Small gift. Found a great business resource online, for free, that chronicles 40+ years of business thinking. Written by Warren Buffett and Charlie Munger, legendary investors at Berkshire Hathaway (BRK). All put together into a book, it is 600 pages long with 4.6 stars on Amazon and sells for $60. Yes, Berkshire Hathaway Shareholder letters (1977-2019) here.
It’s capitalism at it’s best. Direct, realistic, useful, generous, and humble. How you might explain it to your cousin.
2019 Berkshire Hathaway Shareholder Letter
So much to talk about, so much to like. It’s only 13 pages and eventually worth your read here. Will copy/paste quotes from BRK in blue color. The rest is my commentary with underline showing off some of our strategy undergrad concepts.
Three criteria when buying new businesses
In addition, we constantly seek to buy new businesses that meet three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers.
Finally, they must be available at a sensible price.
Commander’s Intent. This is the simple concept from the military. Troops will have a better chance of executing the strategy, if they know what you (the commander) intend. What does success look like? For Buffet, 1) good ROA 2) able and honest managers 3) good price. So simple, and yet hard to find? BRK has 70 companies and $100+ billion in cash.
Fun fact, their holding in T-bills is so large, that it is 4% of the total float of T-bills. Also, this makes 1/4 of their market cap, so I am sure they will be putting that to good use – if/when prices drop. Core competencies = resources + capabilities. Having all the $$, investment discipline, long-term time horizon, it’s almost like a family office.
M&A is like a marriage
This is an analogy I use a good bit in class. Well, 50% of marriages in the US end up in divorce, and roughly speaking, 50%+ of M&A don’t create shareholder value. Not a scientific comparison, but if the Oracle of Omaha says it, I’m in good company.
Reminds me of Michael Porter’s famous article on Corporate Strategy here. The 3 tests of diversification (attractiveness, cost-of-entry, and better-of) and the 4 ways of unlocking value (restructuring, portfolio, transferring skills, and sharing activities).
In reviewing my uneven record, I’ve concluded that acquisitions are similar to marriage: They start, of course, with a joyful wedding – but then reality tends to diverge from pre-nuptial expectations. Sometimes, wonderfully, the new union delivers bliss beyond either party’s hopes. In other cases, disillusionment is swift. Applying those images to corporate acquisitions, I’d have to say it is usually the buyer who encounters unpleasant surprises. It’s easy to get dreamy-eyed during corporate courtships.
Post merger integration. This is where a lot of deals go bad. The wedding is (relatively) easy. It’s the marriage that is tough. Berkshire competes differently; they keep the businesses as stand-alone units, with the legacy management team in place. Smartly, not a lot to integrate.
Pursuing that analogy, I would say that our marital record remains largely acceptable, with all parties happy with the decisions they made long ago. Some of our tie-ups have been positively idyllic. A meaningful number, however, have caused me all too quickly to wonder what I was thinking when I proposed.
P/C (insurance) is a great business model
For me, Berkshire Hathaway is basically a huge insurance company with an amazing investment track record. They collect premiums and get a “float” to invest, until they have to pay out claims. What’s more, they are good at underwriting risk. Question “If it’s such a great business model, how come all insurance companies are not as profitable as Berkshire Hathaway?” Great $10 question. I guess I would respond that a business model is not strategy here.
One reason we were attracted to the P/C business was the industry’s business model: P/C insurers receive premiums upfront and pay claims later. In extreme cases, such as claims arising from exposure to asbestos, or severe workplace accidents, payments can stretch over many decades.
Our P/C companies have meanwhile had an excellent underwriting record. Berkshire has now operated at an underwriting profit for 16 of the last 17 years, the exception being 2017, when our pre-tax loss was a whopping $3.2 billion. For the entire 17-year span, our pre-tax gain totaled $27.5 billion, of which $400 million was recorded in 2019. That record is no accident: Disciplined risk evaluation is the daily focus of our insurance managers, who know that the rewards of float can be drowned by poor underwriting results. All insurers give that message lip service. At Berkshire it is a religion, Old Testament style
“Danger always lurks”
Right after explaining their great history of managing risk, Buffett says, “As I have repeatedly done in the past, I will emphasize now that happy outcomes in insurance are far from a sure thing: We will most certainly not have an underwriting profit in 16 of the next 17 years. Danger always lurks.” Wise enough to be humble. It’s Honda (A) and (B).
