Buffett’s annual letter has been published in association with the annual report of Berkshire Hathaway. The full letter can be accessed here and the annual report accessed here. These are some of the highlights.
Berkshire financial results
The per share book value of the Class A and B shares in the company rose by 4.6 per cent in the year, giving a compound growth of 19.8 per cent for the 47 years since Buffett took control. Buffett pointed out that the book value has risen from $19 to nearly $100,000 in that time. Not bad!
Buffett’s own highlights
1. He is confident that his eventual successors (and Munger’s) will do a good job - Todd Combs and Ted Weschler and he is allowing each of them to play with a billion dollars the coming year. And he has backups.
2. Berkshire has bought Lubrizol, a chemical company run by a superb manager and that company is buying other businesses.
3. All Berkshire’s main businesses - BNSF, Iscar, Lubrizol, Marmon and MidAmerican Energy - had record years.
4. Despite big payouts, the insurance companies still did well.
5. Berkshire made two big investments - $5 billion in preferred stock in Bank of America and a further 700 million shares of IBM at $7.14. They now own 13 per cent of Amex, 8.8 per cent of Coke, 5.5 per cent of IBM and 7.6 per cent of Wells Fargo
6. The $2 billion spent on bonds in Energy Future Holdings was a bummer. Unless gas prices go up, the investment is shaky. Some companies paid back loans made by Berkshire with a resulting loss of income to be hopefully replaced by the investment in Lubrizol.
7. Buffett’s prediction of the housing market coming back was wrong but he remains hopeful. The recovery may be long and painful but will come about. “Today, household formations are consistently exceeding housing starts”. Supply and demand is a constant economic principle.
Buffett says to look at their intrinsic value as represented by the book value of a share and gives a comparative table in the annual report.
Berkshire bought back some shares during the year because his criteria for share repurchasing by a company were met - the company has the funds to do so and the share prices is materially lower than the value of a share. This is the only way existing shareholders gain from a buy back. Buffett used an IBM share repurchase as an example:
When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well. A corollary to this second point: “Talking our book” about a stock we own – were that to be effective – would actually be harmful to Berkshire, not helpful as commentators customarily assume.
Let’s use IBM as an example. As all business observers know, CEOs Lou Gerstner and Sam Palmisano did a superb job in moving IBM from near-bankruptcy twenty years ago to its prominence today. Their operational accomplishments were truly extraordinary. But their financial management was equally brilliant, particularly in recent years as the company’s financial flexibility improved. Indeed, I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders. The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock.
Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%. Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period?
I won’t keep you in suspense. We should wish for IBM’s stock price to languish throughout the five years.
Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.
If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the “disappointing” scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $11 ⁄2 billion more than if the “high-price” repurchase scenario had taken place.
On buying businesses
As you know, when Buffett buys a business, he invests in the people who run it as well as the business itself and this has influenced his reluctance to get rid of these businesses when they under-perform. He explains this by saying that where he gives a commitment to a vendor who remains in the business that he will see it through through thick and thin, he will stick with that commitment. However, when it comes down to the nitty-gritty and there is no hope for improvement, he will cut his losses. He estimates that this has only happened twice in 47 years.
Nebraska Furniture Mart
Another big year for Rose’s baby. Record earnings and a new store coming up in Dallas. The company is in its third generation of Blumkin management.
Berkshire’s plus $1 billion dollar investments in listed companies
It owns the following percentage in these companies.
- American Express Company 13.0 %
- The Coca-Cola Company 8.8 %
- ConocoPhillips 2.3%
- International Business Machines Corp 5.5%
- Johnson & Johnson 1.2%
- Kraft Foods 4.5%
- Munich Re 11.3%
- POSCO 5.1%
- The Procter & Gamble Company 2.6%
- Tesco 3.6%
- U.S. Bancorp 4.1%
- Wal-Mart Stores, Inc1.1%
- Wells Fargo & Company 7.6%
According to Buffett, the banking industry has recovered and he is more than happy with how Wells Fargo has recovered from its mistakes. And he has faith in IBM.
Berkshire will not be making any major new investments in derivatives.
The choices for investors
There are three types of investment according to Buffett:
a) Investments denominated in a given currency, such as bank deposits, cash funds, mortgages and which are supposedly safe. These investments are not risk free because their value can be eroded by inflation, government policy and the actions of speculators.
b) Assets that are not productive and where increase in value depends upon somebody else buying the asset at a higher price, such as tulips during the great Tulip Boom or technological stocks during the buying frenzy of the Dot-Com boom. The risk here is that price rises depend upon an ever increasing pool of speculators. Gold falls within this category even though it is productive in the sense that it has industrial use but industrial demand for gold is limited and secondary to its use as a holding asset.
c) Assets that are productive – businesses, farms, mines etc – and these are the best assets to hold so long as you only buy them on sound investment principles. ‘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.