Table of Contents
1. 2007 Letter
2. 2008 Letter
3. 2009 Letter
4. 2010 Letter
5. 2011 Letter
This issue does not and is not meant to fully summarize or recap the Berkshire Hathaway shareholder letters. Rather, it includes the tidbits I found interesting and wanted to highlight during my reading. Always do your own reading and come to your own conclusions about Mr. Buffett’s opinions.
How to find the quotations: It is difficult to cite specific sections of a given letter because there are no consistent page numbers and the sections are not numbered. The easiest way to find the quote is to open a PDF of the letter and use the search feature.
(Note: This is Part 2 of Issue #58, because the email was too big for it to go out all together.)
4. 2010 Berkshire Hathaway Letter, dated February 26, 2011
- Major World Events Wiki for 2010
- S&P 500 Trajectory (inflation-adjusted): bounced around 1300 then ended up around 1500
- Inflation: 1.6%
- Interest Rate on a 30-year fixed-rate mortgage: 4.69%
- US President: Barack Obama
2010 Letter in PDF from Berkshire Hathaway website
Major Berkshire investments reported in the letter:
Standard of success mentioned at the beginning: per-share book value, and overall book value. (Big change, did not include net worth!)
- This letter was about, again, explaining Berkshire to new shareholders and emphasizing Berkshire’s methods and culture. He went through all the sectors of Berkshire.
- This made me laugh. Because it’s true. “Yearly figures, it should be noted, are neither to be ignored nor viewed as all-important. The pace of the earth’s movement around the sun is not synchronized with the time required for either investment ideas or operating decisions to bear fruit.”
- Recommend reading the whole section on derivatives. He gives great examples. “[We view derivatives] as engaging us in insurance-like activities in which we receive premiums for assuming risks that others wish to shed. Indeed, the thought processes we employ in these derivatives transactions are identical to those we use in our insurance business. You should also understand that we get paid up-front when we enter into the contracts and therefore run no counterparty risk. That’s important.”
- “The fundamental principle of auto racing is that to finish first, you must first finish. That dictum is equally applicable to business and guides our every action at Berkshire.”
- Guys. Charlie and Warren didn’t meet until Charlie was 35! Somehow I’ve never digested that fact before. They’ve done all this starting at middle age. “I didn’t meet Charlie until he was 35, though he grew up within 100 yards of where I have lived for 52 years and also attended the same inner-city public high school in Omaha from which my father, wife, children and two grandchildren graduated.”
- Go read the letter he enclosed from his grandfather. It’s so lovely and special.
- He looks at earnings per share, and a “more subjective, element to an intrinsic value calculation that can be either positive or negative: the efficacy with which retained earnings will be deployed in the future. We, as well as many other businesses, are likely to retain earnings over the next decade that will equal, or even exceed, the capital we presently employ. Some companies will turn these retained dollars into fifty-cent pieces, others into two-dollar bills. This “what-will-they-do-with-the-money” factor must always be evaluated along with the “what-do-we-have-now” calculation in order for us, or anybody, to arrive at a sensible estimate of a company’s intrinsic value. That’s because an outside investor stands by helplessly as management reinvests his share of the company’s earnings. If a CEO can be expected to do this job well, the reinvestment prospects add to the company’s current value; if the CEO’s talents or motives are suspect, today’s value must be discounted. The difference in outcome can be huge. A dollar of then-value in the hands of Sears Roebuck’s or Montgomery Ward’s CEOs in the late 1960s had a far different destiny than did a dollar entrusted to Sam Walton.” (emphasis mine)
- He’s made this point many times over the years, but somehow this one hit me anew. “Many of our CEOs are independently wealthy and work only because they love what they do. They are volunteers, not mercenaries. Because no one can offer them a job they would enjoy more, they can’t be lured away.” For me the checklist point is whether the CEO is there for the money or for the joy of it. Is she a true believer? If this company goes down, is she there for the long haul, or will she take her golden parachute and leave everyone else behind?
- ALL OF THIS. Culture is everything. “Having managers who love their businesses is no small advantage. Cultures self-propagate. Winston Churchill once said, “You shape your houses and then they shape you.” That wisdom applies to businesses as well. Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce imperious behavior. (As one wag put it, “You know you’re no longer CEO when you get in the back seat of your car and it doesn’t move.”) At Berkshire’s “World Headquarters” our annual rent is $270,212. Moreover, the home-office investment in furniture, art, Coke dispenser, lunch room, high-tech equipment – you name it – totals $301,363. As long as Charlie and I treat your money as if it were our own, Berkshire’s managers are likely to be careful with it as well. Our compensation programs, our annual meeting and even our annual reports are all designed with an eye to reinforcing the Berkshire culture, and making it one that will repel and expel managers of a different bent. This culture grows stronger every year, and it will remain intact long after Charlie and I have left the scene.” (emphasis mine)
- Vital checklist point. The danger of debt, and especially the assumptions around debt. “Companies with large debts often assume that these obligations can be refinanced as they mature. That assumption is usually valid. Occasionally, though, either because of company-specific problems or a worldwide shortage of credit, maturities must actually be met by payment. For that, only cash will do the job. Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that’s all that is noticed. Even a short absence of credit can bring a company to its knees.”
