059: Investing Intensive 2012-2016

Table of Contents

1. 2012 Letter
2. 2013 Letter
3. 2014 Letter
4. 2015 Letter
5. 2016 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.

1. 2012 Berkshire Hathaway Letter, dated March 1, 2013

2012 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: “total gain” (it’s not defined, but implied this means net worth) and net worth, as well as per-share book value and overall book value.

“In 2012, Berkshire achieved a total gain for its shareholders of $24.1 billion. We used $1.3 billion of that to repurchase our stock, which left us with an increase in net worth of $22.8 billion for the year.”

Highlights:

  • This letter was about coming out of the chaos of the financial crisis.
  • He specifically sent a message to all the CEOs out there who were STILL blaming their decisions on the crisis. “There was a lot of hand-wringing last year among CEOs who cried “uncertainty” when faced with capital-allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash). At Berkshire, we didn’t share their fears…A thought for my fellow CEOs: Of course, the immediate future is uncertain; America has faced the unknown since 1776. It’s just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them (usually because the recent past has been uneventful).”

Checklist points:

  • Great, simple, list of key attributes for any company. “We’re confident of [our prospects] because we have some outstanding businesses, a cadre of terrific operating managers and a shareholder-oriented culture.”
  • Such an important point that is very easily lost if not on a checklist – it’s easy to look up overall growth, but actual per-share growth shows what’s really going on with a company’s value. “That satisfies our goal of not simply growing, but rather increasing per-share results.” (emphasis Buffett’s)
  • Reminder that being IN the game matters, and that the deck is stacked FOR us, not against us. “American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor. (The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions….Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.” (emphasis mine)
  • What is a company doing to keep up with its peers? “That old line, “The other guy is doing it, so we must as well,” spells trouble in any business, but none more so than insurance.” (emphasis mine)
  • Two excellent points of antifragility: “At MidAmerican, meanwhile, two key factors ensure its ability to service debt under all circumstances: the company’s recession-resistant earnings, which result from our exclusively offering an essential service, and its great diversity of earnings streams, which shield it from being seriously harmed by any single regulatory body.” (emphasis mine)
  • Don’t bargain-hunt. “More than 50 years ago, Charlie told me that it was far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price. Despite the compelling logic of his position, I have sometimes reverted to my old habit of bargain-hunting, with results ranging from tolerable to terrible. Fortunately, my mistakes have usually occurred when I made smaller purchases.”
  • Don’t pay too much. “Of course, a business with terrific economics can be a bad investment if the price paid is excessive. We have paid substantial premiums to net tangible assets for most of our businesses, a cost that is reflected in the large figure we show for intangible assets.”
  • Has this company been allocating capital in these ways? “A profitable company can allocate its earnings in various ways (which are not mutually exclusive). A company’s management should first examine reinvestment possibilities offered by its current business – projects to become more efficient, expand territorially, extend and improve product lines or to otherwise widen the economic moat separating the company from its competitors.”
  • Standard for executives: “For good reason, I regularly extol the accomplishments of our operating managers. They are truly All-Stars, who run their businesses as if they were the only asset owned by their families. I believe their mindset to be as shareholder-oriented as can be found in the universe of large publicly-owned companies. Most have no financial need to work; the joy of hitting business “home runs” means as much to them as their paycheck.” (emphasis mine)

Particular points of candor:

  • He opened the letter with: “A number of good things happened at Berkshire last year, but let’s first get the bad news out of the way.” ha! What CEO starts with bad news?
    • His bad news is that Berkshire didn’t gain as much as the S&P. “To date, we’ve never had a five-year period of underperformance, having managed 43 times to surpass the S&P over such a stretch. (The record is on page 103.) But the S&P has now had gains in each of the last four years, outpacing us over that period. If the market continues to advance in 2013, our streak of fiveyear wins will end.”
    • His other bad news is that he bought only Heinz (yup, the ketchup) in early 2013, so it wasn’t technically in 2012. Ok. Would that all bad news be that!
  • “Charlie and I believe in operating with many redundant layers of liquidity, and we avoid any sort of obligation that could drain our cash in a material way. That reduces our returns in 99 years out of 100. But we will survive in the 100th while many others fail. And we will sleep well in all 100.”

