Individual investors ask what resources to consult when hunting for great companies. My advice: read the shareholder letter the company sends out every year. Next to the financial figures, it is perhaps the most important and accessible source of valuable information.
These communications reveal a lot about a company and its CEO. Some obfuscate, others patronize, and many appear to be ghostwritten, but the best ones share business insights that help readers understand a company. Use these clues as filters just as you would the company’s financial statements. Many companies post such letters on their websites and they are usually part of the annual report.
The gold standard of the genre is Warren Buffett, whose pithy statement from his 1997 letter to shareholders of Berkshire Hathaway sums it up:
“When you receive a communication from us, it will come from the fellow you are paying to run the business. Your Chairman has a firm belief that owners are entitled to hear directly from the CEO as to what is going on and how [he/she] evaluates the business, currently and prospectively. You would demand that in a private company; you should expect no less in a public company.”
Buffett designed his letter as one of many tools used to attract what he calls high-quality shareholders to Berkshire. Quality shareholders (QSs for short) maintain the longest average holding periods and most concentrated positions — Buffett once boasted “that over 95% of our shares are held by investors for whom the holding is at least double the size of their next largest.” High densities of QSs in a company are associated with superior corporate performance.
In his 1983 shareholder letter, Buffett explained: “To obtain only high quality shareholders is no cinch. . . . In large part, however, we feel that high quality ownership can be attracted and maintained if we consistently communicate our business and ownership philosophy—along with no other conflicting messages . . . Through our policies and communications — our “advertisements” — we try to attract investors who will understand our operations, attitudes and expectations. (And, fully as important, we try to dissuade those who won’t.) We want those who think of themselves as business owners and invest in companies with the intention of staying a long time. . . . “
Buffett has attracted almost exclusively QSs at Berkshire. Dozens of CEOs emulate his shareholder letter “advertisements” to attract QSs as well. Numerous surveys of shareholder letters rank them according to various indicators of quality, some statistical and some judgmental. Despite such variety, the same names appear often in both published lists and private polls — invariably starting with Buffett — and they tend to attract a high level of QSs.
Consider together the annual rankings of the best shareholder letters published by Linda Rittenhouse, a leading expert on the genre. and the Quality Shareholders Initiative at George Washington University at George Washington University (QSI), which ranks more than 2,000 large public companies by QS density. Among the Rittenhouse top 25, 80% rank in the top half for QS density. Here are 10 at the top of both rankings:
• Becton Dickinson
• Costco Wholesale
• Honeywell International
• Lockheed Martin
• Southwest Airlines
• Texas Instruments
• Thermo Fisher Scientific
The QSI research, in turn, led to curating the best of the best into a short book, Dear Shareholder, published in 2020. Selections from the letters of leaders of 17 companies are featured, chosen based on the quality of both the letters and the shareholder base. Ten of these include:
• Weston Hicks, Alleghany Corp.
• Jeff Bezos, Amazon.com
• Warren Buffett, Berkshire Hathaway
• Robert Keane, Cimpress
• Mark Leonard, Constellation Software
• Brett Roberts, Credit Acceptance
• Prem Watsa, Fairfax Financial Holdings
• Ian Cumming and Joe Steinberg, Leucadia National (Now Jeffries Financial Group)
• Tom Gayner, Markel Corporation
• Joe Mansueto, Morningstar
As with Buffett’s “advertisements,” these letters have in common an emphasis on long-term thinking and illumination of principles that QSs focus on, including strategic competitive advantages (“moats”), capital allocation, and corporate mission.
In utilizing shareholder letters as an investment screen, please note that single letters taken alone are less meaningful than an arc over many years. Quite a few CEOs have written one great letter, but the best keep it up year after year. Studying the letters of a large number of companies over a long period of time yields valuable guidance for shareholders and managers alike.
Growing into the role
Shareholder letters provide insights into a company’s values, culture, and outlook. It is the forum of greatest freedom for CEO expression, as the letter is both optional and unregulated. As such, intelligent investors can improve not only their understanding of particular businesses, but also their returns on investment.
A common theme to watch for: growing into the letters. The best letters are those of the experienced leader — outstanding executives tend to develop in the job and get better with engagement.
Another feature of outstanding letters is originality, reflecting the personality of the writer and culture of the company. The best letters — as with any kind of writing — are those written with sincerity and passion.
Above all, the golden rule of shareholder letters: Buffett says he writes to provide shareholders information he would want to have if their “positions were reversed.”
A degree of repetition is valuable — especially on enduring core values and practices. One endearing feature of many letters for QSs is core principles that do not change.
Finally, the best shareholder letters tend to focus on challenges, not triumphs. Phil Carret, a legendary investor, though more inclined to diversify than most QSs, observed: “I’m always turned off by an overly optimistic letter from the president in the annual report. If [the] letter is mildly pessimistic, to me that’s a good sign. I like a point I once heard made by a corporate chief executive, that he was less interested in hearing good news from subordinates than bad news. The good news takes care of itself.”
Lawrence A. Cunningham is a professor and director of the Quality Shareholders Initiative at George Washington University. Cunningham’s books include Quality Shareholders; Dear Shareholder; and The Essays of Warren Buffett. Register for his upcoming free book talk hosted by the Museum of American Finance and Fordham University here. Cunningham owns stock in Berkshire Hathaway and is a shareholder, director and vice chairman of the board of Constellation Software.
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