In his 1997 Berkshire Hathaway Annual Letter, Warren Buffett recommends investors shouldn’t get overly excited about strong performance during bull markets (periods of rising stock prices).
This metaphor compares such investors to a duck who thinks its paddling skills caused it to rise after a heavy rain, instead of recognizing the rising water level affecting everyone. He also discusses the ‘drag’ created by taxes and fees that negatively impact Berkshire’s ability to outperform the market.
Here’s an excerpt from the letter:
Given our gain of 34.1%, it is tempting to declare victory and move on. But last year’s performance was no great triumph: Any investor can chalk up large returns when stocks soar, as they did in 1997.
‘In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond.
So what’s our duck rating for 1997? The table on the facing page shows that though we paddled furiously last year, passive ducks that simply invested in the S&P Index rose almost as fast as we did. Our appraisal of 1997’s performance, then: Quack.
When the market booms, we tend to suffer in comparison with the S&P Index. The Index bears no tax costs, nor do mutual funds, since they pass through all tax liabilities to their owners. Last year, on the other hand, Berkshire paid or accrued $4.2 billion for federal income tax, or about 18% of our beginning net worth.
Berkshire will always have corporate taxes to pay, which means it needs to overcome their drag in order to justify its existence.
Obviously, Charlie Munger, Berkshire’s Vice Chairman and my partner, and I won’t be able to lick that handicap every year.
But we expect over time to maintain a modest advantage over the Index, and that is the yardstick against which you should measure us.
We will not ask you to adopt the philosophy of the Chicago Cubs fan who reacted to a string of lackluster seasons by saying, “Why get upset? Everyone has a bad century now and then.”
You can read the entire letter here:
Berkshire Hathaway 1997 Annual Letter
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