I was also struck by:

  • Praise for Todd and Ted’s investments. I was under the impression he hadn’t talked them up much since they joined Berkshire, but perhaps the coming letters will prove that view wrong. “Todd Combs and Ted Weschler, our new investment managers, have proved to be smart, models of integrity, helpful to Berkshire in many ways beyond portfolio management, and a perfect cultural fit. We hit the jackpot with these two. In 2012 each outperformed the S&P 500 by double-digit margins. [in tiny letters:] They left me in the dust as well.”
  • He’s put earnings statements in other letters, I believe, but this time his balance sheet and earnings statement for the Manufacturing, Service and Retailing Operations struck me suddenly as quite useful. These are the numbers Mr. Buffett thinks are important. It’s amazing to know what he sees as being most important. Very useful for a quick review of the numbers.
  • Intangible Assets accounting, which, as we enter a more virtual world, in my opinion is growing more and more important. “…serious investors should understand the disparate nature of intangible assets: Some truly deplete over time while others never lose value. With software, for example, amortization charges are very real expenses. Charges against other intangibles such as the amortization of customer relationships, however, arise through purchase-accounting rules and are clearly not real expenses. GAAP accounting draws no distinction between the two types of charges. Both, that is, are recorded as expenses when calculating earnings – even though from an investor’s viewpoint they could not be more different.”
  • In a section entitled, “We Buy Some Newspapers . . . Newspapers?” he announced his bet on local newspapers. A lot about newspapers here! This feels nostalgic to me, with a bit of – telling us local news is important. It matters. He doesn’t want to let it go. “Newspapers continue to reign supreme, however, in the delivery of local news. If you want to know what’s going on in your town – whether the news is about the mayor or taxes or high school football – there is no substitute for a local newspaper that is doing its job.” Not sure this one panned out. We shall see. BUT then he says, he bought it for cheap, and that it’s all about the price paid. “Berkshire’s cash earnings from its papers will almost certainly trend downward over time. Even a sensible Internet strategy will not be able to prevent modest erosion. At our cost, however, I believe these papers will meet or exceed our economic test for acquisitions. Results to date support that belief…At appropriate prices – and that means at a very low multiple of current earnings – we will purchase more papers of the type we like.” (emphasis Buffett’s)

2. 2013 Berkshire Hathaway Letter, dated February 28, 2014

2013 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, per-share book value, overall book value.

Highlights:

  • This letter was about teaching shareholders about basic long-term investing, particularly that volatility doesn’t matter.
  • (Until recent years) Mr. Buffett has said purchasing Berkshire shares at 1.2x book value is a good deal, becuase it exceeds the intrinsic value. “That’s why our 2012 decision to authorize the repurchase of shares at 120% of book value made sense. Purchases at that level benefit continuing shareholders because per-share intrinsic value exceeds that percentage of book value by a meaningful amount. We did not purchase shares during 2013, however, because the stock price did not descend to the 120% level. If it does, we will be aggressive.” Useful rubric for other company price analysis as well: what’s intrinsic value, and then what’s more-easily-computable approximation of it?
  • There was a LOT of repetition from previous years in this letter. My notes in the margins say “repeat” over and over as I read sentences that rang familiar. Perhaps because by this year, Berkshire was so enormous that he wanted to explain its various sectors to shareholders and didn’t feel like reinventing his descriptions from previous years in order to do so?
  • It was quite repetitive UNTIL the section entitled, “Some Thoughts About Investing.” When Warren Buffett writes some thoughts about investing, I read closely. And, joyously, this is actually his famous essay about the farm and Manhattan investments that we excerpted in Invested!
    • In short: the farm was cheap compared to what it would produce in the coming years, and so was the building in Manhattan. For a long-term investor, who could ignore price volatility and a recession, they were slam dunk buys – even though, as he points out several times, he does not know how to farm and has never visited the NYC building. It’s all math.
    • “I tell these tales to illustrate certain fundamentals of investing:” I put some of them here, but it’s too much to fully excerpt, so I highly recommend reading them, and the entire section, in full.
    • “Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.”
    • “If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so.” (emphasis mine)
    • “With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard.” (emphasis mine)
    • “Forming macro opinions or listening to the macro or market predictions of others is a waste of time.”

