I recently read Warren Buffett’s 2007 letter to the shareholders of Berkshire Hathaway, Inc.  If you’ve never read one of these letters, I highly recommend it.  They are often short (the 2007 letter is just 20 pages long).  It takes about 30 minutes to read it, but the information you gain is priceless.  Each of the letters, dating back to 1977, is available on the Berkshire Hathaway website in PDF form free of charge.

If you can’t or haven’t read Buffett’s 2007 letter, I picked out the ten most important things in that letter and listed them below.  Well, ten wasn’t enough.  I tried to keep it within ten, but I had to add one more quote because I couldn’t leave #11 out.  (The words within quotes are Buffett’s words; the words not in quotes that follow each item–if any–are my humbled analyses.)    

1) On what types of businesses Buffett and his partner, Charlie Munger, like to buy: “Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag.”

Most of these quotes don’t need commentary, nor dare I add anything to them because I am still just an employee.  But this one requires some additional clarification.  This particular advice (#1) is essential for anyone who invests in stocks and mutual funds.  If you want to buy stocks, you should know and understand the business of the company whose shares you are buying.  That company should be in good, long-term economic shape.  It should have good, experienced management, and the stock should not be overvalued.  Today, many people invest in stocks using the “buy, hold, and pray” strategy.  They are passive investors with no knowledge of the companies in which they are investing.   

2) “A truly great business must have an enduring ’moat’ that protects excellent returns on invested capital. . . . [C]apitalism guarantee[s] that competitors will repeatedly assault any business ‘castle’ that is earning high returns.  Therefore a formidable barrier such as a company’s being the low-cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success.  Business history is filled with ‘Roman Candles,’ companies whose moats proved illusory and were soon crossed.” 

3) “[I]f a business requires a superstar to produce great results, the business itself cannot be deemed great.  A medical partnership led by your area’s premier brain surgeon may enjoy outsized and growing earnings, but that tells little about its future.  The partnership’s moat will go when the surgeon goes.  You can count, though, on the moat of the Mayo Clinic to endure, even though you can’t name its CEO.”

This point is a fantastic lesson.  A successful business is about a product, not a person.  That is why your dad can’t sell his law practice.  That is why the owners of the mom-and-pop restaurant down the street aren’t millionaires.  To build a truly successful business, you have to create a product that becomes a well-known brand.  That way, when the original founder of that business exits the picture, the business itself–buoyed by its well-known product–remains vibrant and successful.

4) “There’s no rule that you have to invest money where you’ve earned it.  Indeed, it’s often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can’t for any extended period reinvest a large portion of their earnings internally at high rates of return.”

5) “It’s far better to have an ever-increasing stream of earnings with virtually no major capital requirements.  Ask Microsoft or Google.”

This is crucial, and the Internet has helped this phenomenon become a reality.  When a business can sell more of its brand (like software) without spending a correspondingly large amount of money developing more of that brand, it will increase its earnings exponentially.

6) “The worst sort of business is one that grows rapidly, requires significant capital to engender growth, and then earns little or no money.  Think airlines.  Here a durable competitive advantage has proved elusive ever since the days of the Wright Brothers.  Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.  The airline industry’s demand for capital ever since that first flight has been insatiable.  Investors poured money into a bottomless pit, attracted by growth when they should have been repelled by it.”

Is it any surprise that most of the airlines couldn’t survive the 9/11 terrorist attacks? 

7) On Berkshire’s common stock investments: “American Express and Wells Fargo were both organized by Henry Wells and William Fargo, Amex in 1850 and Wells in 1852.  P&G and Coke began business in 1837 and 1886 respectively.  Start-ups are not our game.”

This quote, more than any of the others, illustrates that investing is about a plan.  Buffett, like every successful investor, has a plan, and he never deviates from it.  That is what investing should be.  Decide on your plan, and stick to it.  If you want to invest in real estate, go for it.  But don’t opt for stocks six months later.  Stick to your plan. 

8) ”The U.S. dollar weakened further in 2007 against major currencies, and it’s no mystery why: Americans like buying products made elsewhere more than the rest of the world likes buying products made in the U.S.  Inevitably, that causes Americans to ship about $2 billion of IOUs and assets daily to the rest of the world.  And over time, that puts pressure on the dollar.”

9) “Despite our country’s many imperfections and unrelenting problems of one sort or another, America’s rule of law, market-responsive economic system, and belief in meritocracy are almost certain to produce ever-growing prosperity for its citizens.”

This positive outlook is a breath of fresh air in the midst of the prevailing gloom and doom perspectives we hear about the U.S. economy on a daily basis.  I only hope that Buffett is right about this one. 

10) “[P]eople who expect to earn 10% annually from equities during this century . . . are implicitly forecasting a level of about 24,000,000 on the Dow by 2100.  If your adviser talks to you about double-digit returns from equities, explain this math to him–not that it will faze him.  Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: ‘Why, sometimes I’ve believed as many as six impossible things before breakfast.’  Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.”

Look at it this way: Why would a high-salaried executive or a rich individual, both of whom have their own transportation to get to work, take the advice of a person (a financial adviser) who takes the subway to work?

11) “Public pension promises are huge and, in many cases, funding is woefully inadequate.  Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed. . . . In a world where people are living longer and inflation is certain, those promises will be anything but easy to keep.”

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