I came away from the Berkshire Hathaway meeting generally reassured about its future as a sound investment.
The results will not be spectacular going forward. Berkshire is simply too big for that. However, the result are likely to be quite satisfactory. I think it is rational to assume (as Buffett himself believes) that Berkshire can still beat the S&P 500 over a complete business cycle, something few managers can do. Moreover, in Berkshire’s case you have a high probability of selecting the manager BEFORE you invest, a rarity.
Buffett has put together a collection of businesses that are not only highly profitable, but also remarkably immunized from creative destruction, which provides a margin of safety. It is not a stretch to assume that one hundred years from now BNSF will still be riding the rails, BH power will be providing energy in one form or another and BH insurance companies will be underwriting. This also is rare.
The key question that will drive Berkshire’s results going forward is whether Buffett or his successors will be able to intelligently put to work the enormous capital the company generates.
For now, Berkshire has shown that it still has this capacity to do this given the following options.
- Tuck-in acquisitions and organic growth, i.e. NFM Texas store
- Large cap-ex investments in rails and energy. Tens of billions can be put to work here over time at satisfactory returns, i.e. 11%-12%.
- Stakes in publicly traded companies
- An occasional whale (this may be aided by 3G Capital)
- “Special Deals” (such as those done with Goldman, GE, BOA, etc.) – Buffett thinks these will still be available after he is gone, based on Berkshire’s reputation and its ability to write a huge check.
- Something we are not thinking about. This may seem a bit of a stretch (and certainly not something to count on) but Buffett is an investing genius who has surprised many times in the past by coming up with new ways to deploy capital.
Another positive is that Berkshire is one the few companies that will have both the firepower – cash, operating profits, borrowing capacity, liquid securities – and investing philosophy to exploit Mr. Market when he goes into a future depressed state. Moreover, confidence is growing that Todd Combs and Ted Weschler are skilled investors who could have a long and successful run ahead of them at Berkshire.
- Buffett continues to espouse return on equity as the preferred metric for economic performance, provided it is adjusted, where necessary, to capture economic reality.
- The scorecard for investment results must take both inflation and taxes into account.
- Buffett underscores outstanding management as a key driver of a successful business, particularly in insurance which tends to “magnify, to an unusual degree, human managerial talent – or the lack of it”.
- Buffett suggest that it probably makes sense to pay-up for great businesses – those that produce high returns on tangible capital employed – rather than purchase statistical bargains in mediocre or subpar businesses.
- Early on, Buffett showed the discipline to walk away from insurance business if it could not be underwritten with an expectation of a profit.
- Successful investing in insurance requires the ability to tolerate lumpy returns.
- Buffett is disinterested in market trends or fads.
- Even sophisticated managers can ignore reality if it is too painful to deal with or if it requires a difficult change in direction. (See the example of how the insurance industry reacted to losses on long-term bonds.)
- Lending money at a fixed price for an extended duration (long-term bonds) is inherently risky in an inflationary world. This is why Buffett favors convertible bonds which function as if they have shortened maturities.
- It generally doesn’t pay to be clever when the tide is running against you.
- You usually have to pay up to purchase a high-quality business.
- “It is difficult to say anything new or meaningful each quarter about events of long-term significance.”
- Buffett takes pride in running a very lean operation at the top.
- Buffett wants a shareholder base that understands Berkshire Hathaway and has rational expectations.
- Buffett likes the trade-offs inherent in running a decentralized operation: whatever he misses by not having more controls he gains in cost savings and responsiveness.
- GAAP financial statements are merely a starting point to understand the economics of a business.
- Berkshire is best understood by looking at its various segments.
- Buffett tries to provide segmented information to investors (“partners”) in the same form that he likes to see it.
- One-time capital gains should not be used in evaluating the performance of any given single year. Nevertheless, they are a meaningful component of Berkshire’s longterm performance.
- Buffett does not believe it is possible to forecast short-term stock market prices.
- Return on equity may be overstated if balance sheet assets, such as property and equipment, are carried materially below replacement cost.
- Textiles is a lousy business characterized by slow capital turnover, low profit margins, poor returns on capital.
- Attempts to improve profitability may yield little benefit if a business’s competitors are able to make the same improvements, i.e. differentiating products, lowering costs, increasing productivity, changing product mix, etc. [Author's note: Buffett will later write that this is akin to standing on your tippy toes at a parade.]
- When it come to controlling costs, management’s past track record is a meaningful indicator of future performance.
- As long as a business is generating at least modest returns, Buffett will consider non-economic factors when deciding to remain in the business.
- The hallmarks of Berkshire’s highly successful insurance operations were already on display in 1978: discipline, growth, realism, conservative expectations, and recognition of the tremendous power of low-cost float coupled with investment skill.
- Buffett reiterates his investment criteria: “(1) businesses we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively.”
- Buffett chides pension fund managers for investing heavily when the market was richly valued and investing relatively little at bargain prices.
- Buffett sought blocks of stock for Berkshire’s insurance portfolios at valuations lower than what they would “command in negotiated sales”.
- As a net buyer of securities, Buffett prefers share prices to stay undervalued rather than quickly re-pricing to unattractive levels.
- Buffett’s policy is to concentrate holdings.
- Forgoing control is completely rational when 1) a meaningful portion of a business can be purchased in the market for less than it would cost to create it, 2) the business has relatively certain prospects, and 3) possesses proven management. See the SAFECO example.
- Buffett praises investee companies’ reinvestment of retained earnings, provided it is done at attractive returns. This anticipates his concept of look-through earnings.
- The best measure of business performance is return on equity, although allowances must made for items that can cloud the metric’s economic meaning, such as high levels of debt or goodwill. Using this metric allows investors to put earnings growth into context.
- Reinsurance generates high levels of float for investment relative to premiums written. [Author's note: It is no coincidence that Buffett put a great deal of emphasis on growing Berkshire's reinsurance business.]
- Successful insurance operations require the discipline to turn away unprofitable business. Also, insurance operations typically enjoy few important competitive advantages. This makes insurance management particularly important.
- When investing for the longterm, day-to-day price fluctuations tell little or nothing about the ultimate results that will be achieved. Results will be determined by the economic performance of the underlying business.
- A key investing concept is to determine where a business will be in 10 to 20 years. A current snapshot, without this longterm view, can be very misleading. Berkshire Hathaway’s performance from 1955 to 1964 provides a stark example.
- Buffett purchased Capital Cities in 1977 at approximately 8 times earnings: $10.9 million in shares generating $1.3 million in look-through earnings. This was a 50% discount to Buffett’s estimate of the valuation level required to purchase the entire company. [Author's note: Moreover, it was a business with numerous hard-to-find advantages.]
- Buffett has simple and clear investment criteria: “We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price.”
- In banking investments, Buffett pays attention to return on assets.
- Buffett likes businesses such as See’s that require little additional capital to grow and that can grow operating earnings even in an industry that is experiencing no unit growth. [Author's note: In See's case, this was done through raising prices.]