Berkshire Hathaway Letters Challenge (BHLC) – A 10 Day Stunt Regarding What Tim Ferriss Said on Smart Passive Income Podcast about an MBA Program Hack

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Tim Ferriss and Pat Flynn had a great talk about the podcasting industry on Pat’s podcast.  

Inspiration:

“If you do a handful of things right, even if your slow and plodding and letharic about it; you will beat almost everyone. It’s amazing…

For those who can get into dense stuff, pick up the annual letters of Warren Buffett to Berkshire Hathaway share holders. That is going to be worth more to you than any MBA program on the planet… I think.” – Tim Ferriss on Smart Passive Income podcast


Skip to 50:56 to hear Tim’s quote

Well that sounds like a great thing to take action on. I thought it would be a glorious challenge to do a rugged crash course and call it:

The 10 Day Berkshire Hathaway Letters Challenge (BHLC).

10 Letters from Warren Buffett to the shareholders of Berkshire Hathaway in 10 days.

Here’s How it Works:

  • Starting June 17th with Letters of Year 1993
  • Reading one year per day until June 27th
  • Drafting a Blog Post and Publishing Notes/Summary on a Daily Basis

Go to the Source of the Berkshire Hathaway Letters Here

Progress:

  1. 1993 - June 17th - BHLC: 1993 Notes and Reviews
  2. 1994 - June 18th - BHLC: 1994 Notes and Reviews
  3. 2006 -June 19th - BHLC: 2006 Notes and Reviews
  4. 2007 -June 20th - BHLC: 2007 Notes and Reviews
  5. 2008 -June 21st - BHLC: 2008 Notes and Reviews
  6. 2009 -June 30th - BHLC: 2009 Notes and Reviews
  7. 2010 -July 1st - BHLC: 2010 Notes and Reviews
  8. 2011 -July 2nd - Coming Soon…
  9. 2012 -July 3rd - Coming Soon…
  10. 2013 -July 4th – Coming Soon…

 Tools Developed During the Challenge

Another hat-tip to Tim, In a different blog post, Tim mentioned using Anki as a flashcard program for rapid learning.

So while going through this process I’m building a flash card system for terms I was previously unaware of. When I’m done, I’ll see if I can upload the file here. I’ll keep you all updated. :)

Alluding to My Failure Regarding the Stunt (Jun. 29th 2014)

Of course, I’m well off my 10 day stretch. I made it 5 straight but failed to keep up the pace as the waves here in Nicaragua allured me to adventure rather than study.

Veronica and I went on a long motorbike ride from Playa Marsella to Playa Gigante. We spent the day riding there. We were lost for much of it. Had a bilingual oil change conversation and other exciting adventures. At playa gigante we  dined while the sunset knowing well that a 3 hour motorbike ride across dusty unknown roads awaited us.

We came across a circus along the way involving a very talented fat acrobat, a monkey riding a horse and some prehistoric looking emus. Finally, back at home late at night, we felt so sore from riding that we couldn’t sit properly.

None-the-less, the show will go on. I’m wrapping this up and pushing forward. Though it’s a challenge to get started with these letters, I find them to be enjoyable and highly educational.

With love from Nicaragua,

Ian and V

BHLC: 2010 Notes and Reviews of Berkshire Hathaway Shareholder Letter

Notes on 2010 Berkshire Hathaway letters to Share holders

Notes on Berkshire Hathaway Shareholder Letter from 2010

Brief Summary of the Year:

Buying derivatives contracts in early 2000s was a gamble.

It turned out to be a nuclear bomb for many of the US financial companies that either tanked or were saved by the government.

Of course, when I say, “saved by the government” I mean that they weaseled themselves into such a disaster that if the US government didn’t bail them out hellfire and brimstone could be reasonably anticipated.

I mean, that’s the great travesty of the system for my generation. I’ve got no faith in these institutions because they set up a system where they can’t fail but they’ll still gyp your for that $10 if your checking account falls 2 cents below. Even if it’s their god damned fees that sent it there.

Blasted Bank of America.

I digress.

Warren Buffett was taking these derivatives contracts early in the 2000s. He used them to buy BSF which is a railroad of sorts.

It’s always baffled me in the USA how there are homeless folks who can’t find a job for $10 dollars an hour while wealthy insurance salesmen drive hummers and can’t understand why the railroads are so expensive.

It’s because of a failure of capital allocation in the united states.

It’s not the role of government, they have no role in this.

The solution will come when people who can make things happen, make things happen.

Warren Buffett converted fear in the financial industry into investment in the railroad infrastructure of the USA. This is delineated in his 2010 letter to the share holders of Bershire Hathaway.

This is what we need. More big dogs hunting elephants and converting fear and greed into productivity and long term economic growth.

Notes For the Year: 

The per-share book value of A&B stock went up 13% in 2010 which isn’t so hot. Over the last 46 years, it’s gone up 20.2% which is pretty hot.

They purchased Burlington Northern Santa Fe (BNSF) which I’ve never heard of though it’s clear that it’s a railway company (note: check this in Wikipedia to learn more TK )

Both of us are enthusiastic about BNSF’s future because railroads have major cost and environmental advantages over trucking, their main competitor. - Warren Buffett

Interesting… Buffett sees the costs and environmental advantages of railways as a hedge against the trucking industry.

Both of us are enthusiastic about BNSF’s future because railroads have major cost and environmental advantages over trucking, their main competitor. Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That’s three times more fuel-efficient than trucking is, which means our railroad owns an important advantage in operating costs. Concurrently, our country gains because of reduced
greenhouse emissions and a much smaller need for imported oil. When traffic travels by rail, society benefits. - Warren Buffett

Notice the theme again: whats good for the country and the people is a good long term investment.

No matter how serene today may be, tomorrow is always uncertain. - Warren Buffett

A great quote to remember

Don’t let that reality spook you. Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective. - Warren Buffett

Valiant predictions for an optimistic future.

The challenge, of course, is the calculation of intrinsic value. - Warren Buffett

As always, the great challenge. How do we calculate intrinsic value?

A dollar of then-value in the hands of Sears Roebuck’s or Montgomery Ward’s CEOs in the late 1960s had a far different destiny than did a dollar entrusted to Sam Walton. - Warren Buffett

 

Charlie and I hope that the per-share earnings of our non-insurance businesses continue to increase at a decent rate. But the job gets tougher as the numbers get larger. We will need both good performance from our current businesses and more major acquisitions. We’re prepared. Our elephant gun has been reloaded, and my trigger finger is itchy. - Warren Buffett

It’s good to be young with a smaller, more dynamic profile as that’s where the per-share earnings can grow based on small game hunting rather than the elephant gun.

“Hire well, manage little” – a code that suits Warren and the managers he hires.

Again the layout of Berkshire. They buy the best companies. Ones that win more money than they can possibly reinvest into themselves. The extra earnings can be used by Berkshire to allocate capital in ways that grow wealth even faster than if those business owners had kept the business. Essentially, BH is capital bucket that catches the runoff capital from a group of highly skilled managers.

Noting that flexibility plays an important role in their capacity for growth and good decisions.

They can take the overflow cash from See’s and Business Wire because those businesses can’t reinvest their earnings back into the company in a meaningful way. BH can and did so in their purchase of BNSF. BH is a big deal insurance company that is the backbone for much of US business. This backbone is also important as they provide relief to stressed (yet value rich) business to pull them through challenging market situations.

Our final advantage is the hard-to-duplicate culture that permeates Berkshire. And in businesses, culture counts. - Warren Buffett

Business culture counts.

Again with the theme of “we eat at our restaurants.” No highly paid CEOs with no consequences if the business collapses. If they let the companies sink, they too, lose money.

It’s like a culture war thing. Warren Buffet loves the frugal, highly productive culture that makes up the organization and expects it to continue long after he dies.

….Government Employees Insurance Co. (now called GEICO). - Warren Buffett

Interesting, Warren actually went to GEICO as a young man because Ben Graham was there. He knocked on the door of a closed office and came in to meet Lorimer “Davy” Davidson. GEICO has gone on to be an unstoppable company after years of ups and downs.

…a sound insurance operation requires four disciplines: 
 
(1) An understanding of all exposures that might cause a policy to incur losses; 
(2) A conservative evaluation of the likelihood of any exposure actually causing a loss and the probable cost if it does; 
(3) The setting of a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and (4) The willingness to walk away if the appropriate premium can’t be obtained. - Warren Buffett

The insurance business seems quite attractive if one could enter it with a creative profitable way that most don’t understand. Think travel insurance… contact Chris Nobel…

At Berkshire, our time horizon is forever. - Warren Buffett

They are reinvesting in the housing construction. Putting more in while the industry is down.

The 4 sectors of Bershire’s business;
1. Insurance
2. Manufacturing and Retail
3. Regulated & Capital-Intensive Businesses
4. Finance and Financial Products (smallest sector)

Buffett is confident in the long term value of rail-roads. Just thinking here: the cost of diesel in trucking is 3x that of railroad. So railroad (the “circulatory system” of the US) will be a long term valuable asset as they have low cost and the environmental impact is low. Of course, a disruptive new technology could blow that all out of the water.

A fusion energy company could make electricity nearly free and then electric vehicles could outpace trucking by far greater ratios than the diesel trucking cost expectation. So these are the issues. Imagine in 1990 if you were to tell people that they could stream videos straight into their Televisions without ever having to set hands on a VHS or a DVD. You’d seem crazy right. Well thats just it. RailRoads to me seem to be fragile against the volatility of upcoming technology. What if Elon Musk was able to create the Hypertron (or whatever it was.) and we could get people from LA to SF in 30 minutes? That would shift everything in regards to the investment… of course the abundance in society would change everything too…

The cost of getting from New York to LA by driving an electric car could go down to like $30. Imagine that. Anyways, who knows if this is going to work out. A TELSA S-model costs a fortune right now.

Time is the friend of the wonderful business. - Warren Buffett

This is inspired by the CoKe company. Essentially Buffett believes that within 10 years of 2010, Coke will pay out annual dividend returns greater to that which they paid for their share in the company.

…the ability to anticipate the effects of economic scenarios not previously observed. - Warren Buffett

The hard to evaluate skill Buffett is seeking (in addition to a record of excellent returns on investments) in a successor as CEO.

Todd Combs has an interesting wikipedia page that I expect will grown in length as time passes.

Warren Buffett is 80 years old as he writes this letter.

We want a compensation system that pays off big for individual success but that also fosters cooperation, not competition. - Warren Buffett

Incentivizing cooperation in Berkshire Hathaway.

You should also understand that we get paid up-front when we enter into the contracts and therefore run no counterparty risk. That’s important. - Warren Buffett

Shirking counter party risk exposure, or the exposure to people not living up to their contracts. With Berkshire Hathaway they agree to derivatives contracts in which they get paid up front to take the risk of other parties who seek to insure against said risk. Essentially, Warren is personally assuring that he will pay someone if what they risk comes to fruition. I should start a shark attack insurance company for surfers and those visiting the beach…

 - Warren Buffett

I just recounted to the wifey how amazing Berkshire is with Warren’s derivatives contracts (essentially insurance against big business failure) deals and she asked me if they were the biggest company in the world. I went to this list which is utterly fascinating. Note: Organize the worlds largest companies by profits (low not high.) The bank of Scotland is on this list but reporting -13.4 billion in losses! WHAT ON EARTH?! Freedom Podcasting is infinitely more profitable than the Royal Bank of Scotland. Wow!
Hold on. According to this list, the most profitable company in the world is Fannie Mae. This is a highly dubious list. Check it out. Tell me what you think in the comments… Back to Buffett.

Side Note: Another fascinating list is the list of the top billionaires in the world. Warren sits at number 4 at the time of writing this article.