Checklist points:

  • Perfect for an investment analysis as well: “[An insurance operation] must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively assess the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained.”
  • “Simply put, insurance is the sale of promises. The “customer” pays money now; the insurer promises to pay money in the future if certain events occur. Sometimes, the promise will not be tested for decades. (Think of life insurance bought by those in their 20s.) Therefore, both the ability and willingness of the insurer to pay – even if economic chaos prevails when payment time arrives – is all-important….Choosing the wrong reinsurer, however – one that down the road proved to be financially strapped or a bad actor – would put the original insurer in danger of getting the liabilities right back in its lap.” (emphasis mine)
  • His price analysis: “We first have to decide whether we can sensibly estimate an earnings range for five years out, or more. If the answer is yes, we will buy the stock (or business) if it sells at a reasonable price in relation to the bottom boundary of our estimate. If, however, we lack the ability to estimate future earnings – which is usually the case – we simply move on to other prospects.”
  • Thought this is not said enough: accumulating over time (i.e. don’t panic in a market high or a market low) leads to mental stillness, and success. “That’s the “what” of investing for the non-professional. The “when” is also important. The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur. (Remember the late Barton Biggs’ observation: “A bull market is like sex. It feels best just before it ends.”) The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs.”

Particular points of candor:

  • Rather unusually, almost no mention of mistakes in this letter! It’s a bit strange. Usually he puts his mistakes up front. This little mention was about it, regarding a leveraged buyout of an electric utility company. “About $2 billion of the debt was purchased by Berkshire, pursuant to a decision I made without consulting with Charlie. That was a big mistake…Last year, we sold our holdings for $259 million. While owning the bonds, we received $837 million in cash interest. Overall, therefore, we suffered a pre-tax loss of $873 million. Next time I’ll call Charlie.”
    • Perhaps having one of the biggest years in a long time went to his head. (Joking! Only joking.)

I was also struck by:

  • Found it interesting that in his purchase of Heinz, he included the names of his investing partners in last year’s letter and this year’s. One year, ok, it’s a mention. Two years in a row? He wants us to know who the partners are exactly, which tells me they are vital in this transaction and ongoing management of the company.
  • Again, namechecked and praised Ted and Todd, very similiarly to how he used to namecheck and praise Lou Simpson. One huge difference, though – he has not told us what exactly their returns were this year, which he did do with Simpson. “In a year in which most equity managers found it impossible to outperform the S&P 500, both Todd Combs and Ted Weschler handily did so. Each now runs a portfolio exceeding $7 billion. They’ve earned it. I must again confess that their investments outperformed mine. (Charlie says I should add “by a lot.”) If such humiliating comparisons continue, I’ll have no choice but to cease talking about them. Todd and Ted have also created significant value for you in several matters unrelated to their portfolio activities. Their contributions are just beginning: Both men have Berkshire blood in their veins.”
  • Hmm!! This date is coming up soon. “Berkshire has one major equity position that is not included in the table: We can buy 700 million shares of Bank of America at any time prior to September 2021 for $5 billion. At yearend these shares were worth $10.9 billion. We are likely to purchase the shares just before expiration of our option.” However, I looked it up online, and he already wound it up, exercising the warrants in 2017 after BoA increased its dividend – so will look out of that in the 2017 letter.

3. 2014 Berkshire Hathaway Letter, dated February 27, 2015

2014 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, and per-share book value. (Change: did not mention overall book value.)