Mistakes in assessing insurance risks can be huge and can take many years – even decades – to surface and ripen. (Think asbestos.) A major catastrophe that will dwarf hurricanes Katrina and Michael will occur – perhaps tomorrow, perhaps many decades from now. “The Big One” may come from a traditional source, such as wind or earthquake, or it may be a total surprise involving, say, a cyber attack having disastrous consequences beyond anything insurers now contemplate. When such a mega-catastrophe strikes, Berkshire will get its share of the losses and they will be big – very big. Unlike many other insurers, however, handling the loss will not come close to straining our resources, and we will be eager to add to our business the next day
No one knows the future, and I guess if you’re high 80s (Buffett) and low 90s (Munger), you have that kind of wisdom (WWI, great depression, WWII etc). One of the articles we read this year was The Big Lie of Strategic Planning here (HBR: Martin). Very apropos for this healthcare crisis and economic coma. Every strategy department was very wrong this year.
Competing differently with wind power
Was not aware of this, but apparently, BRK has a sizable energy business; their acquisitions over the last 20 years would easily put the energy market cap within the top 10 of the US. Apparently, Berkshire Hathaway Energy (BHE) residential customers are charged less than the other large investor-owned Iowa utilities because they BHE competes differently.
That output will totally cover the annual needs of its Iowa customers, which run to about 24.6 million MWh. In other words, our utility will have attained wind self-sufficiency in the state of Iowa. In still another contrast, that other Iowa utility generates less than 10% of its power from wind. Furthermore, we know of no other investor-owned utility, wherever located, that by 2021 will have achieved a position of wind self-sufficiency. In 2000, BHE was serving an agricultural-based economy; today, three of its five largest customers are high-tech giants.
Looking for unbreachable moats (AAPL, BAC, KO, WFC, AMEX)
In the spirit of BRK being an insurance company, they currently have stock market investments of about $250 billion. Warren Buffett famously said, “In business, I look for economic castles protected by unbreachable moats.” Moats definitely gives you a sense of Games of Thrones security. It protects the castle of profits from invaders. After all, everyone is after your profits – just your rival, but also your suppliers (raising prices, lowering quality) and customers (asking for discounts). Many of these stock positions are long-term holdings, in fact, BRK has held Wells Fargo, Coca-Cola, and American Express for 25 years.
Strategy is long-term.
Charlie and I do not view the $248 billion detailed above as a collection of stock market wagers – dalliances to be terminated because of downgrades by “the Street,” an earnings “miss,” expected Federal Reserve actions, possible political developments, forecasts by economists or whatever else might be the subject du jour. What we see in our holdings, rather, is an assembly of companies that we partly own and that, on a weighted basis, are earning more than 20% on the net tangible equity capital required to run their businesses. These companies, also, earn their profits without employing excessive levels of debt.
Founder’s Mentality = Warren Buffett
Bain & Company has a framework called Founder’s Mentality See a 18 minute video here. In a nutshell, it’s a 2×2 matrix which charts the all-too-common trajectory of organizations from young (passionate) to. . old (complacent). It’s a familiar story that any reader working for a Fortune 500 sees in parts/divisions/processes of their companies daily.
So here’s how Warren Buffett – in particular – still has his ownership mindset, and mojo. He is old. So is Charlie Munger. He has a lot of shares. Existing shareholders are afraid that when he dies, his shares will flood the market. Buffett is not shy about talking about his death. He has explained to his executor of his will that his investments will be converted to B shares, then gifted to charities over a 15 year period. NB: Shareholders, don’t worry.