What is sure is that we will have the use of our remaining “float” of $4.2 billion for an average of about 10 more years. (Neither this float nor that arising from the high-yield contracts is included in the insurance float figure of $66 billion.) Since money is fungible, think of a portion of these funds as contributing to the purchase of BNSF. - Warren Buffett

What massive, mind numbing leverage Warren uses here. He’s taking this float of billions of dollars and using it to reinvest in the American railroad reinvestment. It’s amazing.
Money aside, it’s a bet in the future of railroad as a way. He’s using the risk from these big derivatives deals to reinvest into the infrastructure of the US economy. It’s amazing. A real captain of industry.
On a more generalist view. He’s taking fear of big company failure, monetizing it and using it to reinvest in the infastructure of america. Heroic stuff… though he’s doing not to be perceived as a hero, but to add value to the economy (which is of course, heroic if your a capitalist.)

As I have told you before, almost all of our derivatives contracts are free of any obligation to post collateral – a fact that cut the premiums we could otherwise have charged. But that fact also left us feeling comfortable during the financial crisis, allowing us in those days to commit to some advantageous purchases. Foregoing some additional derivatives premiums proved to be well worth it. - Warren Buffett

… and in avoiding the high leverage derivatives contracts, he created space to invest in the real business assets. This is a really great story. He’s quite candid about the reality of the situation. He’s taken the fear of 2009 and reinvested it into railroad redevelopment. (The coolest thing I’ve ever understood about high level economics in my life. -> converting high level financial fear into physical value delivery in the for of RAILROADS. V please remind me about this.)

See Fear to Investment note. A rant, but one that probably is my best understanding of the invaluable role that Buffett has played in the economy by turning fear into investment via his derivatives contracts and investment in BNSF (Burlington Northern Santa Fe)

Charlie and I could – quite legally – cause net income in any given period to be almost any number we would like. - Warren Buffett

On the importance of Net Income at Berkshire Hathaway. Note: This doesn’t mean they are messing with the books. It’s just that they could chose to invest less and hold more earnings, thus showing net income, or invest more and hold less earning and show a lower net income (but a higher potential return on investment.)

If we really thought net income important, we could regularly feed realized gains into it simply because we have a huge amount of unrealized gains upon which to draw. Rest assured, though, that Charlie and I have never sold a security because of the effect a sale would have on the net income we were soon to report. We both have a deep disgust for “game playing” with numbers, a practice that was rampant throughout corporate America in the 1990s and still persists, though it occurs less frequently and less blatantly than it used to. - Warren Buffett

A disgust for the “game playing” of the grand financial beasts. They would rather show net income losses rather than pander to selling valuable assets to show cash in hand.

Operating earnings, despite having some shortcomings, are in general a reasonable guide as to how our businesses are doing. Ignore our net income figure, however. Regulations require that we report it to you. But if you find reporters focusing on it, that will speak more to their performance than ours. - Warren Buffett

A reiteration of course.

Again the Black-Scholes formula comes up which is, the theoretical estimate of price for options (according to wiki.) I think understanding what Buffett is saying here would essentially change the way one sees the world.

Both Charlie and I believe that Black-Scholes produces wildly inappropriate values when applied to long-dated options. - Warren Buffett

Pft. I take it back. While Buffett finds Black Sholes valuable at times, he also finds it “wildly inappropriate” for others.

We continue, nevertheless, to use that formula in presenting our financial statements. Black-Scholes is the accepted standard for option valuation – almost all leading business schools teach it – and we would be accused of shoddy accounting if we deviated from it. Moreover, we would present our auditors with an insurmountable problem were we to do that: They have clients who are our counterparties and who use Black-Scholes values for the same contracts we hold. It would be impossible for our auditors to attest to the accuracy of both their values and ours were the two far apart. - Warren Buffett

Wow again… A deep, intrisic understanding of Black Scholes may be a game changer in 2010.

Part of the appeal of Black-Scholes to auditors and regulators is that it produces a precise number. Charlie and I can’t supply one of those. We believe the true liability of our contracts to be far lower than that calculated by Black-Scholes, but we can’t come up with an exact figure – anymore than we can come up with a precise value for GEICO, BNSF, or for Berkshire Hathaway itself. Our inability to pinpoint a number doesn’t bother us: We would rather be approximately right than precisely wrong. - Warren Buffett
We would rather be approximately right than precisely wrong. - Warren Buffett

A memorable quote to place in the memory banks.

Academics’ current practice of teaching Black-Scholes as revealed truth needs re-examination. For that matter, so does the academic’s inclination to dwell on the valuation of options. You can be highly successful as an investor without having the slightest ability to value an option. What students should be learning is how to value a business. That’s what investing is all about. - Warren Buffett

Value Investing again. Of course, value investing is a challenge… but that’s what we need in the new economy.
Buffett doesn’t claim to be able to value invest in new tech. What do we need to do to get us there? I don’t know but I’m going to find out.

The fundamental principle of auto racing is that to finish first, you must first finish. That dictum is equally applicable to business and guides our every action at Berkshire. - Warren Buffett

Timeless lessons.

Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that’s all that is noticed. - Warren Buffett

It’s all about preparing for the times of need rather than expecting the times of abundance.

At Berkshire, we have taken his $1,000 solution a bit further and have pledged that we will hold at least $10 billion of cash, excluding that held at our regulated utility and railroad businesses. Because of that commitment, we customarily keep at least $20 billion on hand so that we can both withstand unprecedented insurance losses (our largest to date having been about $3 billion from Katrina, the insurance industry’s most expensive catastrophe) and quickly seize acquisition or investment opportunities, even during times of financial turmoil. - Warren Buffett

Berkshire played a pivotal role in the Katrina catastrophe by distributing $3 billion. I was on the ground floor there a year later seeing the shambles that were left. I don’t know where that money went. I’d love to explore that more. If there is ever an opportunity I hope those reading this will help me to invest more time in understanding what the hell was going on in the 9th ward. With 3 Billion floating around, it makes no sense that the place was in such rubble. Where was the discrepancy?

We keep our cash largely in U.S. Treasury bills - Warren Buffett

Again the long term trust in the nation. God Bless Berkshire Hathaway.

Furthermore, not a dime of cash has left Berkshire for dividends or share repurchases during the past 40 years. Instead, we have retained all of our earnings to strengthen our business, a reinforcement now running about $1 billion per month. Our net worth has thus increased from $48 million to $157 billion during those four decades and our intrinsic value has grown far more. No other American corporation has come close to building up its financial strength in this unrelenting way. - Warren Buffett

THIS IS HOW TO GROW WEALTH!

By being so cautious in respect to leverage, we penalize our returns by a minor amount. Having loads of liquidity, though, lets us sleep well. Moreover, during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival. That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008. - Warren Buffett

h. y. p. e. r. predators. Want to play big? Carry liquidity through really hard times and then buy big with companies that have long term economic potential (shoes, sugar water and railroads), great management and intrinsic value.

Come by bus; leave by private jet. - Warren Buffett

Spend. The capitalist woodstock urges you to spend.

This group efficiently deals with a multitude of SEC and other regulatory requirements, files a 14,097- page Federal income tax return along with state and foreign returns, responds to countless shareholder and media inquiries, gets out the annual report, prepares for the country’s largest annual meeting, coordinates the Board’s activities – and the list goes on and on. They handle all of these business tasks cheerfully and with unbelievable efficiency, making my life easy and joyful. Their efforts go beyond activities strictly related to Berkshire: They deal with 48 universities (selected from 200 applicants) who will send students to Omaha this school year for a day with me and also handle all kinds of requests that I receive, arrange my travel, and even get me hamburgers for lunch. No CEO has it better. - Warren Buffett

He’s got it made. There is a yearly party celebrating the accomplishments of his Berkshire Hathaway. Astounding results, even in a year where they didn’t accomplish their goals.
Continue reading

BHLC: 2009 Notes and Reviews of Berkshire Hathaway Shareholder Letter

From 2009 Letter to the Berkshire Hathaway Investors

Notes on Berkshire Hathaway Shareholder Letter from 2009

Brief Summary of the Year:

2009 was a year with the harshest language I’ve yet read from Buffett. He struck out against the financial institutions that warranted a “to big to fail” bailout of CEOs who were “derelict” in their treatment of derivative losses.

Of course, the jovial enjoyment of the investing space was the predominant factor and Buffett spent most of his time discussing modest profits but great purchases which will show profits in years to come.

Mix all of this scandal in with a message of distrust for the media and an explanation of how mergers often leave them holding the short end of the stick, this was a fascinating letter full of indescribably valuable strategic information.

Again, I’m surprised with how interesting and well written each one of these letters are.

Notes For the Year:

Gain in net worth for 2009 was $21.8 billion. The stock went up 19.8%. 20.3% growth from $19 to $84,487 since 45 years ago. Wow.

...in each annual report, consequently, we restate the economic principles that guide us. - Warren Buffett

This is a lesson backed up assiduously. In these letters, come gains or losses, Buffett seems to repeat the sam mantra and I expect to hear more of it today: Good management, economic forces moving in that direction and long term belief in the bets they place… That’s what we can expect to learn for every letter going forward.

6,000 new shares added to the 500,000 so there has been dilution in the stock? I don’t know. Obviously it’s not a lot but how do they account for these mammoth movements? I think if one can understand this fully, one would have robust business acumen.

S&P is their Bogey (or poor performance benchmark) -> No investor should pay them to perform at this level so they must exceed it’s performance.

There is a big challenge in accounting for value. They settle reluctantly on book value though it is a “crude proxy for it [calculation for value].

So the above rate of 20.3% is merely the book value of their investing operations which Buffett expects to be a woefully low price for their holdings.
… (I’m getting better at understanding these things.)

He goes on to describe that if they accounded for the gain in market-value for the entire 45-year period they would have shown 434,057% growth. I think this is an illustration of 2 things. 1. They perform really really well. 2. Book-value and market value are poor indicators of real performance.

In other words, our defense has been better than our
offense, and that’s likely to continue. - Warren Buffett

Defense seems to be the name of the game. Nassim Talebs Anti-fragile is a defense based strategy right? Bet against on the thing that will fall apart with volatility, defend yourself by not betting on things that grow with volatility.

Long ago, Charlie laid out his strongest ambition: “All I want to know is where I’m going to die, so I’ll never go there.” That bit of wisdom was inspired by Jacobi, the great Prussian mathematician, who counseled “Invert, always invert” as an aid to solving difficult problems. (I can report as well that this inversion approach works on a less lofty level: Sing a country song in reverse, and you will quickly recover your car, house and wife.) - Warren Buffett

What a genius passage. It’s funny yet has wisdom of ages. Wow.

...avoid businesses whose futures we can’t evaluate - Warren Buffett

I don’t think Buffett has much Facebook stock.

The idea here is that they only invest in companies they understand to one degree or another. Buffett likes shoe companies and companies that sell sugar water. All those that jump on hot new companies are playing with fire.

At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable. Even then, we will make plenty of mistakes. - Warren Buffett

They make mistakes betting on companies they are reasonably certain about… how could they make money doing it for companies they don’t understand.

We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback position at Berkshire. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses. - Warren Buffett

 

When the financial system went into cardiac arrest in September 2008, Berkshire was a supplier of liquidity and capital to the system, not a supplicant. - Warren Buffett

Sounds like in 2008 BSH was able to get a good deal on Wriggly gum and invest in companies while everyone else was going fire sale.

Most of our managers, however, use the independence we grant them magnificently, rewarding our confidence by maintaining an owner oriented attitude that is invaluable and too seldom found in huge organizations. - Warren Buffett

As always, the importance of strong management with the importance of the owners not interfering in the business. Owner oriented management is invaluable
These guys have 257,000 employees…

They allude to the fact that they have no interest in Wall Street or any other buy and sell, media focused shenanigans. They invest in good companies that they believe will grow over the long run.