“During our tenure, we have consistently compared the yearly performance of the S&P 500 to the change in Berkshire’s per-share book value. We’ve done that because book value has been a crude, but useful, tracking device for the number that really counts: intrinsic business value. In our early decades, the relationship between book value and intrinsic value was much closer than it is now. That was true because Berkshire’s assets were then largely securities whose values were continuously restated to reflect their current market prices. In Wall Street parlance, most of the assets involved in the calculation of book value were “marked to market.” Today, our emphasis has shifted in a major way to owning and operating large businesses. Many of these are worth far more than their cost-based carrying value. But that amount is never revalued upward no matter how much the value of these companies has increased. Consequently, the gap between Berkshire’s intrinsic value and its book value has materially widened. With that in mind, we have added a new set of data – the historical record of Berkshire’s stock price – to the performance table on the facing page….In our view, the increase in Berkshire’s per-share intrinsic value over the past 50 years is roughly equal to the 1,826,163% gain in market price of the company’s shares.” (emphasis mine)

Highlights:

  • This letter was about reporting the current state of Berkshire, and not much else. Bullet points about recent news, descriptions of the business sectors, and a small section at the end for Mr. Buffett’s investing views. It was light on non-Berkshire views. That’s because it was REALLY pointing to his 50th anniversary reflections, which followed the letter.
    • “A note to readers: Fifty years ago, today’s management took charge at Berkshire. For this Golden Anniversary, Warren Buffett and Charlie Munger each wrote his views of what has happened at Berkshire during the past 50 years and what each expects during the next 50. Neither changed a word of his commentary after reading what the other had written. Warren’s thoughts begin on page 24 and Charlie’s on page 39. Shareholders, particularly new ones, may find it useful to read those letters before reading the report on 2014, which begins below.”
      • LOGISTICS NOTE: Because their 50th anniversary essays are separate from the letters, yet rich with value and I want to focus on them, I will summarize them separately after we finish all the letters in the Investing Intensive.
  • Again it was a lot of repeated paragraphs, word for word, about the various sectors of Berkshire. The interesting bits came after all that, after the “Investments” section.
  • Businesses have done better than currencies. “Our investment results have been helped by a terrific tailwind. During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196% shown on page 2. Concurrently, the purchasing power of the dollar declined a staggering 87%. That decrease means that it now takes $1 to buy what could be bought for 13¢ in 1965 (as measured by the Consumer Price Index). There is an important message for investors in that disparate performance between stocks and dollars. Think back to our 2011 annual report, in which we defined 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.” The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency.” (emphasis mine)

Checklist points:

  • Am I doing any of these risky things? “Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets.” (emphasis mine)

Particular points of candor:

  • Did not disappoint with candor this year: he opened the letter with some bad news about BNSF’s service failures. And, what Berkshire is going to do about it. Exactly the kind of bad news from a CEO I like to read: here’s what happened, and here’s what we’re going to do about it. “During the year, BNSF disappointed many of its customers. These shippers depend on us, and service failures can badly hurt their businesses….BNSF is, by far, Berkshire’s most important non-insurance subsidiary and, to improve its performance, we will spend $6 billion on plant and equipment in 2015. That sum is nearly 50% more than any other railroad has spent in a single year and is a truly extraordinary amount, whether compared to revenues, earnings or depreciation charges. Though weather, which was particularly severe last year, will always cause railroads a variety of operating problems, our responsibility is to do whatever it takes to restore our service to industry-leading levels. That can’t be done overnight: The extensive work required to increase system capacity sometimes disrupts operations while it is underway. Recently, however, our outsized expenditures are beginning to show results. During the last three months, BNSF’s performance metrics have materially improved from last year’s figures.” (emphasis mine)
  • When you decide to sell, sell. “Attentive readers will notice that Tesco, which last year appeared in the list of our largest common stock investments, is now absent. An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling….In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)….We sold Tesco shares throughout the year and are now out of the position. (The company, we should mention, has hired new management, and we wish them well.)”

I was also struck by:

  • Ha! Funny. And crazy. “With the acquisition of Van Tuyl, Berkshire now owns 9 1/2 companies that would be listed on the Fortune 500 were they independent (Heinz is the 1/2 ). That leaves 490 1/2 fish in the sea. Our lines are out.”

4. 2015 Berkshire Hathaway Letter, dated February 27, 2016

2015 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, and per-share book value.

