I discovered some interesting reading in Warren Buffett’s recent annual report from Berkshire Hathaway. I have read this report for years and always find it to contain valuable information. I found some of his comments in this recent report rather intriguing given how he threw himself out to be a political ping pong as of late.

When you open the report, one thing stands out right away. Just look at how Berkshire’s performance compares to the S&P 500 from 1964 to 2011. The difference is astronomical. Over that period, Berkshire generated a 513,055% total return compared to the S&P 500 at 6,397%. This translates to compounded average annual gains of 19.8% compared to 9.2%. Having a history in the investment world, these numbers are super impressive, and they lend Warren an immense amount of respect and financial acumen.

On page 18 of the report, Warren talks about investments that never produce anything but will get purchased because the investor hopes the price will go up. Increasing prices on an asset that doesn’t produce anything only happens when many others want to buy it too and drive the price up. One asset that is representative of this is gold. Warren says “Gold, however, has two significant shortcomings, being neither of much use nor procreative” and “if you own one ounce of gold for an eternity, you will still own one ounce at its end.”

He then goes on to compare the cumulative stock of gold (worth about $9.7 trillion) with what productive assets you could buy. With that amount you could get 400 million acres of US cropland and 16 ExxonMobils (worlds most profitable company). The land would produce $200 billion, and all the ExxonMobils would produce $640 billion per year. That is $840 billion returned to you every year for the same investment amount compared to getting back zero from your gold.

I agree with his thinking here. Given these statements and an earlier comment in the report stating he is giving most of his money to philanthropies, I have two questions for Mr. Buffett.

First, given this line of thinking about spending money on productive assets, whether I had $5 million or $5 trillion to spend, invest, or be taxed, wouldn’t you rather have it in the hands of a productive producer for society (like yourself) rather than a non productive producer for society like the US government ?

Second, if you think we should have an estate tax on successful people like yourself then why are you not giving all your estate to the US Government instead of giving it to productive, accountable charities like the Gates Foundation which takes great pains in making sure their money is spent productivily?

Having come from the investment world, I like to stay informed and keep my eye on what people are seeing and thinking about prospects for growth and where the world is going.  For that reason, I always find reading Berkshire Hathaway’s annual report written by Warren Buffett very informative, down to earth, and a balancer to all the hype and exaggeration about how bad things look out there.  The world is not ending, even though it is going to be a hard road for many.

We have been overwhelmed by the reports and video’s coming from Japan.  So many people are carrying heavy hearts for what the Japanese people are experiencing, and will continue to experience as they rebuild their lives and their homes.  We all wish major blessings and much inner strength to all of Japan, and to our EO friends over there, to help them get through these tough times.

A few weeks back, before this tragedy, Mr. Buffet made some interesting comments in his report, which happen to be very appropriate for hard times, be it the state of the US Economy, a natural disaster or personal crises.  He started with commenting on how over the span of his life living standards have increased over 6 times.  He followed with “The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective.”

I agree with this wholeheartedly and know that this applies not just to America, but everyone participating in the world capitalist economy.  Japan dealt with the mass destruction of WWII and nuclear attacks, to become the 2^nd largest economy in the world (now 3^rd).  The Japanese people have shown a very high consciousness deal with this crisis, and with all the human potential they possessed getting it done before, they can do it again. 

Other observations in his report had to do with the future prospects of companies to create intrinsic value.  He focuses on 2 areas, which he calls the “what-will-they-do-with-the-money” factor and “what-do-we-have-now” calculation.  In order for CEO’s to do a good job, they must look at these areas and allocate effectively.  Buffett used the example of going back to 1960 and seeing how Sears and Roebuck or Montgomery Ward’s CEO’s allocated capital compared to Sam Walton.

He also talked about how culture counts, and that CEO’s and directors should act like owners.  Under the Berkshire system they receive “token compensation: no options, no restricted stock and, for that matter, virtually no cash.”  There’s no liability insurance in place either, so if they mess up, they lose their own money as well.

In regards to leverage and debt, Buffett is not a fan of what he calls “financial adventurism”.  A lot of people have gotten rich and magnified their gains through the use of borrowed money, but many have also become very poor in the process.  Having a large amount of debt in your business can be destructive if the timing of maturity or refinancing comes during a worldwide credit shortage.  Buffett is a fan of having lots of cash on hand, this way you always have money to deal with a crisis or take advantage of an opportunity. He keeps at least 10 Billion and usually up to 20 Billion on hand.  Cash is King! 

22 years in the investment world, running a money management and mutual firm taught me a thing or two. I experienced ups and downs, and learned a lot. The world is a difficult place when it comes to stock markets, and trying to decide where to place your money. In case you haven’t noticed, after a decade the markets today are still lower than they were in 2000. Scary thought.

It’s my experience that those in the marketplace that manage money have short streaks of what appears to be brilliance. They are labeled as a guru, right up until something changes in the market, and they go back to being the average Joe, or even worse, losing lots of money. I saw this happen firsthand when my partner and portfolio manager was labeled a guru when we had the number 1 performing growth and income fund and were on CNBC regularly. We were propelled there by placing money in what we felt was the direction of a more connected world, then supercharged by a floor of money released into the economy by the Fed in fear of Y2K. All that changed in the early 2000’s.

Being in that world and around all those “perceived” investment guru’s helped me see that no one had the market truly figured out, and in my opinion, still don’t. You will always find portfolio managers that generate above market returns for a while, then something changes and they revert back to the mean. Most people jump on board when the good performance numbers start to show up in the 3rd and 5th year rankings, but that is usually about the time that funds begin to fall back to mediocre, or even worse, fall like a rock.

Given my observations, I’ve chosen to invest in index funds with the lowest expense ratios, or not invest in the market at all. I read a great book a few years back that provided the numbers to support this theory, and even directed how to invest in the index funds and diversify between cash, bonds, international, large and small stocks. It’s called “The Smartest Investment Book You’ll Ever Read”, and if you’re going to invest in stocks or mutual funds, I fully agree with the title. If will provide you with a simple and easy to follow process.

If you read this and think, “Well Greg, what about Warren Buffett? He has blown away the market for over 40 years?” My response is, Warren Buffettis not stock market investing. He buys meaningful interest in business that his company either controls or advises on finance to help steer success. This is running businesses, not stock market investing.