Last year we saw, in one instance, how sound-bite reporting can go wrong. Among the 12,830 words in the annual letter was this sentence: “We are certain, for example, that the economy will be in shambles throughout 2009 – and probably well beyond – but that conclusion does not tell us whether the market will rise or fall.” Many news organizations reported – indeed, blared – the first part of the sentence while making no mention whatsoever of its ending. I regard this as terrible journalism: - Warren Buffett

Don’t trust the mainstream media.

Buffett describes the insurance game and why it generally underperforms the S&P but concludes that the reason they are so successful is that they have such great managers. Typical Buffett.

As always, a passion for work is important to Buffett if he believes in a management team = “tap dancing to work.”

An old Wall Street joke gets close to our experience:
 
Customer: Thanks for putting me in XYZ stock at 5. I hear it’s up to 18.
 
Broker: Yes, and that’s just the beginning. In fact, the company is doing so well now, that it’s an even better buy at 18 than it was when you made your purchase.
 
Customer: Damn, I knew I should have waited. - Warren Buffett

The plight of the misinformed customer.

Throughout the world, he is known as the man to call when something both very large and unusual needs to be insured. - Warren Buffett

Talking about Ajit Jain – The Super-Cat insurer. As opposed to GEICO – thousands of small contracts, he does a few big ones.

If Charlie, I and Ajit are ever in a sinking boat – and you can only save one of us – swim to Ajit. - Warren Buffett

Buffett loves Ajit Jain.

Big loss of $44 million and Warren considers it all his fault. GEICO credit cards weren’t such a great idea after all.

I subtly indicated that I was older and wiser. I was just older. - Warren Buffett

The MidAmerican Energy Holding has a home retailer that made money in 2009 despite a still falling housing market.

BSH owns regulated power monopolies in the midwest which reinvest all their profits back into the organizations to keep up with improving… Check it out they are even motivated by environmentalism:

Moreover, we continue to pour huge sums of money into our operations so as to not only prepare for the future but also make these operations more environmentally friendly. Since we purchased MidAmerican ten
years ago, it has never paid a dividend. We have instead used earnings to improve and expand our properties in each of the territories we serve. As one dramatic example, in the last three years our Iowa and Western utilities have earned $2.5 billion, while in this same period spending $3 billion on wind generation facilities. - Warren Buffett

Great stuff.

Indeed, the best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow. - Warren Buffett

Boom! Freedom Podcasting fits this category.

Theme: Working together for the betterment of the country and the people by not competing when working together is an option (in regards to big operations like electricity and railroads.)

Here’s a list of their manufacturing products: paint, jewelry, shoe manufacturing, agriculture equipment, furniture retailing, kitchen tools, candy manufacture and retailing, furniture retailing.
Notice a common thing here? Each one of these businesses has been around for more than 200 years.

ISCAR, the Israel based cutting tools operation was able to buy a japanese firm so they are ready to profit when building comes back. Greedy when others are fearful strategy at work.

NetJets was a huge loss, but Buffett put Dave Sokol (former builder/operator of Mid American Energy) in power. They lost $711 million in 2009 but Buffett reports the company is profitable now.

Buffett, the family and everyone he knows flies on NetJets. It’s a company they need to keep alive and safe going into the future. “We eat our own cooking,” he says.

Total industry output, meanwhile, has fallen from 382,000 units in 1999 to 60,000 units in 2009. - Warren Buffett

The numbers above denote the fall in Mobile home demand in 2009 of about 85%. Destruction.

Common theme with Buffett is “Competitive Positions.” This means they have picked the company that is the strongest in the industry… so while others fail (the 3 top modular home competitors which bankrupt in 2009) they keep going (with Clayton Homes.) Of course, big survivors bias here (as with NetJets) the reason the Berkshire Hathaway business don’t go broke is because they can lose a few hundred million in a year and turn it all around after the rest of the industry has died.

When it’s raining gold, reach for a bucket, not a thimble. - Warren Buffett

Great little Warren Buffett sayings to stick to memory.

We have long invested in derivatives contracts that Charlie and I think are mispriced, just as we try to invest in mispriced stocks and bonds. - Warren Buffett

Another common theme for Buffett and Munger; always looking for assets that are mispriced.

In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full responsibility for risk control. - Warren Buffett

Boom. Big “wag of the finger” on all investment banks that delegated (and incentivized the mismanagement) collateralized debt obligations to the lower management.

CEOs and, in many cases, directors have long benefitted from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well. - Warren Buffett

Back in 2007 (or was it 1994) Buffett was haranguing the large CEO bonuses and whatnot. Now his predictions have come to pass, but the government has bailed out the villains. The oracle of Omaha…

In evaluating a stock-for-stock offer, shareholders of the target company quite understandably focus on the market price of the acquirer’s shares that are to be given them. But they also expect the transaction to deliver them the intrinsic value of their own shares – the ones they are giving up. If shares of a prospective acquirer are selling below their intrinsic value, it’s impossible for that buyer to make a sensible deal in an all-stock deal. You simply can’t exchange an undervalued stock for a fully-valued one without hurting your shareholders.
 
Imagine, if you will, Company A and Company B, of equal size and both with businesses intrinsically worth $100 per share. Both of their stocks, however, sell for $80 per share. The CEO of A, long on confidence and short on smarts, offers 11⁄4 shares of A for each share of B, correctly telling his directors that B is worth $100 per share. He will neglect to explain, though, that what he is giving will cost his shareholders $125 in intrinsic value. If the directors are mathematically challenged as well, and a deal is therefore completed, the shareholders of B will end up owning 55.6% of A & B’s combined assets and A’s shareholders will own 44.4%. Not everyone at A, it should be noted, is a loser from this nonsensical transaction. Its CEO now runs a company twice as large as his original domain, in a world where size tends to correlate with both prestige and compensation. - Warren Buffett

This is a loaded analogy of how big company mergers work. Equal value companies of equal size and one merges to another with stock options. What happens? This is a great question to have on an MBA exam I would imagine. What’s going on here?

What’s happening is that value is misunderstood and purpose of each party is misunderstood as well. At the end, a large transaction has occurred to the benefit of another.

When stock is the currency being contemplated in an acquisition and when directors are hearing from an advisor, it appears to me that there is only one way to get a rational and balanced discussion. Directors should
hire a second advisor to make the case against the proposed acquisition, with its fee contingent on the deal not going through. Absent this drastic remedy, our recommendation in respect to the use of advisors remains: “Don’t ask the barber whether you need a haircut.” - Warren Buffett

Alluding back to the inversion approach theme from the previous memorable token.

Again Warren Buffett is railing out against these large, expensive investment banks and their wildly paid employees. The market value of a stock has little to do with the intrinsic value. Of course, it would be the most financially valuable skill ever to have Warren Buffett’s capacity for assessing the value of a company. From the letters it’s management, an understood industry, long term economic prospects and capital to profit ratios. It’s a lot of variables…

I can’t resist telling you a true story from long ago. We owned stock in a large well-run bank that for decades had been statutorily prevented from acquisitions. Eventually, the law was changed and our bank
immediately began looking for possible purchases. Its managers – fine people and able bankers – not unexpectedly began to behave like teenage boys who had just discovered girls.
 
They soon focused on a much smaller bank, also well-run and having similar financial characteristics in such areas as return on equity, interest margin, loan quality, etc. Our bank sold at a modest price (that’s why
we had bought into it), hovering near book value and possessing a very low price/earnings ratio. Alongside, though, the small-bank owner was being wooed by other large banks in the state and was holding out for a price close to three times book value. Moreover, he wanted stock, not cash. 
 
Naturally, our fellows caved in and agreed to this value-destroying deal. “We need to show that we are
in the hunt. Besides, it’s only a small deal,” they said, as if only major harm to shareholders would have been a legitimate reason for holding back. Charlie’s reaction at the time: “Are we supposed to applaud because the dog that fouls our lawn is a Chihuahua rather than a Saint Bernard?”
 
The seller of the smaller bank – no fool – then delivered one final demand in his negotiations. “After the merger,” he in effect said, perhaps using words that were phrased more diplomatically than these, “I’m going to be a large shareholder of your bank, and it will represent a huge portion of my net worth. You have to promise me, therefore, that you’ll never again do a deal this dumb.”
Yes, the merger went through. The owner of the small bank became richer, we became poorer, and the managers of the big bank – newly bigger – lived happily ever after. - Warren Buffett

A great analogy for gleaming another lesson about value investing from Mr. Buffett.

Ahhh to the annual meeting. It’s been molding over time. Once a small event, now described as the, “Woodstock for capitalists” with 35,000 attendees this year. That’s about as many people that went to Burningman in 2007.

The best reason to exit, of course, is to shop. - Warren Buffett

He’s still as consistent as ever.

At 86 and 79, Charlie and I remain lucky beyond our dreams. We were born in America; had terrific parents who saw that we got good educations; have enjoyed wonderful families and great health; and came equipped with a “business” gene that allows us to prosper in a manner hugely disproportionate to that
experienced by many people who contribute as much or more to our society’s well-being. Moreover, we have long had jobs that we love, in which we are helped in countless ways by talented and cheerful associates. Indeed, over the years, our work has become ever more fascinating; no wonder we tap-dance to work. If pushed, we would gladly pay substantial sums to have our jobs (but don’t tell the Comp Committee). - Warren Buffett

The reflections on the party are amazing. I mean, the event has been growing rapidly over the past few years. It’s probably bigger than BSH now.

An impressive year.
Continue reading

BHLC: 2008 Notes and Reviews of Berkshire Hathaway Shareholder Letter

Notes on Berkshire Hathaway Shareholder Letter from 2008

Brief Summary of the Year:

This has been, hands down, my favorite article so far. It’s probably because this was a year I remember very well and there were economic events unfolding that I never fully understood.

This is hands down the best thing I’ve ever read to really get down to the core of what was happening with the government bailout of 2008. It’s fascinating stuff.

It’s also great to experience Buffett in a down year. He’s always winning and even in the years which he looses, he keeps to his principles and seems honest with his appraisal of his job for the year.

Notes For the Year:

Our decrease in net worth during 2008 was $11.5 billion. - Warren Buffett

This is the first year (that I’ve read) in which Warren didn’t record growth in value. This will be interesting to read as it will give a great description of how a great investor deals with inevitable losses.

This [2008 financial system meltdown] debilitating spiral has spurred our govern- ment to take massive action. In poker terms, the Treasury and the Fed have gone   “all in.” Economic medicine that was previously meted out by the cupful has       recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome after effects. Their precise nature is anyone’s      guess, though one likely consequence is an onslaught of inflation. 
 
Moreover, major industries have become dependent on Federal assistance, and they  will be followed by cities and states bearing mind-boggling requests. Weaning     these entities from the public teat will be a political challenge. They won’t     leave willingly. - Warren Buffett

On the government bail-outs of 2008 and understanding the level of involvement the government had to take to keep the system from failing.

Amid this bad news, however, never forget that our country has faced far worse    travails in the past. In the 20th Century alone, we dealt with two great wars (oneof which we initially appeared to be losing); a dozen or so panics and recessions;virulent inflation that led to a 211⁄2% prime rate in 1980; and the Great Depress-ion of the 1930s, when unemployment ranged between 15% and 25% for many years.    America has had no shortage of challenges. - Warren Buffett

Ever the optimist Warren Buffett is. He notes that this isn’t the biggest challenge the US has ever faced…

Though the path has not been smooth, our economic system has worked extraordinar- ily well over time. It has unleashed human potential as no other system has, and  it will continue to do so. America’s best days lie ahead. - Warren Buffett

Warren Buffett on the long term sustainability of the US economic system (or/and the world economic system.)

In good years and bad, Charlie and I simply focus on four goals:
  • (1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash;

 

 

  • (2) widening the “moats” around our operating businesses that give them durable competitive advantages;

 

 

  • (3) acquiring and developing new and varied streams of earnings;

 

 

  • (4) expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results.