Highlights:

  • This letter was about knowing thyself.
    • “If you want to guarantee yourself a lifetime of misery, be sure to marry someone with the intent of changing their behavior.” – Charlie Munger
    • An essay on the effect of productivity improvements on business and growth overall (good) and also on the workers who can’t innovate into the new economy (quite bad for them). For me this veered slightly into the political realm, and it was interesting to read, but is it relevant?
  • The Kraft Heinz merger happened this year. Some really interesting points, and new spin on how a company chooses to run itself, in the checklist section.
  • Again, word-for-word repeated paragraphs from the previous few years about the performance of the various Berkshire sectors.
  • Big point made again about amortization charges not reflecting real costs, due to the disparate nature of intangible assets. However, when it comes to depreciation of fixed assets, it’s a different story – and I particularly perked up my eyes at this because Charlie Munger so often has said EBITDA is a lie told by CEOs to make their numbers look better. “I suggest that you ignore a portion of GAAP amortization costs. But it is with some trepidation that I do that, knowing that it has become common for managers to tell their owners to ignore certain expense items that are all too real….Depreciation charges are a more complicated subject but are almost always true costs. Certainly they are at Berkshire. I wish we could keep our businesses competitive while spending less than our depreciation charge, but in 51 years I’ve yet to figure out how to do so. Indeed, the depreciation charge we record in our railroad business falls far short of the capital outlays needed to merely keep the railroad running properly, a mismatch that leads to GAAP earnings that are higher than true economic earnings. (This overstatement of earnings exists at all railroads.) When CEOs or investment bankers tout pre-depreciation figures such as EBITDA as a valuation guide, watch their noses lengthen while they speak.”

Checklist points:

  • Market value is volatile, but should eventually track book value (and intrinsic value). “The unrecorded increase in the value of our owned businesses explains why Berkshire’s aggregate market-value gain – tabulated on the facing page – materially exceeds our book-value gain. The two indicators vary erratically over short periods. Last year, for example, book-value performance was superior. Over time, however, market-value gains should continue their historical tendency to exceed gains in book value.” (emphasis mine)
  • Very interesting section on differing ways to run good businesses (very interesting because the Kraft Heinz merger hasn’t been all that great). My checklist takeaway: turnarounds are risky. Sometimes they work. Sometimes they don’t.
    • “Jorge Paulo and his associates could not be better partners. We share with them a passion to buy, build and hold large businesses that satisfy basic needs and desires. We follow different paths, however, in pursuing this goal. Their method, at which they have been extraordinarily successful, is to buy companies that offer an opportunity for eliminating many unnecessary costs and then – very promptly – to make the moves that will get the job done. Their actions significantly boost productivity, the all-important factor in America’s economic growth over the past 240 years.”
    • “At Berkshire, we, too, crave efficiency and detest bureaucracy. To achieve our goals, however, we follow an approach emphasizing avoidance of bloat, buying businesses such as PCC that have long been run by cost-conscious and efficient managers. After the purchase, our role is simply to create an environment in which these CEOs – and their eventual successors, who typically are like-minded – can maximize both their managerial effectiveness and the pleasure they derive from their jobs. (With this hands-off style, I am heeding a well-known Mungerism: “If you want to guarantee yourself a lifetime of misery, be sure to marry someone with the intent of changing their behavior.”)”
  • Regarding assessing risk factors, fair comments. He notes that the litany of risk factors in an annual report don’t express: “(1) the probability of the threatening event actually occurring; (2) the range of costs if it does occur; and (3) the timing of the possible loss. A threat that will only surface 50 years from now may be a problem for society, but it is not a financial problem for today’s investor….When we took over [Berkshire Hathaway] in 1965, its risks could have been encapsulated in a single sentence: “The northern textile business in which all of our capital resides is destined for recurring losses and will eventually disappear.” That development, however, was no death knell. We simply adapted. And we will continue to do so.”

