Every last Saturday of February, a must read for the weekend comes out: Warren Buffett’s letter to the Shareholders of Berkshire Hathaway [PDF, 499KB]. This year, it is the 50th anniversary since Buffett took over the company, and thus together with the letter both him and Charlie Munger, his partner and vice chairman, have included as well two letters describing the last 50 years, what made them so successful and what can be expected in the following years. The 3 letters together make up 42 pages, a strongly recommended read.
From this year’s letter, I wanted to bring attention to the following quotes or passages on simplicity of some transactions, on the sale of TESCO, the distinction between volatility and risk, not using borrowed money to invest, consequences of using shares instead of cash for acquisitions, the synergies announced in M&A, the importance of cash, trust and bureaucracy:
On simplicity of some transactions and trust. Last year he introduced the acquisition of Nebraska Furniture Mart, this year is the turn of National Indemnity:
[…] since 1967, when we acquired National Indemnity and its sister company, National Fire & Marine, for $8.6 million. Though that purchase had monumental consequences for Berkshire, its execution was simplicity itself.
Jack Ringwalt, a friend of mine who was the controlling shareholder of the two companies, came to my office saying he would like to sell. Fifteen minutes later, we had a deal. Neither of Jack’s companies had ever had an audit by a public accounting firm, and I didn’t ask for one. My reasoning: (1) Jack was honest and (2) He was also a bit quirky and likely to walk away if the deal became at all complicated.
On pages 128-129, we reproduce the 1 1 ⁄2-page purchase agreement we used to finalize the transaction. That contract was homemade: Neither side used a lawyer. Per page, this has to be Berkshire’s best deal: National Indemnity today has GAAP (generally accepted accounting principles) net worth of $111 billion, which exceeds that of any other insurer in the world.
On the advantages of using an animated character as advertising tool in low cost operations:
[…] No one likes to buy auto insurance. Almost everyone, though, likes to drive. The insurance consequently needed is a major expenditure for most families. Savings matter to them – and only a low-cost operation can deliver these. […]
[…] Our gecko never tires of telling Americans how GEICO can save them important money. The gecko, I should add, has one particularly endearing quality – he works without pay. Unlike a human spokesperson, he never gets a swelled head from his fame nor does he have an agent to constantly remind us how valuable he is. I love the little guy.
On his lack of decisiveness in selling TESCO:
[…] An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling.
At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount.
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.)
During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.
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.) Our after-tax loss from this investment was $444 million, about 1/5 of 1% of Berkshire’s net worth.
On volatility versus risk:
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
On not using borrowed money to invest:
[…] borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.
A confession after having introduce the major mistake of acquiring Berkshire (a sinking textile company) out of stubborness:
Can you believe that in 1975 I bought Waumbec Mills, another New England textile company? Of course, the purchase price was a “bargain” based on the assets we received and the projected synergies with Berkshire’s existing textile business. Nevertheless – surprise, surprise – Waumbec was a disaster, with the mill having to be closed down not many years later.
On his initial strategy of buying low priced small companies and why he changed it:
[…] Most of my gains in those early years, though, came from investments in mediocre companies that traded at bargain prices. Ben Graham had taught me that technique, and it worked.
But a major weakness in this approach gradually became apparent: Cigar-butt investing was scalable only to a point. With large sums, it would never work well.
In addition, though marginal businesses purchased at cheap prices may be attractive as short-term investments, they are the wrong foundation on which to build a large and enduring enterprise. […]
On using shares instead of cash for acquisitions:
Consequently, Berkshire paid $433 million for Dexter and, rather promptly, its value went to zero. GAAP accounting, however, doesn’t come close to recording the magnitude of my error. The fact is that I gave Berkshire stock to the sellers of Dexter rather than cash, and the shares I used for the purchase are now worth about $5.7 billion. As a financial disaster, this one deserves a spot in the Guinness Book of World Records.
Several of my subsequent errors also involved the use of Berkshire shares to purchase businesses whose earnings were destined to simply limp along. Mistakes of that kind are deadly. Trading shares of a wonderful business – which Berkshire most certainly is – for ownership of a so-so business irreparably destroys value.
On the trumpeted synergies announced in M&A:
(As a director of 19 companies over the years, I’ve never heard “dis-synergies” mentioned, though I’ve witnessed plenty of these once deals have closed.) Post mortems of acquisitions, in which reality is honestly compared to the original projections, are rare in American boardrooms. They should instead be standard practice.
At a healthy business, cash is sometimes thought of as something to be minimized – as an unproductive asset that acts as a drag on such markers as return on equity. Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent.
American business provided a case study of that in 2008. In September of that year, many long-prosperous companies suddenly wondered whether their checks would bounce in the days ahead. Overnight, their financial oxygen disappeared.
At Berkshire, our “breathing” went uninterrupted. Indeed, in a three-week period spanning late September and early October, we supplied $15.6 billion of fresh money to American businesses.
On trust and bureaucracy:
With only occasional exceptions, furthermore, our trust produces better results than would be achieved by streams of directives, endless reviews and layers of bureaucracy. Charlie and I try to interact with our managers in a manner consistent with what we would wish for, if the positions were reversed.
The books that are recommended this year in the letter are:
- “Where Are the Customers’ Yachts?”, by Fred Schwed,
- “The Little Book of Common Sense Investing”, by Jack Bogle,
- “Berkshire Hathaway Letters to Shareholders”, compilation by Max Olson,
- a new book in preparation commemorating the 50th anniversary of Berkshire Hathaway under present management.
Another article about Jim Ling in D magazine (from 1982) is recommended to understand the mentality of some CEOs running holdings at the time and why some negative perception towards holdings continue to exist today.
Finally, in the two last letters from Buffett and Munger, in which they review the future prospects of Berkshire there is some language that will no doubt stir again the rumours of whether Buffett may step down as CEO and / or chairman anytime soon. We will see.
For nostalgic investors, in this year’s annual report it is embedded Berkshire’s 1964 annual report (pages 130-142).
See the review I made of 2009, 2012 and 2013 letters.