 

- Warren Buffett

Again, reiterating the points Buffett considers so important. Management, Moats, New Income steams and big positions, extra money and low obligation.

Buffett notes that the earnings of businesses connected to the overall economy suffered during this period but the businesses less directly related to the overall economy did great.

Again, the insurance business did great:

Nevertheless, the insurance group delivered an underwriting gain for the sixth    consecutive year. This means that our $58.5 billion of insurance “float” – money  that doesn’t belong to us but that we hold and invest for our own benefit – cost  us less than zero. In fact, we were paid $2.8 billion to hold our float during    2008. Charlie and I find this enjoyable...
 
...our insurance operation, the core business of Berkshire, is an economic        powerhouse.- Warren Buffett

Funny. Also, they get paid on every step of the way. Great business model.

Price is what you pay; value is what you get. - Ben Graham

Buffett goes on to discuss various businesses. MidAmerican, a real estate brokerage conglomerate that operates pipelines as well.

PacifiCorp was a 2006 purchase that has grown from 33 megawatts to 794 by this period while decreasing employees by 2%

Our long-avowed goal is to be the “buyer of choice” for businesses – particularly those built and owned by families. The way to achieve this goal is to deserve it. That means we must keep our promises; avoid leveraging up acquired businesses;    grant unusual autonomy to our managers; and hold the purchased companies through  thick and thin (though we prefer thick and thicker). - Warren Buffett

As always, the Berkshire Hathaway commitment to being a good buyer of businesses is powerful.

Buffett essentially bashes “private equity” firms as being fee rich and loading companies with bad debt. Now, that the economy is in a slump, these firms hold all their cash when it would be best for the businesses if they deployed the cash.

Again, Buffett is enamored with GEICO. For each employee at GEICO there were 299 policies in 2003, at this period there are 439 per employee. Efficiency has been the key to their massive success. Lower cost, high value.

General Re, our large international reinsurer, also had an outstanding year in    2008. Some time back, the company had serious problems (which I totally failed to detect when we purchased it in late 1998). By 2001, when Joe Brandon took over as CEO, assisted by his partner, Tad Montross, General Re’s culture had further      deteriorated, exhibiting a loss of discipline in underwriting, reserving and      expenses. After Joe and Tad took charge, these problems were decisively and       successfully addressed. Today General Re has regained its luster. Last spring Joe stepped down, and Tad became CEO. Charlie and I are grateful to Joe for righting  the ship and are certain that, with Tad, General Re’s future is in the best of    hands. - Warren Buffett

Warren Buffett’s way of seeing a replacement in management along with the general theme on the importance of managers.

It’s crucial that insurance companies have a robust culture of underwriting, reserving and expensing.

A promise is no better than the person or institution making it. - Warren Buffett

Another core theme of Buffett’s letters is the importance of being your word.

“It’s difficult for an empty sack to stand upright. - Ben Franklin

Buffett brings this up to illustrate that because General Re is backed by Berkshire Hathaway (a company with mammoth amounts of capital at hand), they can back all their promises.

To begin with, the need for meaningful down payments was frequently ignored. Some-times fakery was involved. (“That certainly looks like a $2,000 cat to me” says   the salesman who will receive a $3,000 commission if the loan goes through.)      Moreover, impossible-to-meet monthly payments were being agreed to by borrowers   who signed up because they had nothing to lose. The resulting mortgages were      usually packaged (“securitized”) and sold by Wall Street firms to unsuspecting    investors. This chain of folly had to end badly, and it did. - Warren Buffett

Warren Buffett summing up the poor mortgage behavior and even more scandalous behavior of wall street selling the securities.

He then goes into discussing Clayton homes and says that they didn’t participate in the poor mortgage behavior like the rest of the financial industry.

Why are our borrowers – characteristically people with modest incomes and far-from-great credit scores – performing so well? The answer is elementary, going right  back to Lending 101. Our borrowers simply looked at how full-bore mortgage        payments would compare with their actual – not hoped-for – income and then decidedwhether they could live with that commitment. Simply put, they took out a mortgagewith the intention of paying it off, whatever the course of home prices.          - Warren Buffett
Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with    shaky balance sheets but government backing. At the moment, it is much better to  be a financial cripple with a government guarantee than a Gibraltar without one.  - Warren Buffett
We wrote this “second-to-pay” insurance for rates averaging 3.3%. That’s right; wehave been paid far more for becoming the second to pay than the 1.5% we would haveearlier charged to be the first to pay. In one extreme case, we actually agreed tobe fourth to pay, nonetheless receiving about three times the 1% premium charged  by the monoline that remains first to pay. In other words, three other monolines  have to first go broke before we need to write a check. - Warren Buffett

After this statement, Buffett goes on to describe the dangerousness of the business. Essentially, they are ensuring that bonds will be paid, but if bonds aren’t paid on a large scale, the decision on how to sort the problem out will fall on government which will be likely to side with the people rather than the bond insurance holder.

Investors should be skeptical of history-based models. - Warren Buffett
Our advice: Beware of geeks bearing formulas. - Warren Buffett
I still believe the odds are good that oil sells far higher in the future than thecurrent $40-$50 price. But so far I have been dead wrong. Even if prices should   rise, moreover, the terrible timing of my purchase has cost Berkshire several     billion dollars. - Warren Buffett

Regarding the purchase of ConocoPhillips, Buffett bought an oil and gas company right when oil and gas prices were at their apex.

Beware the investment activity that produces applause; the great moves are usuallygreeted by yawns. - Warren Buffett

Timeless investing advice I believe.

Derivatives are dangerous. They have dramatically increased the leverage and risksin our financial system. They have made it almost impossible for investors to     understand and analyze our largest commercial banks and investment banks. They    allowed Fannie Mae and Freddie Mac to engage in massive miss-statements of        earnings for years. So indecipherable were Freddie and Fannie that their federal  regulator, OFHEO, whose more than 100 employees had no job except the oversight ofthese two institutions, totally missed their cooking of the books.                - Warren Buffett

The mistakes Freddie and Fannie were making were so tremendous that the government couldn’t even see them. Despite the fact that they were the most heavily regulated organizations in the US, they still were able to create tremendous problems that went under the radar of all the regulators.

Warren Buffett on what happened in 2008 with the financial derivatives market and why it’s so dangerous to have derivative contracts on the books.

A normal stock or bond trade is completed in a few days when one party getting itscash, the other its securities. Counterparty risk therefore quickly disappears,   which means credit problems can’t accumulate. This rapid settlement process is keyto maintaining the integrity of markets. That, in fact, is a reason for NYSE and
NASDAQ shortening the settlement period from five days to three days in 1995.
 
Derivatives contracts, in contrast, often go unsettled for years, or even decades,with counterparties building up huge claims against each other. “Paper” assets andliabilities – often hard to quantify – become important parts of financial state- ments though these items will not be validated for many years. Additionally, a    frightening web of mutual dependence develops among huge financial institutions.  Receivables and payables by the billions become concentrated in the hands of a fewlarge dealers who are apt to be highly-leveraged in other ways as well.           Participants seeking to dodge troubles face the same problem as someone seeking toavoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with.
 
Sleeping around, to continue our metaphor, can actually be useful for large       derivatives dealers because it assures them government aid if trouble hits. In    other words, only companies having problems that can infect the entire            neighborhood – I won’t mention names – are certain to become a concern of the     state (an outcome, I’m sad to say, that is proper). From this irritating reality comes The First Law of Corporate Survival for ambitious CEOs who pile on leverage  and run large and unfathomable derivatives books: Modest incompetence simply won’tdo; it’s mindboggling screw-ups that are required. - Warren Buffett

How it benefits the financial industry to take big, dangerous bets and share all the bad debt tools amongst each other. They created a situation where they were all in such a bad place that they were backed up by the government.

My belief that the CEO of any large financial organization must be the Chief Risk Officer as well. If we lose money on our derivatives, it will be my fault.        - Warren Buffett

As always, Warren takes all the credit when he succeeds and fails in business. It’s ok for him to trade derivatives contracts because he monitors them and knows what’s happening.
It doesn’t work for the big financial firms and the government backed firms because when they build these derivatives contract portfolios that are largely created by people who are incentivized to buy more (via fees and commissions.) It’s a Moral Hazard to have others do it, for Buffett, it’s his name on the line so he has the moral incentive to get it right.

Black Scholes formula – This is a big one. Read the wikipedia to get it in your brain.

Buffett goes into describing 4 categories of contracts Berkshire holds. 1. Equity portfolio 2. Derivatives requiring Berkshire Hathaway when credit losses occur 3. Credit Default Swaps for corporations who can’t pay their debt. 4. Tax-exempt bond insurance contracts.

This is valuable stuff. When seeking an understanding of derivatives markets, I don’t think there is a better way to understand it than to read this passage.

Continue reading

BHLC: 2007 Notes and Reviews of Berkshire Hathaway Shareholder Letter

Notes on Berkshire Hathaway Shareholder Letter from 2007

Brief Summary of the Year:

Despite harrowing things going on in the economy this year, Berkshire profited largely from another year nearly free of super catastrophes (for which they insure against.) Buffett calls out some imperfections in the US economy like grotesque financial practices and a pension program that is unlikely to perform as promised. Of course, he goes on merrily regarding many great decisions in value-rich organizations that out perform the economy in huge ways. As always, the wrap up and invite to the party is lovely and enticing.

Notes For the Year:

Our gain in net worth during 2007 was $12.3 billion, which increased the per-sharebook value of both our Class A and Class B stock by 11%. Over the last 43 years   (that is, since present management took over) book value has grown from $19 to    $78,008, a rate of 21.1% compounded annually.* - Warren Buffett

Warren Buffett is dependable. You can count on him starting off each of these letters with the exact same thing. Results.

Overall, our 76 operating businesses did well last year. The few that had problemswere primarily those linked to housing, among them our brick, carpet and real     estate brokerage operations. Their setbacks are minor and temporary. Our          competitive position in these businesses remains strong, and we have first class  CEOs who run them right, in good times or bad. - Warren Buffett

Straight to the point about CEOs and management being a soul of excellent companies.

Today, our country is experiencing widespread pain because of that erroneous      belief. As house prices fall, a huge amount of financial folly is being exposed.  You only learn who has been swimming naked when the tide goes out – and what we   are witnessing at some of our largest financial institutions is an ugly sight.    - Warren Buffett

Wow, swimming naked when the tide goes out…

We also were very lucky in 2007, the second year in a row free of major insured   catastrophes. - Warren Buffett

Again Buffett acknowledges his managerial team for a job well done and again (as in 2007) they escape super catastrophes which they insure against.

This must have helped them in 2007 to avoid some of the economic turmoil of the year. They had another great year of insuring against evils that never came to be.

That party is over. It’s a certainty that insurance-industry profit margins,      including ours, will fall significantly in 2008. Prices are down, and exposures inexorably rise. Even if the U.S. has its third consecutive catastrophe-light year, industry profit margins will probably shrink by four percentage points or so. If  the winds roar or the earth trembles, results could be far worse. So be prepared  for lower insurance earnings during the next few years. - Warren Buffett
Berkshire’s past record can’t be duplicated or even approached. Our base of assetsand earnings is now far too large for us to make outsized gains in the future.    - Warren Buffett

Again, Buffett (as in 2006 & 1995) is reminding people that they will have challenges making so much money in the future because their simply too large to allocate capital in the same areas.

In our efforts, we will be aided enormously by the managers who have joined Berk- shire. This is an unusual group in several ways. First, most of them have no      financial need to work. Many sold us their businesses for large sums and run them because they love doing so, not because they need the money. - Warren Buffett

Of course, Warren is speaking about the CEOs of the companies they purchase. They are very wealthy people who continue to run the businesses despite the fact that they could go live on a yatch for the rest of their lives.