Particular points of candor:
- “Most companies limit themselves to reinvesting funds within the industry in which they have been operating. That often restricts them, however, to a “universe” for capital allocation that is both tiny and quite inferior to what is available in the wider world….When I took control of Berkshire in 1965, I didn’t exploit this advantage [to invest in any industry]. Berkshire was then only in textiles, where it had in the previous decade lost significant money. The dumbest thing I could have done was to pursue “opportunities” to improve and expand the existing textile operation – so for years that’s exactly what I did. And then, in a final burst of brilliance, I went out and bought another textile company. Aaaaaaargh! Eventually I came to my senses, heading first into insurance and then into other industries.”
- NetJets seems to be doing better. Shows what changing the leader can do. “Even though NetJets was consistently a runaway winner with customers, our financial results, since its acquisition in 1998, were a failure. In the 11 years through 2009, the company reported an aggregate pre-tax loss of $157 million, a figure that was far understated since borrowing costs at NetJets were heavily subsidized by its free use of Berkshire’s credit. Had NetJets been operating on a stand-alone basis, its loss over the years would have been several hundreds of millions greater. We are now charging NetJets an appropriate fee for Berkshire’s guarantee. Despite this fee (which came to $38 million in 2010), NetJets earned $207 million pre-tax in 2010, a swing of $918 million from 2009. Dave’s quick restructuring of management and the company’s rationalization of its purchasing and spending policies has ended the hemorrhaging of cash and turned what was Berkshire’s only major business problem into a solidly profitable operation.” (emphasis mine)
I was also struck by:
- Awww. “All things considered, the third best investment I ever made was the purchase of my home, though I would have made far more money had I instead rented and used the purchase money to buy stocks. (The two best investments were wedding rings.) For the $31,500 I paid for our house, my family and I gained 52 years of terrific memories with more to come.”
- Lou Simpson retired in this year, 2010. “Last summer, Lou Simpson told me he wished to retire. Since Lou was a mere 74 – an age Charlie and I regard as appropriate only for trainees at Berkshire – his call was a surprise. Lou joined GEICO as its investment manager in 1979, and his service to that company has been invaluable. In the 2004 Annual Report, I detailed his record with equities, and I have omitted updates only because his performance made mine look bad. Who needs that? Lou has never been one to advertise his talents. But I will: Simply put, Lou is one of the investment greats. We will miss him.” Interesting. Clearly a huge disappointment to Mr. Buffett, as he had pipped Simpson to succeed him to manage Berkshire’s investments. Indeed he then follows in the letter to describe his new succession plans. But Simpson did not end up retiring. He started his own little fund and by my quick internet search was managing $3 billion. Then turned it into a family office recently. Nice interview he gave to Kellogg. I suspect there’s a little bit of resentment in that former relationship and it may be why Mr. Buffett has been so reluctant to name his successors since then.
- Therefore, Todd Combs entered the picture. “When Charlie and I met Todd Combs, we knew he fit our requirements. Todd, as was the case with Lou, will be paid a salary plus a contingent payment based on his performance relative to the S&P.”
- “As long as I am CEO, I will continue to manage the great majority of Berkshire’s holdings, both bonds and equities. Todd initially will manage funds in the range of one to three billion dollars, an amount he can reset annually. His focus will be equities but he is not restricted to that form of investment. (Fund consultants like to require style boxes such as “long-short,” “macro,” “international equities.” At Berkshire our only style box is “smart.”) Over time, we may add one or two investment managers if we find the right individuals. Should we do that, we will probably have 80% of each manager’s performance compensation be dependent on his or her own portfolio and 20% on that of the other manager(s). We want a compensation system that pays off big for individual success but that also fosters cooperation, not competition.” (emphasis mine)
- “One footnote: When we issued a press release about Todd’s joining us, a number of commentators pointed out that he was “little-known” and expressed puzzlement that we didn’t seek a “big-name.” I wonder how many of them would have known of Lou in 1979, Ajit in 1985, or, for that matter, Charlie in 1959. Our goal was to find a 2-year-old Secretariat, not a 10-year-old Seabiscuit. (Whoops – that may not be the smartest metaphor for an 80-year-old CEO to use.)” He does not get enough credit for finding and choosing these people!