I have never sold any shares and have no plans to do so. Today, my will specifically directs its executors – as well as the trustees who will succeed them in administering my estate after the will is closed – not to sell any Berkshire shares. My will also absolves both the executors and the trustees from liability for maintaining what obviously will be an extreme concentration of assets.
CEOs are not impartial
There is a ton of academic research on this, I am sure, but Warren Buffett makes it simple. 1) When a CEO & team want an acquisition to happen, it tends to happen 2) there is rarely a well-argued “red team” of dissenting opinions, rather, there’s more than likely a persuasive investment banker or management consultant presenting the management’s thesis. Yes, CEOs can be victim to lots of decision-making biases. Kinda no surprise, right?
Overall, the deck is stacked in favor of the deal that’s coveted by the CEO and his/her obliging staff. It would be an interesting exercise for a company to hire two “expert” acquisition advisors, one pro and one con, to deliver his or her views on a proposed deal to the board – with the winning advisor to receive, say, ten times a token sum paid to the loser.
Don’t hold your breath awaiting this reform: The current system, whatever its shortcomings for shareholders, works magnificently for CEOs and the many advisors and other professionals who feast on deals. A venerable caution will forever be true when advice from Wall Street is contemplated: Don’t ask the barber whether you need a haircut.
Boards are not impartial
Not to worry, right? There is an independent board of directors who will keep the CEO in check. Hmm, that sounds good, but this is how Buffett explains it. . . A board director can make up to $200-300K to sit in on 5-6 meetings we year (not bad, right)? And if they want to sit on a 2nd board (uh, who wouldn’t?), they will likely get a referral from the CEO of the first board. Are you starting to see the broken alignment of incentives?
The CEO of a company searching for board members will almost certainly check with the NWD’s current CEO as to whether NWD is a “good” director. “Good,” of course, is a code word. If the NWD has seriously challenged his/her present CEO’s compensation or acquisition dreams, his or her candidacy will silently die. When seeking directors, CEOs don’t look for pit bulls. It’s the cocker spaniel that gets taken home.
We are all duds at one thing or another
Strategy is about trade-offs. You can’t be good at everything. Find what your competitive advantage. Full stop.
Nevertheless, many of these good souls [Directors] are people whom I would never have chosen to handle money or business matters. It simply was not their game. They, in turn, would never have asked me for help in removing a tooth, decorating their home or improving their golf swing. Moreover, if I were ever scheduled to appear on Dancing With the Stars, I would immediately seek refuge in the Witness Protection Program. We are all duds at one thing or another. For most of us, the list is long. The important point to recognize is that if you are Bobby Fischer, you must play only chess for money.
Thought and principles, not robot-like “process,”
Something I tell students all the time, “Don’t be a business robot” Trust me, the AI algorithms with their huge data sets will out-robot-you everyday. We – humans – need to focus on being more principled, empathetic, creative, and crafty.
At Berkshire, we will continue to look for business-savvy directors who are owner-oriented and arrive with a strong specific interest in our company. Thought and principles, not robot-like “process,” will guide their actions. In representing your interests, they will, of course, seek managers whose goals include delighting their customers, cherishing their associates and acting as good citizens of both their communities and our country.
BRK paid $3.6B in taxes; 1.5% of the US corporate total
Buffett believes that the rich don’t pay their fair share of taxes; once he commented that his tax rate (largely from capital gains) is lower than his secretary. Business is society. BOOM. Yes, he believes that taxes play a critical part in making the country go-round. While a number of US companies relocate their headquarters to lower their tax rates (understandable, and a bit sad), guess is that Berkshire Hathaway will never relocate to Ireland.
In 2019, Berkshire sent $3.6 billion to the U.S. Treasury to pay its current income tax. The U.S. government collected $243 billion from corporate income tax payments during the same period. From these statistics, you can take pride that your company delivered 1 1⁄2% of the federal income taxes paid by all of corporate America. In most future years, we both hope and expect to send far larger sums to the Treasury.