Lesson: When looking for a company to invest in, invest in the one that is run by a team who are there for the love of the game, not for the money.

Conversely, our CEO’s scorecards for success are not whether they obtain my job   but instead are the long-term performances of their businesses. Their decisions   flow from a here-today, here-forever mindset. I think our rare and hard-to-  replicate managerial structure gives Berkshire a real advantage. - WarrenBuffett

The love for the long term performance of the business is what Warren looks for in the managerial team. This is the soul factor of great dedicated management teams.

Here, we made little progress in 2007 until very late in the year. Then, on       Christmas day, Charlie and I finally earned our pay checks by contracting for the largest cash purchase in Berkshire’s history. The seeds of this transaction were  planted in 1954. - Warren Buffett

They didn’t make any deals until Christmas. Again the theme, “We don’t make lots of calls, but when we do it’s big.”

Anyways, this deal has been brewing since 1954!

We will soon purchase 60% of Marmon and will acquire virtually all of the balance within six years. - Warren Buffett

Latest acquisition Marmon Group.

During the past year, many large deals have been renegotiated or killed entirely. With the Pritzkers, as with Berkshire, a deal is a deal. - Warren Buffett

A deal is a deal. Many large deals were killed because of complications, the one that went through was the one that was based on a handshake and a look at the financial statements. “No advisors, no nit-picking.”

Another common theme in these letters, simplicity, honor and common sense when making business deals.

Byron Trott of Goldman Sachs – whose praises I sang in the 2003 report –          facilitated the Marmon transaction. Byron is the rare investment banker who puts  himself in his client’s shoes. Charlie and I trust him completely.                - Warren Buffett

Goldman Sachs’s Byron Trott facilitated the deal for Berkshire Hathaway and Marmon. It’s interesting that they outsource for facilitators in deals like this. Of course, it makes perfect sense too.

Charlie and I look for companies that have a) a business we understand; b) favor- able long-term economics; c) able and trustworthy management; and d) a sensible   price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we arealso happy to simply buy small portions of great businesses by way of stockmarket purchases. It’s better to have a part interest in the Hope Diamond than to own allof a rhinestone. 
 
A truly great business must have an enduring “moat” that protects excellent       returns on invested capital. The dynamics of capitalism guarantee that competitorswill repeatedly assault any business “castle” that is earning high returns. There-fore a formidable barrier such as company’s being the low cost producer (GEICO,   Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American  Express) is essential for sustained success. Business history is filled with      “Roman  Candles,” companies whose moats proved illusory and were soon crossed.
 
Our criterion of “enduring” causes us to rule out companies in industries prone torapid and continuous change. Though capitalism’s “creative destruction” is highly beneficial for society, it precludes investment certainty. A moat that must be    continuously rebuilt will eventually be no moat at all.
 
Additionally, this criterion eliminates the business whose success depends on     having a great manager. Of course, a terrific CEO is a huge asset for any enter-  prise, and at Berkshire we have an abundance of these managers. Their abilities   have created billions of dollars of value that would never have materialized if   typical CEOs had been running their businesses. But if a business requires a superstar to produce great results, the business itself cannot be deemed great. A      medical partnership led by your area’s premier brain surgeon may enjoy outsized   and growing earnings, but that tells little about its future. The partnership’s   moat will go when the surgeon goes. You can count, though, on the moat of the MayoClinic to endure, even though you can’t name its CEO. - Warren Buffett

Most straight forward way to understand how Warren Buffett and Charlie Mungers pick companies.

Just as Adam and Eve kick-started an activity that led to six billion humans,     See’s has given birth to multiple new streams of cash for us. (The biblical       command to “be fruitful and multiply” is one we take seriously at Berkshire.)     - Warren Buffett

This is is a humorous wrap up to a very important lesson regarding how long term business decisions begin to branch into many beautiful things while moving forward. The lesson, take profits and reinvest them into other attractive businesses… of course, the most attractive businesses will be making too much money to reinvest 100% of the money into them.

When we purchased FlightSafety in 1996, its pre-tax operating earnings were $111  million, and its net investment in fixed assets was $570 million. Since our pur-  chase, depreciation charges have totalled $923 million. But capital expenditures  have totalled $1.635 billion, most of that for simulators to catch the new air-   plane models that are constantly being introduced. (A simulator can cost us more  than $12 million, and we have 273 of them.) - Warren Buffett

Remarkable. Another business Berkshire Hathaway is involved in.

Now let’s move to the gruesome. The worst sort of business is one that grows      rapidly, requires significant capital to engender the growth, and then earns      little or no money. Think airlines. Here a durable competitive advantage has      proven elusive ever since the days of the Wright Brothers. Indeed, if a farsightedcapitalist had been present at Kitty Hawk, he would have done his successors a    huge favor by shooting Orville down. - Warren Buffett

Warren Buffett Hates Airlines.

To sum up, think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are      added. Finally, the gruesome account both pays an inadequate interest rate and    requires you to keep adding money at those disappointing returns. - Warren Buffett

Again, all very obvious but it’s interesting to hear and take in these lessons. The key to a powerful asset is that you keep getting paid by it. Duh, right?

To date, Dexter is the worst deal that I’ve made. But I’ll make more mistakes in  the future – you can bet on that. A line from Bobby Bare’s country song explains  what too often happens with acquisitions: “I’ve never gone to bed with an ugly    woman, but I’ve sure woke up with a few.” - Warren Buffett

Remarkably open about his mistakes. In the paragraph above he discusses how this mistake cost $433 million. It was a mistake he made in 1993!

This self depreciating confession is clearly framed in a way that establishes him as honest and willing to let the ugly side show. You know, he’s still sitting on billions of gains for the month so the investors reading this are unlikely to be upset with him about a measly $433 million right?

Now they get into accounting. Check out the tables:
Berkshire Hathaway Float:Underwriting Loss 67-71

They started off making little, but they carried millions in float. This is an interesting aspect… just because you’re making little profit, how do you account for the value of carrying so much money? Is this expensive or are they profiting from the activity?Berkshire Hathaway Float:Underwriting Loss 03-07
So they learned a lot. Now they’re making millions on it and jeez, holding billions of dollars in float! Again, is this a great thing to have so much money that isn’t yours in the bank? I mean, as long as you don’t touch it, it’s no big deal right?

When Berkshire acquired control in 1995, that share was 2.5%. Not coincidentally, annual ad expenditures by GEICO have increased from $31 million to $751 million   during the same period. - Warren Buffett

Buffett seems to be in love with GEICO.

Berkshire has an 87.4% (diluted) interest in MidAmerican Energy - Warren Buffett

What does diluted stock mean? It means that shares have been issued since purchase which change the fundamental positions and effect things like voting rights, ownership percentage and the value of individual shares.

We agreed to purchase 35,464,337 shares of MidAmerican at $35.05 per share in     1999, a year in which its per-share earnings were $2.59. Why the odd figure of    $35.05? I originally decided the business was worth $35.00 per share to Berkshire.Now, I’m a “one-price” guy (remember See’s?) and for several days the investment  bankers representing MidAmerican had no luck in getting me to increase Berkshire’soffer. But, finally, they caught me in a moment of weakness, and I caved, telling them I would go to $35.05. With that, I explained, they could tell their client   they had wrung the last nickel out of me. At the time, it hurt. - Warren Buffett

How to wring a nickel out of Warren Buffett.
So I wanted to know exactly what I’m looking at when reading a balance sheet so I figured it would be great to get a revamping of skills. If you’d like to play along, I suggest going through this Khan Academy exercise. It’s free.

Also another diversion yet useful in exploring this subject, check out The World’s Billionaires.

Susan came to Borsheims 25 years ago as a $4-an-hour saleswoman. Though she lackeda managerial background, I did not hesitate to make her CEO in 1994. She’s smart, she loves the business, and she loves her associates. That beats having an MBA    degree any time. - Warren Buffett

Warren Buffett on the importance and value of an MBA.

(An aside: Charlie and I are not big fans of resumes. Instead, we focus on brains,passion and integrity. Another of our great managers is Cathy Baron Tamraz, who   has significantly increased Business Wire’s earnings since we purchased it early  in 2006. She is an owner’s dream. It is positively dangerous to stand between     Cathy and a business prospect. Cathy, it should be noted, began her career as a   cab driver.) - Warren Buffett

Again, resumes are no good. Focus on brains (or hard work in understanding a specific subject), passion and integrity. Brains, Passion & Integrity.

For many decades, Iscar moved tungsten to Israel, where brains turned it into something far more valuable. Late in 2007, Iscar opened a large plant in Dalian,      China. In effect, we’ve now moved the brains to the tungsten. Major opportunities for growth await Iscar. It's management team, led by Eitan Wertheimer, Jacob      Harpaz, and Danny Goldman, is certain to make the most of them. - Warren Buffett

The Tungsten used to move to Israel where it was made into tools by brainy types. Now the brainy types have moved to China where the tools are made by brainy types. Funny way to say, we exported manufacturing to Dalian, China.

The NetJets brand – with its promise of safety, service and security – grows      stronger every year. - Warren Buffett

NetJet is still doing well.

Clayton’s loan portfolio is financed by Berkshire. For this funding, we charge    Clayton one percentage point over Berkshire’s borrowing cost – a fee that amountedto $85 million last year. Clayton’s 2007 pre-tax earnings of $526 million are     after its paying this fee. The flip side of this transaction is that Berkshire    recorded $85 million as income, which is included in “other” in the following     table. - Warren Buffett

Clayton Homes, the largest U.S. manufacturer and marketer of homes is owned by Berkshire Hathaway and they loan money to the company as well. So they are a investment client and when they win, Berkshire gets the gains in income too! What an advantageous set up.

P&G and Coke began business in 1837 and 1886 respectively. Start-ups are not our  game. - Warren Buffett

Hey Warren Buffett? Are you looking for a startup company to invest in?

The second test, more subjective, is whether their “moats” – a metaphor for the   superiorities they possess that make life difficult for their competitors – have  widened during the year. All of the “big four” scored positively on that test.    - Warren Buffett

Again with the “Moat” theme. Warren likes businesses that are insulated from competition in one way or another. Notice Wal-Mart, Kraft, Johnson & Johnson, Coca-Cola, Anheuser-Busch Company, American Express. Of course, it’s going to be hard to create a company that goes head to head and captures large amounts of brand equity.

We made one large sale last year. In 2002 and 2003 Berkshire bought 1.3% of       PetroChina for $488 million, a price that valued the entire business at about $37 billion. Charlie and I then felt that the company was worth about $100 billion. By2007, two factors had materially increased its value: the price of oil had climbedsignificantly, and PetroChina’s management had done a great job in building oil   and gas reserves. In the second half of last year, the market value of the companyrose to $275 billion, about what we thought it was worth compared to other giant  oil companies. So we sold our holdings for $4 billion. A footnote: We paid the IRStax of $1.2 billion on our PetroChina gain. This sum paid all costs of the U.S.   government – defence, social security, you name it – for about four hours.        - Warren Buffett

On selling their PetroChina holdings for $4 billion. Wow.

The sale culminated in $1.2 billion which pays for the US government for 4 hours. Wow.

Buffett has increased his derivatives contracts that he manages from 62 to 94. He splits them into 2 categories.

Important aspects of the derivative contracts market. 1. No Counterparty Risk as they hold the money. 2. Differing accounting rules for derivatives contracts so they are only effecting the balance sheets if they are sold or written down.

You will recall that in our catastrophe insurance business, we are always ready totrade increased volatility in reported earnings in the short run for greater gainsin net worth in the long run. That is our philosophy in derivatives as well.      - Warren Buffett

Trade volatility for value and net worth? Of course.

