I’ve read all fifty years’ worth of Warren Buffett’s Berkshire Hathaway annual letters to shareholders. You can too, for just three dollars. His latter-day letters are the more well-known ones, as he really hit his stride as a quipster in the 1980’s. But the earlier ones are a lot more interesting.
In the late 1960’s Buffett began writing to shareholders explaining his desire to buy the common stocks of other corporations with Berkshire’s excess cash. Interestingly, Buffett wrote these letters but they were signed by someone else at first, the sitting CEO of the company.
His explanation for dabbling in outside investments was that the textile business was prone to huge cyclical swings and was, quite possibly, facing a more existential threat thanks to plunging prices and the need for heavy spending on equipment. Stocks, Buffett argued, could smooth out the annual returns to shareholders and enhance them in the long run if he was prudent in identifying value.
And it worked. The first few annual letters betray a sense of elation at the fact that rising stocks were offsetting the travails of the textile industry, just as he had anticipated.
And then the bear market of 1973-1974 hit and Buffett didn’t have anything encouraging to say about his stockholdings at all. It was a mess from top to bottom as the S&P went through the convulsions that would bring it into a 50% drawdown in short order. Buffett’s value picks weren’t spared the destruction.
But Buffett persevered in his strategy, using his writing ability to maintain the faith among the company’s shareholders, employees and even his fellow managers, who must surely have been shaken up by the bear market that slammed the company from both directions. He continued to follow the teachings of his mentor, Ben Graham, investing where stocks were too cheap to ignore.
You know the rest. He’s become the richest investor in history and the decaying husk of his New England textile company shed itself to reveal a gleaming insurance empire with large investments in some of the greatest American corporations of all time.
I consider David Einhorn to be one of history’s great investors – if not on the same level as Buffett, certainly in the same conversation. Einhorn is coming off of a horrific year, during which he was short the two top-performing stocks in the S&P 500 and long two of the worst ten. His trade timing was terrible even on the longs and shorts he was right about. All told, his Greenlight Capital fund lost 20% in 2015 with the S&P 500’s total return around plus-1%.
This week, Einhorn’s year-end letter to his clients surfaced and it’s a must-read for serious investors everywhere. What does an elite investor do after a year like the one Greenlight has just gone through? I think you handle it in exactly the way David Einhorn has – an unflinching autopsy detailing what went wrong.
Einhorn’s assessment of his firm’s process and the bigger picture of the investing environment throughout the year gives investors exactly what they need to hear in order to determine whether or not they should stay. It is honest, critical and, above all, brimming with humility.
And humility is probably the thing that separates good investors from the truly great ones over time. You cannot be a market participant and completely avoid the possibility of having a terrible year. This is because all good investors adhere to a particular style, and, by definition, styles go in and out of favor.
What Buffett was doing in 1974 wasn’t broken, it was simply out of favor. Other more market-timing oriented strategies just temporarily looked better. What Einhorn was doing during the dot com bubble years wasn’t broken, it was just out of favor. Value investing was out, hyperbolic growth investing just temporarily looked better.
Investors without the humility to admit mistakes are not going to last long. On the other hand, good investors who are willing to analyze their mistakes and be frank about what environments will and will not favor their strategies have the chance to transcend and become great.
I recommend Einhorn’s full letter for investors at all levels of experience and education. You are going to lose sometimes, no matter how good you are. This is how to lose right.