- Well, that’s good, though faint praise. “Rest assured, though, that Charlie and I have never sold a security because of the effect a sale would have on the net income we were soon to report. We both have a deep disgust for “game playing” with numbers, a practice that was rampant throughout corporate America in the 1990s and still persists, though it occurs less frequently and less blatantly than it used to.”
- What does he do with money that isn’t invested? “We keep our cash largely in U.S. Treasury bills and avoid other short-term securities yielding a few more basis points, a policy we adhered to long before the frailties of commercial paper and money market funds became apparent in September 2008.”
5. 2011 Berkshire Hathaway Letter, dated February 25, 2012
- Major World Events Wiki for 2011
- S&P 500 Trajectory (inflation-adjusted): started around 1500, big drop, then ended up back around 1500
- Inflation: 3.15%
- Interest Rate on a 30-year fixed-rate mortgage: 4.45%
- US President: Barack Obama
2011 Letter in PDF from Berkshire Hathaway website
Major Berkshire investments reported in the letter:
Standard of success mentioned at the beginning: per-share book value, and overall book value.
- This letter was about the many many MANY companies of Berkshire. There are so many now that he spent the entire letter describing them, and then ended by running down his views of various types of investments.
- “Charlie and I measure our performance by the rate of gain in Berkshire’s per-share intrinsic business value. If our gain over time outstrips the performance of the S&P 500, we have earned our paychecks. If it doesn’t, we are overpaid at any price. We have no way to pinpoint intrinsic value. But we do have a useful, though considerably understated, proxy for it: per-share book value. This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values. That’s because the amount by which Berkshire’s intrinsic value exceeds book value does not swing wildly from year to year, though it increases in most years.”
- Stock price isn’t everything. He went through an example using IBM’s stock price staying low, which gives the opportunity for well-priced share repurchases. “The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.”
- “Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date. From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period.” (emphasis mine)
- He says there are 3 major categories of investments: (Note this is all worth reading and not easily summarized, so I recommend especially reading the section about gold.)
- “Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.
- “The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century. This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future. The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative.”
- “My own preference – and you knew this was coming – is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM and our own See’s Candy meet that double-barreled test. Certain other companies – think of our regulated utilities, for example – fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.”
Particular points of candor:
- “Last year, I told you that “a housing recovery will probably begin within a year or so.” I was dead wrong….Housing will come back – you can be sure of that. Over time, the number of housing units necessarily matches the number of households (after allowing for a normal level of vacancies). For a period of years prior to 2008, however, America added more housing units than households. Inevitably, we ended up with far too many units and the bubble popped with a violence that shook the entire economy. That created still another problem for housing: Early in a recession, household formations slow, and in 2009 the decrease was dramatic. That devastating supply/demand equation is now reversed: Every day we are creating more households than housing units. People may postpone hitching up during uncertain times, but eventually hormones take over. And while “doubling-up” may be the initial reaction of some during a recession, living with in-laws can quickly lose its allure.”
I was also struck by:
- “As 2011 started, Todd Combs joined us as an investment manager, and shortly after yearend Ted Weschler came aboard. Both of these men have outstanding investment skills and a deep commitment to Berkshire. Each will be handling a few billion dollars in 2012, but they have the brains, judgment and character to manage our entire portfolio when Charlie and I are no longer running Berkshire.”
- Note no name. “Your Board is equally enthusiastic about my successor as CEO, an individual to whom they have had a great deal of exposure and whose managerial and human qualities they admire. (We have two superb back-up candidates as well.)”
- “When our quarterly filings report relatively small holdings, these are not likely to be buys I made (though the media often overlook that point) but rather holdings denoting purchases by Todd or Ted.”
- Found this point about the public-private relationship interesting food for thought. “To fulfill its societal obligation, BNSF regularly invests far more than its depreciation charge, with the excess amounting to $1.8 billion in 2011. The three other major U.S. railroads are making similar outlays. Though many people decry our country’s inadequate infrastructure spending, that criticism cannot be levied against the railroad industry. It is pouring money – funds from the private sector – into the investment projects needed to provide better and more extensive service in the future. If railroads were not making these huge expenditures, our country’s publicly-financed highway system would face even greater congestion and maintenance problems than exist today. Massive investments of the sort that BNSF is making would be foolish if it could not earn appropriate returns on the incremental sums it commits. But I am confident it will do so because of the value it delivers. Many years ago Ben Franklin counseled, “Keep thy shop, and thy shop will keep thee.” Translating this to our regulated businesses, he might today say, “Take care of your customer, and the regulator – your customer’s representative – will take care of you.” Good behavior by each party begets good behavior in return.”