The U.S. dollar weakened further in 2007 against major currencies, and it’s no    mystery why: Americans like buying products made elsewhere more than the rest of  the world likes buying products made in the U.S. Inevitably, that causes America  to ship about $2 billion of IOUs and assets daily to the rest of the world. And   over time, that puts pressure on the dollar. - Warren Buffett

Warren Buffett on the value of the dollar when Americans are buying more than producing.

They invested in the Brazilian Real.

But any Brazilian who followed this apparently prudent course would have lost halfhis net worth over the past five years. Here’s the year-by-year record (indexed)  of the real versus the dollar from the end of 2002 to year end 2007: 100; 122; 133; 152; 166; 199. Every year the real went up and the dollar fell. Moreover, duringmuch of this period the Brazilian government was actually holding down the value  of the real and supporting our currency by buying dollars in the market. - Warren Buffett

A few questions here:
1. Why does the Real double in value against the dollar from 2002 to 2007?
2. Why was the Brazilian Government holding the value down by buying dollars? (competition? to drive up exports? a policy to keep food prices down?)
3. How does Buffett know that the Brazilian government is buying US dollars? Is this publicly available information?

For example, in 2001 and 2002 we purchased €310 million Amazon.com, Inc. 6 7/8 of 2010 at 57% of par. At the time, Amazon bonds were priced as “junk” credits,      though they were anything but. (Yes, Virginia, you can occasionally find markets  that are ridiculously inefficient – or at least you can find them anywhere except at the finance departments of some leading business schools.) - Warren Buffett

Imagine buying Amazon in 2001/2002 for almost nothing because the stocks value was considered junk. Pierre Odimar would be your partner now!

Getting back to the succession bit. Now they are up to 3 successors whereas last year he only had one. Guess the Fredrick W. Cook and Company didn’t screw up the industry too much.

During the 20th Century, the Dow advanced from 66 to 11,497. This gain, though it appears huge, shrinks to 5.3% when compounded annually. - Warren Buffett

The Dow shows an annual gain of 5.3% (not 7% like I generally thought… perhaps the S&P 500 returns 7%?)

Naturally, everyone expects to be above average. And those helpers – bless their  hearts – will certainly encourage their clients in this belief. But, as a class,  the helper-aided group must be below average. The reason is simple: 1) Investors, overall, will necessarily earn an average return, minus costs they incur; 2) Pass-ive and index investors, through their very inactivity, will earn that average    minus costs that are very low; 3) With that group earning average returns, so mustthe remaining group – the active investors. But this group will incur high trans- action, management, and advisory costs. Therefore, the active investors will have their returns diminished by a far greater percentage than will their inactive     brethren. That means that the passive group – the “know-nothings” – must win.     - Warren Buffett

Again the Gotrock family and the helpers are not going to help. It’s better to do nothing (e.g. invest and hold for the long term in value rich companies) than hire financial advisors and other “helper” types.

Buffett anticipates that pension plans won’t play out the way they are promised. He doesn’t say social security directly, and maybe he isn’t discussing social security… but that’s what I gleam while reading this. Of course, he’s probably talking about 401ks and Roth IRA’s as well. Also, government positions and their pension plans.

I’ve never been a believer that my Social Security debits from past pay checks will ever be realized so this doesn’t come as too much of a surprise… but with Warren Buffett alluding to a point that may support this, I’ll doubtlessly be looking elsewhere.

A fellow was on an important business trip in Europe when his sister called to    tell him that their dad had died. Her brother explained that he couldn’t get back but said to spare nothing on the funeral, whose cost he would cover. When he      returned, his sister told him that the service had been beautiful and presented   him with bills totalling $8,000. He paid up, but a month later received a bill    from the mortuary for $10. He paid that, too – and still another $10 charge he    received a month later. When a third $10 invoice was sent to him the following    month, the perplexed man called his sister to ask what was going on. “Oh,” she    replied, “I forgot to tell you. We buried Dad in a rented suit.” - Warren Buffett

Rented suit – The term has a new meaning now. Despite the grotesque nature of the allegory, it’s a valuable thing to avoid in business. Yet, a great deal if you’re the suit rental company.

Continue reading

BHLC: 2006 Notes and Reviews of Berkshire Hathaway Shareholder Letter

Notes on Berkshire Hathaway Shareholder Letter from 2006

Brief Summary of the Year:

Berkshire Hathaway claim the largest single year gain in net worth by an American organization in all time. It’s amazing. The piece is wary of the credit usage by American’s as a whole and the growth in “helpers” who take money out of the economy without producing much of value. It ends, as always on a happy note, inviting everyone to the big party.

Notes For the Year:

The pattern remains the same. I anticipate that Buffett will always start these letters with the same thing: Results. Of course, they are probably positive results.

21% means they are down from their previous results in 1994. Economic problems during 2001 must not have been great to Berkshire Hathaway but their results are still remarkable even when down. This will be exciting to read each new letter as we progress into the 2008 financial mess. Will Warren and Charlie be able to avoid the toxic debt? My guess is, yes because of their investment strategy.

Our gain in net worth during 2006 was $16.9 billion, which increased the per-sharebook value of both our Class A and Class B stock by 18.4%. Over the last 42 years (that is, since present management took over) book value has grown from $19 to    $70,281, a rate of 21.4% compounded annually.*
We believe that $16.9 billion is a record for a one-year gain in net worth – more than has ever been booked by any American business, leaving aside boosts that haveoccurred because of mergers (e.g., AOL’s purchase of Time Warner). Of course,     Exxon Mobil and other companies earn far more than Berkshire, but their earnings  largely go to dividends and/or repurchases, rather than to building net worth.    - Warren Buffett

Wow. 16.9 billion gain in net worth in a year. Perhaps the biggest gain in net value of any American business of all time. Amazing. I love to imagine being world class, imagine what it’d be like to be on the team that created the largest amount of wealth ever in a year. What a remarkable feeling.

Attributes the year’s success to the lack of super disasters which they insure against (hurricanes, floods, fires, etc.)

Last year, the red ink from this activity [super-cat insurance] turned black –    very black. - Warren Buffett

This is a fun way to say, “we made a whole lot of money.”

Tony Nicely, GEICO’s CEO, went to work at the company 45 years ago, two months    after turning 18. - Warren Buffett

As always, Warren places a high value on management. He goes on to describe how GEICO’s policies increased from 5.7 to 8.1 million at a time when employees fell 3.5 percent. Amazing results. Not so great for GEICO employees likely… that would be an interesting story to hear: “How working at GEICO changed during 2006.” Perhaps only interesting to business geeks that is.

Last year I told you that if you had a new son or grandson to be sure to name him Tony. But Don Keough, a Berkshire director, recently had a better idea. After     reviewing GEICO’s performance in 2006, he wrote me, “Forget births. Tell the shareholders to immediately change the names of their present children to Tony or      Antoinette.” Don signed his letter “Tony.” - Warren Buffett

This is hilarious. You can tell Warren loves the people he works with and the game of owning big companies.

“We shape our buildings, and afterwards our buildings shape us.” - Warren Buffett" - Winston Churchill

Buffett is great at selecting quality quotes.
He quotes Ronald Reagan again with this quote: “It’s probably true that hard work never killed anyone – but why take the chance?”

So I’ve taken the easy route, just sitting back and working through great managerswho run their own shows. My only tasks are to cheer them on, sculpt and harden ourcorporate culture, and make major capital-allocation decisions. - Warren Buffett
We’ve long wanted, nonetheless, to extend Berkshire’s appeal beyond U.S.borders.  And last year, our globe-trotting finally got underway. - Warren Buffett

Berkshire went global in 2006. This is interesting.

Their first international purchase was ISCAR, who makes and sells small, consumable cutting tools and large machine tools.

The result: ISCAR makes money because it enables its customers to make more money.There is no better recipe for continued success. - Warren Buffett

How to succeed in business according to Warren Buffett. Of course, this statement is a standard for him. Common sense, clear as day statements that are so obvious that I guess they get overlooked.

[Owner of a company] loves running his business. - Warren Buffett

Another purchase in a year? Perhaps they are ramping it up because they are making so much more money.

This purchase for an electronic components company called TTI

It’s quite interesting to hear Warren talking about Love as an asset to a managerial team. This isn’t what I expected when reading through this. TTI’s CEO Paul Andrews, Jr. wanted to set up an owner for the company because he saw the disruptive nature of a dying founder. So reason for selling is clearly an important role when allocating capital.

Our exemplar is the older man who crashed his grocery cart into that of a much    younger fellow while both were shopping. The elderly man explained apologetically that he had lost track of his wife and was preoccupied searching for her. His new acquaintance said that by coincidence his wife had also wandered off and suggestedthat it might be more efficient if they jointly looked for the two women. Agreeing, the older man asked his new companion what his wife looked like. “She’s a gorg- eous blonde,” the fellow answered, “with a body that would cause a bishop to go   through a stained glass window, and she’s wearing tight white shorts. How about yours?” The senior citizen wasted no words: “Forget her, we’ll look for yours.”
 
What we are looking for is described on page 25. If you have an acquisition       candidate that fits, call me – day or night. And then watch me shatter a stained  glass window. - Warren Buffett
When we were due to close the purchase at Charlie’s office, Jack was late. Finallyarriving, he explained that he had been driving around looking for a parking meterwith some unexpired time. That was a magic moment for me. I knew then that Jack   was going to be my kind of manager. - Warren Buffett

What Warren Buffett looks for in a quality management team? – FRUGALITY

The big unknown is super-cat insurance. Were the terrible hurricane seasons
of 2004-05 aberrations? Or were they our planet’s first warning that the climate  of the 21st Century will differ materially from what we’ve seen in the past? If   the answer to the second question is yes, 2006 will soon be perceived as a        misleading period of calm preceding a series of devastating storms. These could
rock the insurance industry. It’s naïve to think of Katrina as anything close to aworst-case event.
 
Neither Ajit Jain, who manages our super-cat operation, nor I know what lies      ahead. We do know that it would be a huge mistake to bet that evolving atmosphericchanges are benign in their implications for insurers. - Warren Buffett

Warren Buffett on climate change and super-cat insurance.

Be fearful when others are greedy, and be greedy when others are fearful. - WarrenBuffett

The super-cat industry is filling up with new entrants so they are making less from it. Warren alludes to the idea that they may soon not take on the exposure as the premiums are going down.

He goes on to give a history of the insurance agency. It’s well written and fun to read.

What’s important to remember is that retroactive insurance contracts always       produce underwriting losses for us. - Warren Buffett

So reading this, I didn’t understand what Underwriting Losses were (wiki). Essentially underwriting gain or loss is the money left over from insurance activities after payouts and admin costs are covered. It doesn’t account for extra income created through investment of said activities.

In the above quote, Warren describes the accounting challenges when declaring big wins when playing the super-catastrophe insurance game. They diversify the costs to be $450 million a year while bringing in more than that to stay profitable. The size of this challenge is helpful to Berkshire Hathaway because they are a rare organization that can accept such large amounts.

Aren’t you glad that I promised you there would be no quiz? - Warren Buffett

Buffett is a great writer. This is the conclusion of a very dense accounting/super-cat insurance game details he wraps the whole thought up at the end with this. He promised at the beginning of the category that this was heavy stuff and there would be a quiz.

This motley group, which sells products ranging from lollipops to motor homes,    earned a pleasing 25% on average tangible net worth last year. It’s noteworthy    also that these operations used only minor financial leverage in achieving that   return. Clearly we own some terrific businesses. - Warren Buffett

Companies that can grow in net worth without financial leverage is attractive to Buffett.

Companies and their products in Berkshire’s Manufacturing, Service and Retailing Operations:
Shaw Industries – Carpet Producer
MiTek – Manufacturer of Connectors for Roof Trusses

“If you want to get a reputation as a good businessman, be sure to get into a good business.” - A Wise Friend

Buffett goes into a story about how profitable the newspaper industry was when they were young, indeed even a poor newpaper couldn’t avoid, “gushing profits.”

