What to look for while reading the annual report?

I have been developing a new habit for the last ten days. What’s that habit? I have been listening to Berkshire’s Annual General Meeting (AGM) starting from 1994. How long will I take to complete it all? There are 25 AGMs, and each one would be 5 hours long. If I spend 1.5 hours on average every day, then I should be able to finish it all in three months. How on earth can I get an extra 1.5 hours every day?

When there is a will, there’s a way. I have been listening to the recordings while commuting and before falling asleep. I am wrapping up with 1996 today. While listening to the recordings, I came across an interesting piece in which Buffett and Munger spoke about the importance of being numerate, the protocol for reading the annual report, and what to look for while reading the annual report. This is a rare gem, and you need to spend a lot of time reading, rereading, and reflecting on it. You can access the recordings for all the AGMs from here.

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1995 AGM

Warren Buffett: I don’t think any great amount of mathematical aptitude is — not aptitude, but mathematical knowledge is a — advanced math is of no use in the investment process. And understanding a mathematical relationship, sort of an ability to quantify — a numeracy, as they call it, I think that’s generally helpful in investments because something that tells you when things make sense or don’t make sense, or sort of how an item in one area relates to something someplace else.

But that doesn’t really require any great mathematical ability. It really requires sort of a mathematical awareness and a numeracy. And I think it is a help to be able to see that. I mean, I think Charlie and I probably, when we read about one business, we’re always thinking of it against a screen of dozens of businesses — it’s just sort of automatic, and —

But that’s just like a scout in baseball thinking about one baseball player against an alternative. I mean, you only have a given number on the squad and thinking, you know, “One guy may be a little faster, one guy can hit a little better,” all of that sort of thing. And it’s always in your mind, you are prioritizing and selecting in some manner. My own feeling about the best way to apply that is just to read everything in sight. You know, I mean, if you’re reading a few hundred annual reports a year and you’ve read Graham, and Fisher, and a few things, you’ll soon see whether it kind of falls into place or not.

Charlie Munger: Yeah. I think the set of numbers — the one set of numbers in America that are the best quick guide to measuring one business against another are the Value Line numbers.

Warren Buffett: I’d agree with that.

Charlie Munger: That stuff on the log scale paper going back 15 years, that is the best one-shot description of a lot of big businesses that exists in America. I can’t imagine anybody being in the investment business involving common stocks without that thing on the shelf.

Warren Buffett: And, if you sort of have in your head how all of that looks in different industries and different businesses, then you’ve got a backdrop against which to measure. I mean, if you’d never watched a baseball game and never seen a statistic on it, you wouldn’t know whether a .300 hitter was a good hitter or not. You have to have some kind of a mosaic there that you’re thinking is implanted against, in effect. And the Value Line figures, you know, they cycle it every 13 weeks. And if you ripple through that, you’ll have a pretty good idea of what’s happened over time in American business.

1996 AGM

Warren Buffett: What I’m trying to do as I read reports, A, I like to understand just generally what’s going on in all kinds of businesses. If we own stock in a company and in an industry, and there are eight other companies that are in the same industry, I want to own or be on the mailing list for the reports for the other eight, because I can’t understand how my company is doing unless I understand what the other eight are doing.

I want to have the perspective of, in terms of market share, what’s going on in the business or their margins or the trend of margins, all kinds of things that I can’t get unless I know — I can’t be an intelligent owner of a business unless I know what all the other businesses in that industry are doing. And so, I try to get that information out of a report.

If I’m thinking about investing in a specific company, I try to size up their business and the people that are running it. And over the years, I have found reading a lot of reports to be quite useful in terms of making business decisions at Berkshire. If we own all of a business, I want to own shares in all of the competitors just to keep track of what’s going on. And I want to be able to intelligently evaluate how our managers are doing that. And I can’t do that unless I know the industry backdrop against which they’re working.

It’s amazing, you know, what — how well you can do in investing, really, with what I would call outside information. I find inside information — I’m not sure how useful that is. But outside information — there’s all kinds of information around, as to businesses. And you don’t have to understand all of them. You just have to understand the ones that you’re thinking about getting in. And you can do it, if you just — nobody will do it for you. You can’t read — in my view — you can’t read Wall Street reports and get anything out of them. You have to do it yourself and get your arms around it. I don’t think we’ve ever gotten an idea, you know, in 40 years from a Wall Street report. But we’ve gotten a lot of ideas from annual reports.

Charlie Munger: What I find is that it takes a long time to read the annual report even if it’s a comparatively simple business because if you really are trying to understand it, it’s not a bit easy.

Warren Buffett: Yeah. I would say that, on average, in a business, we’re really interested in, even though we know what to skip, to some extent, and what to read, I mean, it’s going to be 45 minutes or an hour on a report.

And if there are six or eight companies in the industry, that’s going to be six or eight hours, perhaps, and then their quarterlies and a lot of other — I mean, it — the way you learn about businesses is by absorbing information about them, thinking, deciding what counts and what doesn’t count, relating one thing to another. And, you know, that’s the job.

And you can’t get that by looking at a bunch of little numbers on a chart bobbing up and down about a — or reading, you know, market commentary and periodicals or anything of the sort. That just won’t do it. You’ve got to understand the businesses. That’s where it all begins and ends.