Letter to Shareholders
“Buffett's 1993 letter on the definition of risk, why volatility is not risk, and the importance of owning businesses that can survive any economic environment.”
Key Points
- →Berkshire's book value grew 14.3% vs S&P 500's 10.1%
- →Explained why risk is permanent loss of capital, not short-term price volatility
- →Most investors misidentify volatility as risk and demand returns they don't need to take
- →The best businesses can survive any economic environment
1993 Letter to Shareholders
To the Shareholders of Berkshire Hathaway Inc.
In 1993, Berkshire's book value grew 14.3%, outperforming the S&P 500's 10.1% return. More importantly, our intrinsic value continued to compound at rates that will build enormous wealth over time.
"Risk comes from not knowing what you are doing. If you understand the business you own and buy at a price that provides a margin of safety, risk becomes negligible."
The Definition of Risk
Most investors define risk as volatility. This is wrong. Volatility is a measure of price movements; risk is the possibility of permanent loss.
A business that you can hold forever has no risk, even if its price fluctuates wildly in the short term. The short-term price is irrelevant to the long-term owner. What matters is the underlying business value.
Conversely, a business whose competitive position is eroding may have stable prices but enormous risk. You might avoid short-term losses but suffer permanent damage to your capital.
Volatility Is Not Risk
Academics define risk using standard deviation of returns. This mathematical approach is seductive but misleading. It confuses short-term price movements with long-term value.
A stock that falls 50% is not twice as risky as one that falls 25%. If the underlying business is sound, the 50% decline is an opportunity, not a danger. If the business is impaired, a 25% decline might be the beginning of total loss.
The Margin of Safety
Our investment approach emphasizes margin of safety. We buy businesses at prices that provide a cushion against error. This cushion doesn't guarantee success, but it dramatically improves the odds.
The margin of safety is not a precise calculation. It's more art than science. But the principle is clear: don't pay full price for anything. Wait for the market to offer opportunities.
Looking Forward
Our approach remains constant:
- Understand what you own — You cannot assess risk without understanding the business
- Buy with a margin of safety — Leave room for error
- Think in terms of business value — Ignore short-term price volatility
- Own businesses that can survive — The best businesses thrive in any environment
Warren E. Buffett February 1994
Concepts in This Letter
Companies Mentioned
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