88%.”
“Given that pathetic return, our bonds had become a dumb – a really dumb – investment compared to American equities. Over time, the S&P 500 – which mirrors a huge cross-section of American business, appropriately weighted by market value – has earned far more than 10% annually on shareholders’ equity (net worth).

In November 2012, as we were considering all this, the cash return from dividends on the S&P 500 was 2.5% annually, about triple the yield on our U.S. Treasury bond. These dividend payments were almost certain to grow. Beyond that, huge sums were being retained by the companies comprising the 500. These businesses would use their retained earnings to expand their operations and, frequently, to repurchase their shares as well. Either course would, over time, substantially increase earnings-per-share. And – as has been the case since 1776 – whatever its problems of the minute, the American economy was going to move forward.

Do you agree that equities are a better investment compared to bonds in the long run? There are certain times where bonds outperformed equities on average.