According to Buffett the larger the paper, the more ad’s. People trusted the newspapers with more ad’s so the industry became a game of “Survival of the Fattest.”

Simply put, if cable and satellite broadcasting, as well as the internet, had comealong first, newspapers as we know them probably would never have existed.        - Warren Buffett

In 2006 Buffett realized the newspaper game is a dying one.

Fixed costs are high in the newspaper business, and that’s bad news when unit     volume heads south. - Warren Buffett

Again, on the decaying nature of the newspaper industry.
Surprisingly, Buffett decides to stay in the game despite his expectations that the gushing profits will stop. Still, they expect the businesses to stay profitable. Will be interesting to see going forward if they continue to stay afloat and if Berkshire Hathaway stays in the game.

Once you’ve flown NetJets, returning to commercial flights is like going back to  holding hands. - Warren Buffett

Again with the value and management importance for their investments. NetJets is a company that does fractional ownership and rental of private business jets.

The slowdown in residential real estate activity stems in part from the weakened  lending practices of recent years. The “optional” contracts and “teaser” rates    that have been popular have allowed borrowers to make payments in the early years of their mortgages that fall far short of covering normal interest costs.         Naturally, there are few defaults when virtually nothing is required of a         borrower. As a cynic has said, “A rolling loan gathers no loss.” But payments not made add to principal, and borrowers who can’t afford normal monthly payments     early on are hit later with above-normal monthly obligations. This is the ScarlettO’Hara scenario: “I’ll think about that tomorrow.” For many home owners,          “tomorrow” has now arrived. Consequently there is a huge overhang of offerings in several of 'HomeServices’ markets. Nevertheless, we will be seeking to purchase   additional brokerage operations. A decade from now, HomeServices will almost      certainly be much larger. - Warren Buffett

Here we’ve got Buffett seeing the growth in sub-prime mortgages. Despite that, he looks to the even longer term and he believes that purchasing housing brokerage companies going forward is still a good idea. I’m interested to see how this plays out in the upcoming letters.

I fervently believe in real trade – the more the better for both us and the world.We had about $1.44 trillion of this honest-to-God trade in 2006. But the U.S. alsohad $.76 trillion of pseudo-trade last year – imports for which we exchanged no   goods or services. (Ponder, for a moment, how commentators would describe the     situation if our imports were $.76 trillion – a full 6% of GDP – and we had no    exports.) Making these purchases that weren’t reciprocated by sales, the U.S.     necessarily transferred ownership of its assets or IOUs to the rest of the world. Like a very wealthy but self-indulgent family, we peeled off a bit of what we     owned in order to consume more than we produced. - Warren Buffett

Alluding to economic problems in the USA. We’re spending money we don’t have and giving nothing but IOUs in return. 2006 development of trade problems in the US.

He continues…

These transfers will have consequences, however. Already the prediction I made    last year about one fall-out from our spending binge has come true: The “invest-  ment income” account of our country – positive in every previous year since 1915 –turned negative in 2006. Foreigners now earn more on their U.S. investments than  we do on our investments abroad. In effect, we’ve used up our bank account and    turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience “reverse compounding” as we pay ever-increasing amounts of interest on interest. - Warren Buffett

The consequences of living on credit will be felt by the younger generations…
He continues…

I want to emphasize that even though our course is unwise, Americans will live    better ten or twenty years from now than they do today. Per-capita wealth will    increase. But our citizens will also be forced every year to ship a significant   portion of their current production abroad merely to service the cost of our huge debtor position. It won’t be pleasant to work part of each day to pay for the over-consumption of your ancestors. I believe that at some point in the future U.S.   workers and voters will find this annual “tribute” so onerous that there will be asevere political backlash. How that - Warren Buffett

Ominous stuff from Mr. Buffett. The nature of consumption in the USA turned from growth and production to gluttony and consumption in 2006. I’m very interested to see how this plays out going forward in the letters of 2007 and 2008 as it all comes crashing down.

Why, you may wonder, are we fooling around with such potentially toxic material?  The answer is that derivatives, just like stocks and bonds, are sometimes wildly  miss priced. - Warren Buffett

The derivatives markets play an important role in the coming financial crash. Of course, Buffett didn’t know this at the time. I’m very interested to see how this plays out going forward.

The good news: At 76, I feel terrific and, according to all measurable indicators,am in excellent health. It’s amazing what Cherry Coke and hamburgers will do for afellow. - Warren Buffett

As always, he discusses his health and the prospects of a new predecessor. Funny that they have a challenge for hiring someone because if they bring anyone on, they will immediately have a resume worth far more than their current position. If someone takes a job with Berkshire, they immediately could move on and make more money and manage more money at a different firm.

In 1929, the first Malcolm G. Chace played an important role in merging four New  England textile operations into Berkshire Fine Spinning Associates. That company  merged with Hathaway Manufacturing in 1955 to form Berkshire Hathaway, and MalcolmG. Chace, Jr. became its chairman. - Warren Buffett

How the name Berkshire Hathaway came to be.

And – surprise, surprise – director compensation has soared in recent years,      pushed up by recommendations from corporate America’s favorite consultant,        Ratchet, Ratchet and Bingo. - Warren Buffett

I didn’t understand what this means. Essentially Buffett is denouncing consulting firms (like Frederic W. Cook’s) who persuade large organizations to pay their managing directors wildly. In this New York Times article, you can learn all about it.
Funny, Buffett says he likes to live comfortably but Munger is all Sackcloth and Ashes.

Charlie and I believe our four criteria are essential if directors are to do theirjob – which, by law, is to faithfully represent owners. Yet these criteria are    usually ignored. Instead, consultants and CEOs seeking board candidates will oftensay, “We’re looking for a woman,” or “a Hispanic,” or “someone from abroad,” or   what have you. It sometimes sounds as if the mission is to stock Noah’s ark. Over the years I’ve been queried many times about potential directors and have yet to  hear anyone ask, “Does he think like an intelligent owner?” The questions I       instead get would sound ridiculous to someone seeking candidates for, say, a foot-ball team, or an arbitration panel or a military command. In those cases, the     selectors would look for people who had the specific talents and attitudes that   were required for a specialized job. At Berkshire, we are in the specialized      activity of running a business well, and therefore we seek business judgment.     - Warren Buffett

How to select a team to perform a specific job well. Also, this is really funny -> “… it sounds as if the mission is to stock Noah’s ark.” LoL

Berkshire will pay about $4.4 billion in federal income tax on its 2006 earnings. In its last fiscal year the U.S. Government spent $2.6 trillion, or about $7      billion per day. Thus, for more than half of one day, Berkshire picked up the tab for all federal expenditures, ranging from Social Security and Medicare payments  to the cost of our armed services. Had there been only 600 taxpayers like         Berkshire, no one else in America would have needed to pay any federal income or  payroll taxes. - Warren Buffett

Wow! Berkshire and the federal government. The US government spends 7 billion a day. Holy Cow! Berkshire paid $4.4 billion in federal income tax for 2006… That’s tremendous…. but it only pays for 1/2 a day of federal expenditures. I’d guess that truckloads of money are being burnt in this world by the federal government. Wow.

Last year I arranged for the bulk of my Berkshire holdings to go to five          charitable foundations, thus carrying out part of my lifelong plan to eventually  use all of my shares for philanthropic purposes. - Warren Buffett

An honorable plan.

In last year’s report I allegorically described the Gotrocks family – a clan that owned all of America’s businesses and that counterproductively attempted to       increase its investment returns by paying ever-greater commissions and fees to    “helpers.” Sad to say, the “family” continued its self-destructive ways in 2006.  - Warren Buffett

CNN Money has an excerpt of Warren’s 2005 letter which I thought was very valuable describing the allegoric Gotrocks Family and the helpers they bring on to suck their money away.
Note: Call this promise the adult version of Lake Woebegon. Another character trait of Buffett -> Old school American found of public radio’s, A Prairie Home Companion.

In 2006, promises and fees hit new highs. A flood of money went from institutionalinvestors to the 2-and-20 crowd. For those innocent of this arrangement, let me   explain: It’s a lopsided system whereby 2% of your principal is paid each year to the manager even if he accomplishes nothing – or, for that matter, loses you      abundle – and, additionally, 20% of your profit is paid to him if he succeeds,    even if his success is due simply to a rising tide. - Warren Buffett

Two and Twenty is a pricing structure for financial planners and hedge fund managers. They’re the “helpers” in Buffett’s Gotrock Family allegory.

Buffett is clearly not a fan of all of these helpers that take money from productive businesses that create value and ingest it into “helping” organizations which create no real-value in the economy.

The inexorable math of this grotesque arrangement is certain to make the   Gotrocks family poorer over time than it would have been had it never heard of    these “hyper-helpers.” Even so, the 2-and-20 action spreads. Its effects bring to mind the old adage: When someone with experience proposes a deal to someone with  money, too often the fellow with money ends up with the experience, and the fellowwith experience ends up with the money
There is simply no possibility that what Walter Schloss achieved over 47 years wasdue to chance. - Warren Buffett

Walter Schloss – Learn more about this guy. He, Warren Buffett and Benjamine Graham are the “value investors.”

...a new Berkshire movie will be shown at 8:30 - Warren Buffett

If you have ever seen a Berkshire movie could you please point it out. I’d love to link up a Berkshire movie in this post. Please comment below or send me a message (ian@ianrobinson.net) Thank you.

Books mentioned by Warren in this Letter:
Seeking Wisdom: From Darwin to Munger by Peter Bevelin

This book (Where are the Customers’ Yachts?) was first published in 1940 and is   now in its 4th edition. The funniest book ever written about investing, it lightlydelivers many truly important messages on the subject - Warren Buffett

Where are the Customers’ Yachts? by Fred Schwed

Charlie and I are extraordinarily lucky. We were born in America; had terrific    parents who saw that we got good educations; have enjoyed wonderful families and  great health; and came equipped with a “business” gene that allows us to prosper  in a manner hugely disproportionate to other people who contribute as much or moreto our society’s well-being. Moreover, we have long had jobs that we love, in     which we are helped every day in countless ways by talented and cheerful          associates. No wonder we tap dance to work. But nothing is more fun for us than   getting together with our shareholder-partners at Berkshire’s annual meeting. So  join us on May 5th at the Qwest for our annual Woodstock for Capitalists. We’ll   see you there. - Warren Buffett

As always, they seem to be enjoying life in a humble yet fitting way for a pair of guys who spent the year increasing their nominal net worth to a degree never before seen in American history.

Let’s see how they keep up in the coming years. 2007 will be another good one likely, but 2008? We’ll see…

Continue reading

BHLC: 1994 Notes and Reviews of Berkshire Hathaway Shareholder Letter

Notes on Berkshire Hathaway Shareholder Letter from 1994

Brief Summary of the Year:

Buffett is all about the simple, honest business principles. I thought this would be challenging to understand, but he makes it simple and rooted in common sense. I think that’s the power of these letters.

Notes For the Year:

Foreword: This is my second time reading a Berkshire Hathaway article so there will be revelation notes regarding continuations in format and other gems you get when diving into a new subject and begin to make connections. I hope these notes and quotes help you in whatever your working on.

Again he starts with dramatic yet simple numbers. 13.9% gain in 1994. Over the past 30 years, 23%. Very simple and to the point.

Charlie Munger, Berkshire's Vice Chairman and my partner, 
and I make few predictions.  One we will confidently offer, 
however, is that the future performance of Berkshire won't come 
close to matching the performance of the past. - Warren Buffett

So this is a bit odd. He’s telling everyone that he doesn’t think they will perform like in the past. If his job is to attract investors, this is uncommon behavior. Perhaps that’s why it works so well.

