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Warren Buffett, arguably the world’s most successful investor, pens an eagerly awaited Annual Letter on his investment vehicle, Berkshire Hathaway.  The letter is chock full of investment insights. This year’s, marking his 50th year at Berkshire’s helm, revealed “what has happened at Berkshire during the past 50 years and what [they] expect…. during the next 50.”
           Mr. Buffett has piloted Berkshire to a 21.6% annualized return over the last 50 years, doing circles around the none too shabby return on the S&P 500 of 9.9%.
           Mr. Buffett, age 84, and number two Charlie Munger, age 90, danced around the question of Berkshire’s successor, a critical issue for the seasoned duo. They also did not share their immediate investment plans, indicating that in the ultra-competitive world of investing you don’t telegraph your next buys.
           However, this 43 page letter, with over 25,000 words, had many insights that mere mortals can use. These stood out:
Financials Are Lucrative
         Of Mr. Buffett’s publicly traded equity investments, nearly half are financials. The centerpiece of Berkshire’s operations is insurance.Â
           In contrast, the S&P 500 is composed of just 14% financials. So, perhaps the key takeaway from Mr. Buffett’s investment activities is, if you want to outperform, overweight financials.
           Buffett admonishes constantly the perils of overpaying. An investment in financials would be especially timely now because they are the one group that has not fully recovered from the 2008-2009 downturn.
           Most financials trade at cheaper valuations than Berkshire itself. Many blue chip financials trade at or around book value, less than 12 times earnings, while Berkshire trades a closer to 1.7 times book value and over 20 times earnings.
           The centerpiece of Mr. Buffett’s insurance holdings is property and casualty businesses. Wholly owned insurance subsidiaries include Geico, National Indemnity, and General Re. Astute investors may imitate Buffett by considering such publicly traded insurance stalwarts as Chubb (CB), Travelers (TRV), and Allstate (ALL). They all might be considered acquisition targets by Berkshire, despite potential anti-trust concerns.
           Mr. Buffett also likes banks, holding major stakes in Wells Fargo (WFC, Financial), US Bancorp (USB, Financial), and Bank of America (BAC, Financial). The underlying theme here is their conservative operations and massive holdings of low cost FDIC insured deposits, giving them a reliable, low cost source of funds. Mr. Buffett notes that one headwind for financials is the low interest rate environment, which reduces the yield on their investments; if higher rates are on the way that may only add to financials’ appeal.Â
Technology – Too Complicated, Too Expensive
           Despite tech stocks being the S&P 500’s largest sector, Mr. Buffett is no fan. His objections seem to be twofold: First, he wants to see a proven record of profitability before diving in, so technologies that only offer the next new thing are too risky for him.
           Second, he says tech is too difficult to understand. That may just be another way this investment genius justifies refusing to pay the high prices tech typically commands.
           Mr. Buffett does have a major stake in IBM (IBM, Financial). It’s the only one of his major holdings that he’s lost money on, but he admitted to adding to the position in 2014.
           Those who want to emulate Mr. Buffett but still maintain some exposure to this most important industry may want to add IBM to their holdings. Despite its beefed up commitment to the cloud, social media, and mobile computing, all areas in which Mr. Buffett would undoubtedly feign ignorance, certainly at this point he would endorse the cheap valuation.
Healthcare Offers No Special Appeal
           Healthcare has been a remarkable performer over the last three years. For example, Fidelity’s Select Biotechnology (FBIOX) and its Select Health Care (FSPHX) are up 198% and 151%, respectively, over the last three years, easily lapping the S&P (64%). Further, healthcare is one of the most important sectors of our economy, approaching nearly 20% of it.
           Yet, it gets no mention from Mr. Buffett. Undoubtedly, valuations at this point hold little appeal. The expense of research and development, uncertainty of pipelines, and the inevitable patent expirations may flunk his test of predictable earnings.
           So, a takeaway from Mr. Buffett is to approach this sector with a light touch. For those who want to maintain some exposure, note his holdings of Sanofi (SNY).
           Although not discussed in the Annual Letter, it is an inexpensive pharma name, trading at just 11 times earnings, close to its cheapest price in the last 52 weeks, and with a near 4% dividend. Mr. Buffett showed no special love for overseas investing in his latest letter, but French-based Sanofi has more revenues from the US (30%) than from Europe (25%), with the balance from hopefully faster growing emerging economies.
Target Smaller Companies
         Mr. Buffett has garnered attention recently for his plug for investing in the S&P 500, at least if you can’t invest like him. Yet many of his comments in his Annual Letter might give an S&P 500 investor pause.
           A recurring theme is that, given Berkshire’s size, investors should not expect the types of growth, at least in percentage terms, that Berkshire generated when it was smaller. Buffett’s reasoning would seem to apply to all large companies.
           Because the S&P 500 weights companies according to their market place value, that index may be not be optimal if you are looking for faster growing companies.
           Given Mr. Buffett’s focus on low costs, yet appreciation for the growth potential of smaller companies, it would be logical for an index investor to prefer index funds focusing on holdings smaller than the large cap S&P 500. An example might be Fidelity’s Spartan Small Cap Index Fund (FSSVX).
A Bull on the Economy Can Profit From Cyclicals
           Mr. Buffett is an unabashed bull on the US and on its economy. He ridicules those who bet against its continual growth.
           His portfolio is consistent with his optimism. For example, all modes of transportation are well represented, including trains, planes, autos, pipelines, etc.Â
           One holding to watch is Deere (DE, Financial). One of Mr. Buffett’s top 15 holdings, this farm equipment maker prospers when farmers do well, interest rates are low, and optimism abounds. It’s attractively priced, at less than 9 times earnings and 1 times sales.
Avoid at All Costs Paying Too Much
           A timeless lesson from Mr. Buffett is the perils of paying too much. For Mr. Buffett, a sound investment can become a loser if price discipline is not maintained.
           Indeed, Mr. Buffett sees his own investment vehicle, Berkshire Hathaway, as potentially a poor investment if investors pay too much. To underscore his point, while Mr. Buffett preaches the value of stock buybacks to increase earnings per share by decreasing share count, he promises his own company won’t engage in that practice absent its stock price reaching a certain low level.
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Investors’ Worst Enemies are Themselves
           Mr. Buffett believes most investors pay too much for advice, trade too much, chase performance, and are overly swayed by short term considerations.
           He believes patience to be an investor’s greatest virtue, and eschews what he calls the gin rummy approach to investing, whereby an investor periodically dumps a (temporarily) underperforming investment as he might discard a card from his hand.
           In sum, Mr. Buffett’s golden anniversary Annual Letter, while refraining from tipping off the public to his next big investment, is filled with valuable insights for the average investor.