Particular points of candor:

  • Last year, he admitted BNSF fell down on the job (primarily due to weather events), and said they would invest a huge amount of money in infrastructure so it wouldn’t happen again. $6 billion, to be precise. And now, the follow-up! (Unfortunately, follow-up is horribly rare in CEO letters.) “After a poor performance in 2014, our BNSF railroad dramatically improved its service to customers last year. To attain that result, we invested about $5.8 billion during the year in capital expenditures, a sum far and away the record for any American railroad and nearly three times our annual depreciation charge. It was money well spent.” (emphasis mine)
    • And the follow-through: “For most American railroads, 2015 was a disappointing year. Aggregate ton-miles fell, and earnings weakened as well. BNSF, however, maintained volume, and pre-tax income rose to a record $6.8 billion* (a gain of $606 million from 2014).”
  • On choosing not to go into hostile takeover territory: “Berkshire, however, will join only with partners making friendly acquisitions. To be sure, certain hostile offers are justified: Some CEOs forget that it is shareholders for whom they should be working, while other managers are woefully inept. In either case, directors may be blind to the problem or simply reluctant to make the change required. That’s when new faces are needed. We, though, will leave these “opportunities” for others. At Berkshire, we go only where we are welcome.”

I was also struck by:

  • He likes to characterize his subsidiary companies with cute names. I don’t know. It kind of makes me wonder about all the Berkshire companies outside of those groupings. Why don’t they get cute nicknames? “BNSF is the largest of our “Powerhouse Five,” a group that also includes Berkshire Hathaway Energy, Marmon, Lubrizol and IMC. Combined, these companies – our five most profitable non-insurance businesses – earned $13.1 billion in 2015, an increase of $650 million over 2014….Next year, I will be discussing the “Powerhouse Six.” The newcomer will be Precision Castparts Corp. (“PCC”), a business that we purchased a month ago for more than $32 billion of cash.”
    • With my amazing crystal ball to look into the future, I know that the PCC purchase hasn’t turned out so well. Therefore, I find it quite interesting to read Mr. Buffett’s description of his new fave at the time. What did he love about this company? It certainly sounds excellent: “Under CEO Mark Donegan, PCC has become the world’s premier supplier of aerospace components (most of them destined to be original equipment, though spares are important to the company as well). Mark’s accomplishments remind me of the magic regularly performed by Jacob Harpaz at IMC, our remarkable Israeli manufacturer of cutting tools. The two men transform very ordinary raw materials into extraordinary products that are used by major manufacturers worldwide. Each is the da Vinci of his craft. PCC’s products, often delivered under multi-year contracts, are key components in most large aircraft….A personal thank-you: The PCC acquisition would not have happened without the input and assistance of our own Todd Combs, who brought the company to my attention a few years ago and went on to educate me about both the business and Mark. Though Todd and Ted Weschler are primarily investment managers – they each handle about $9 billion for us – both of them cheerfully and ably add major value to Berkshire in other ways as well. Hiring these two was one of my best moves.”
  • A repeat, but still made me laugh. “With the PCC acquisition, Berkshire will own 10 1/4 companies that would populate the Fortune 500 if they were stand-alone businesses. (Our 27% holding of Kraft Heinz is the 1/4.) That leaves just under 98% of America’s business giants that have yet to call us. Operators are standing by.”
  • This is very sweet. He’s clearly proud of the culture he has created, and happy that others like it as well. “In 2015, Berkshire’s revenues increased by $16 billion. Look carefully, however, at the two pictures on the facing page. The top one is from last year’s report and shows the entire Berkshire home-office crew at our Christmas lunch. Below that photo is this year’s Christmas photo portraying the same 25 people identically positioned. In 2015, no one joined us, no one left. And the odds are good that you will see a photo of the same 25 next year. Can you imagine another very large company – we employ 361,270 people worldwide – enjoying that kind of employment stability at headquarters? At Berkshire we have hired some wonderful people – and they have stayed with us. Moreover, no one is hired unless he or she is truly needed. That’s why you’ve never read about “restructuring” charges at Berkshire.”

5. 2016 Berkshire Hathaway Letter, dated February 25, 2017

2016 Letter in PDF from Berkshire Hathaway website

Major Berkshire investments reported in the letter:

Standard of success mentioned at the beginning: net worth, and per-share book value.

Highlights:

  • This letter was about
  • The famous washtubs line! “Some years, the gains in underlying earning power we achieve will be minor; very occasionally, the cash register will ring loud. Charlie and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.”
  • Notable, after years in which he slammed the US dollar and talked a lot about finding investments in other currencies and countries, that in this letter he’s quite the American businesses cheerleader.
  • “During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.” (emphasis Buffett’s)

Checklist points:

  • He’s making a point about American stability of wealth here, but actually I get a slightly different takeaway for the checklist: If this investment goes badly, to whom does this wealth go? I’ve always thought of an investment that goes down as “money lost,” but his point here is brilliantly that the money is not “lost,” it’s moved. To whom will it move? Who benefits if this company fails? Another line of thought to find antifragility. “It’s true, of course, that American owners of homes, autos and other assets have often borrowed heavily to finance their purchases. If an owner defaults, however, his or her asset does not disappear or lose its usefulness. Rather, ownership customarily passes to an American lending institution that then disposes of it to an American buyer. Our nation’s wealth remains intact. As Gertrude Stein put it, “Money is always there, but the pockets change.”” (emphasis mine)
  • Looking through this lens at companies, as I now do, really lays bare just HOW MANY of them tout Adjusted EBITDA and don’t mention their GAAP earnings except where legally required. It’s frustrating and I don’t like it one bit, and clearly Mr. Buffett here has had it up to here with the practice. Rarely does he use italics. “Too many managements – and the number seems to grow every year – are looking for any means to report, and indeed feature, “adjusted earnings” that are higher than their company’s GAAP earnings. There are many ways for practitioners to perform this legerdemain. Two of their favorites are the omission of “restructuring costs” and “stock-based compensation” as expenses. Charlie and I want managements, in their commentary, to describe unusual items – good or bad – that affect the GAAP numbers. After all, the reason we look at these numbers of the past is to make estimates of the future. But a management that regularly attempts to wave away very real costs by highlighting “adjusted per-share earnings” makes us nervous. That’s because bad behavior is contagious: CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be “helpful” as well. Goals like that can lead, for example, to insurers underestimating their loss reserves, a practice that has destroyed many industry participants. Charlie and I cringe when we hear analysts talk admiringly about managements who always “make the numbers.” In truth, business is too unpredictable for the numbers always to be met. Inevitably, surprises occur. When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers.” (emphasis Buffett’s)

Particular points of candor:

  • Interesting overview of how he sees what’s happened in Berkshire, and how it has shifted from a business focused on investments to a business focused on operating businesses. I’ve left out the successes he cited, as the mistakes are always more interesting – though that section, entitled “What We Hope to Accomplish” is worth reading in full.
  • “I earlier described our gradual shift from a company obtaining most of its gains from investment activities to one that grows in value by owning businesses. Launching that transition, we took baby steps making small acquisitions whose impact on Berkshire’s profits was dwarfed by our gains from marketable securities. Despite that cautious approach, I made one particularly egregious error, acquiring Dexter Shoe for $434 million in 1993. Dexter’s value promptly went to zero. The story gets worse: I used stock for the purchase, giving the sellers 25,203 shares of Berkshire that at yearend 2016 were worth more than $6 billion.”
  • “Unfortunately, I followed the GEICO purchase by foolishly using Berkshire stock – a boatload of stock – to buy General Reinsurance in late 1998. After some early problems, General Re has become a fine insurance operation that we prize. It was, nevertheless, a terrible mistake on my part to issue 272,200 shares of Berkshire in buying General Re, an act that increased our outstanding shares by a whopping 21.8%. My error caused Berkshire shareholders to give far more than they received (a practice that – despite the Biblical endorsement – is far from blessed when you are buying businesses).”

I was also struck by:

  • Those BoA warrants were burning a hole in his pocket. “If the dividend rate on Bank of America common stock – now 30 cents annually – should rise above 44 cents before 2021, we would anticipate making a cashless exchange of our preferred into common. If the common dividend remains below 44 cents, it is highly probable that we will exercise the warrant immediately before it expires.”
  • Long essay on how the fees charged by fund managers drags down their returns, and that because there are so few good investment managers out there who are worth the fees, he recommends people just buy the index. Not sure it’s helpful for our purposes here, but interesting to observe that he spent valuable space in his letter calling out Wall Street. He cares a great deal about teaching his readers how to find real value in investing.
  • The description has been growing for years, and it’s really quite striking that his information about the annual meeting now stretches to four entire pages of the letter. I remember when it was not even mentioned, and then a tiny paragraph…ah, memories.

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