The problem is not that what has worked in the past will 
cease to work in the future.  To the contrary, we believe that 
our formula - the purchase at sensible prices of businesses that 
have good underlying economics and are run by honest and able 
people - is certain to produce reasonable success. - Warren Buffett

As always, he’s a devotee to his strategy of intrinsic value being composed of sensible prices, underlying economic formula & management teams. (Change from the pervious year? No, but omitting something from the previous years list of 5.)

A fat wallet, however, is the enemy of superior investment 
results. - Warren Buffett
"If something is not worth doing at all, it's not 
worth doing well." - Charlie Munger

So in 1994 Charlie and Warren decided they would only invest in companies in which they could deploy $100 million plus. Their investment universe has shrunk dramatically.

Ted Williams, in The Story of My Life:

"My argument is, to be a good hitter, you've got to get a good ball to hit.  It's the first rule in the book.  If I have to bite at stuff that is out 
of my happy zone, I'm not a .344 hitter.  I might only be a .250 
hitter."  Charlie and I agree and will try to wait for 
opportunities that are well within our own "happy zone." - Warren Buffett

Again like 1993, Buffett describes that just because they are holding considerable cash, they aren’t likely to do anything with it unless it’s a sure win (or in their “happy zone.”)

We will continue to ignore political and economic forecasts, 
which are an expensive distraction for many investors and 
businessmen. - Warren Buffett

Forget politics and economic forecasts and mark them as unimportant.

Indeed, we have usually made our best purchases when 
apprehensions about some macro event were at a peak.  Fear is the 
foe of the faddist, but the friend of the fundamentalist. - Warren Buffett

Faddist?

What we promise you - along with more modest gains - is that 
during your ownership of Berkshire, you will fare just as Charlie 
and I do.  If you suffer, we will suffer; if we prosper, so will 
you.  And we will not break this bond by introducing compensation 
arrangements that give us a greater participation in the upside 
than the downside. - Warren Buffett

Their pricing structure is not predatory like Bank of America or many investment “offers.” They are in the battle with their clients and losses and wins are shared by all. Alignment of incentives.

Casey Stengel described managing a baseball team as "getting paid for home runs ather fellows hit."  That's my formula at Berkshire, also. - Warren Buffett

Warren Buffett’s formula for investing.

Again, like last year, Buffett dives into the success of Gillette and Coke illustrating why they are so important to the success of the company.

It's far better to own a significant portion of the Hope 
diamond than 100% of a rhinestone, and the companies just 
mentioned easily qualify as rare gems.  Best of all, we aren't 
limited to simply a few of this breed, but instead possess a 
growing collection. - Warren Buffett

Again, pressing the value of intrinsic value and why choosing great companies is the key to their success.

We continue to give you book value figures, however, because they serve as a      rough, albeit significantly understated, tracking measure for Berkshire's 
intrinsic value. - Warren Buffett

Book Numbers to Buffett aren’t the most valuable indicators (maybe they are in Jim Cramer’s Mad Money) because one should focus on intrinsic value rather than book value. They provide the data as an understated, rough meaning of the value of a company.

We define intrinsic value as the discounted value of the 
cash that can be taken out of a business during its remaining 
life. - Warren Buffett

I’m pretty sure this is a direct repetition from last years definition of intrinsic value.

Now let's get less academic and look at Scott Fetzer, an 
example from Berkshire's own experience.  This account will not 
only illustrate how the relationship of book value and intrinsic 
value can change but also will provide an accounting lesson that 
I know you have been breathlessly awaiting.  Naturally, I've 
chosen here to talk about an acquisition that has turned out to 
be a huge winner.

     Berkshire purchased Scott Fetzer at the beginning of 1986.  
At the time, the company was a collection of 22 businesses, and 
today we have exactly the same line-up - no additions and no 
disposals.  Scott Fetzer's main operations are World Book, Kirby, 
and Campbell Hausfeld, but many other units are important 
contributors to earnings as well.

     We paid $315.2 million for Scott Fetzer, which at the time 
had $172.6 million of book value.  The $142.6 million premium we 
handed over indicated our belief that the company's intrinsic 
value was close to double its book value.

     In the table below we trace the book value of Scott Fetzer, 
as well as its earnings and dividends, since our purchase. - Warren Buffett

How intrinsic value and book value shift over time.

Throughout our years of ownership, Scott Fetzer has operated as a 
conservatively-financed and liquid enterprise. - Warren Buffett

Conservatively-financed liquid enterprise – This is something to aspire to as a young entrepreneur.

You might expect that Scott Fetzer's success could only be 
explained by a cyclical peak in earnings, a monopolistic 
position, or leverage.  But no such circumstances apply.  Rather, 
the company's success comes from the managerial expertise of CEO 
Ralph Schey, of whom I'll tell you more later. - Warren Buffett

Again with the hailing of great management teams. Great management teams play a pivotal role in Warren Buffett’s love for your business.

The reasons for Ralph [Schey]'s success are not complicated.  Ben 
Graham taught me 45 years ago that in investing it is not 
necessary to do extraordinary things to get extraordinary 
results. - Warren Buffett

Buffett is purposeful in giving credit to others. His mentor from 45 years ago especially as he is mentioned in 1993′s letter too.

Charlie and I, at 71 and 64 respectively, now keep George Foreman's 
picture on our desks.  You can make that our book scorn for a 
mandatory retirement age will grow stronger every year. - Warren Buffett

“You can make book.” ? What does that mean -> Warren Buffett on how retirement age is for suckers. His love for investing shines through in every word of this letter.

Understanding intrinsic value is as important for managers 
as it is for investors.  When managers are making capital 
allocation decisions - including decisions to repurchase shares - 
it's vital that they act in ways that increase per-share, 
intrinsic value and avoid moves that decrease it.  This principle 
may seem obvious but we constantly see it violated.  And, when 
misallocations occur, shareholders are hurt. - Warren Buffett
Going back to our college-education example, imagine that a 25-year-old 
first-year MBA student is considering merging his future economic 
interests with those of a 25-year-old day laborer.  The MBA 
student, a non-earner, would find that a "share-for-share" merger 
of his equity interest in himself with that of the day laborer 
would enhance his near-term earnings (in a big way!).  But what 
could be sillier for the student than a deal of this kind? - Warren Buffett

Warren Buffett thinks you should get a job, not an MBA.

Almost by definition, a really good business generates 
far more money (at least after its early years) than it can use 
internally. - Warren Buffett

Warren Buffets advice for picking good companies, find one’s that have far more money than it can use internally. Sounds obvious right?

The acquisition problem is often compounded by a biological 
bias:  Many CEO's attain their positions in part because they 
possess an abundance of animal spirits and ego.  If an executive 
is heavily endowed with these qualities - which, it should be 
acknowledged, sometimes have their advantages - they won't 
disappear when he reaches the top.  When such a CEO is encouraged 
by his advisors to make deals, he responds much as would a 
teenage boy who is encouraged by his father to have a normal sex 
life.  It's not a push he needs. - Warren Buffett

About CEO’s – How they got to their position creates a challenge when they are advised to start building investment opportunities. They rose to the top of an organization, that doesn’t mean they are good at (or even competent) at capital allocation. Warren and Charlie are the top investors in the world and they only buy a company a year.

At Berkshire, our managers will continue to earn 
extraordinary returns from what appear to be ordinary businesses. 
As a first step, these managers will look for ways to deploy 
their earnings advantageously in their businesses.  What's left, 
they will send to Charlie and me.  We then will try to use those 
funds in ways that build per-share intrinsic value.  Our goal 
will be to acquire either part or all of businesses that we 
believe we understand, that have good, sustainable underlying 
economics, and that are run by managers whom we like, admire and 
trust. - Warren Buffett

How they structure the business inside Berkshire Hathaway and another plug at intrinsic value.

In setting compensation, we like to hold out the promise of 
large carrots, but make sure their delivery is tied directly to 
results in the area that a manager controls. - Warren Buffett

Warren Buffett about setting compensation and providing big money opportunities to management teams, as long as the money is tied directly to results that the manager has direct control over. Again, it seems so obvious, but when things get large, it’s easy to lose track.

The product of this money's-not-free approach is definitely 
visible at Scott Fetzer.  If Ralph can employ incremental funds 
at good returns, it pays him to do so:  His bonus increases when 
earnings on additional capital exceed a meaningful hurdle charge. 
But our bonus calculation is symmetrical:  If incremental 
investment yields sub-standard returns, the shortfall is costly 
to Ralph as well as to Berkshire.  The consequence of this two-
way arrangement is that it pays Ralph - and pays him well - to 
send to Omaha any cash he can't advantageously use in his 
business. - Warren Buffett

MONEY’S-NOT-FREE APPROACH – This goes in direct contradiction to the way some government sectors waste money to show that they need more money. Here at the best capital allocation organization in the world, they do the opposite, you have money you don’t know how to spend? Just sent it up the ladder and we’ll keep the cash until a great deal comes around.

In our book, alignment means being a partner in both directions, not just on the  upside. Many "alignment" plans flunk this basic test, being artful forms 
of "heads I win, tails you lose." - Warren Buffett

Alignment of incentives is so important. He’s back on the same point.

I can't resist mentioning that our compensation arrangement 
with Ralph Schey was worked out in about five minutes,
immediately upon our purchase of Scott Fetzer and without the 
"help" of lawyers or compensation consultants. - Warren Buffett

Another theme of Warren Buffett deals. The deal is worked out easily, no lawyers, no compensation consultants. This was similar with the 100 year old woman from last years letters. A hand-shake and a good business managers word are all you need to be sure of a solid deal. Simplicity at the highest courts of business.

It made sense to him and to me in 1986, and it makes sense now. - Warren Buffett

Long term approach to great deal setting.

In all instances, we pursue rationality. - Warren Buffett

Again, great simple deals. How to prosper over the long run is to seek rational, mutually beneficial relationships.

We have carefully designed both the company and our jobs so that we do things we  enjoy with people we like. Equally important, we are forced to do very few 
boring or unpleasant tasks. - Warren Buffett

On how to build organizations that maximize what they are the best at. Follow your passion message from Warren Buffett.

Indeed, if we were not paid at all, Charlie and I would be 
delighted with the cushy jobs we hold.  At bottom, we subscribe 
to Ronald Reagan's creed:  "It's probably true that hard work 
never killed anyone, but I figure why take the chance." - Warren Buffett

Warren Buffett on the value of hard work. LoL

Our intent is to supply you with the financial information that we would wish you to give us if our positions were reversed. - Warren Buffett

Again he’s repeating himself here. The Golden Rule seems to be a constant at Berkshire Hathaway.

LOOK THROUGH EARNINGS – Source: http://www.investopedia.com/terms/l/look-through-earnings.asp

Look-through earnings include the profits that a company pays to its shareholders in the form of dividends and the retained earnings that the company uses to expand its operations. This concept was popularized by Warren Buffet to analyze the overall earnings-generating capabilities of the firm. The idea is that all of these profits have value to investors – the dividends provide an immediate benefit, while the retained earnings should increase the stock’s value in the future.

As we've explained in past reports, what counts in our 
insurance business is, first, the amount of "float" we develop and, 
second, its cost to us.  Float is money we hold but don't own.  In 
an insurance operation, float arises because most policies require 
that premiums be prepaid and, more importantly, because it usually 
takes time for an insurer to hear about and resolve loss claims. - Warren Buffett

How Warren Buffett describes float money which is money they hold but don’t own yet. This is like when you pay an insurance company, they keep some of that cash on hand to prepare for the inevitable claims that are sure to come and need to be paid out. They would call it float money as it’s money they have but can’t spend.

Here Berkshire has a major advantage: Ajit Jain, our super-cat manager, whose 
underwriting skills are the finest.  His value to us is simply enormous.          - Warren Buffett

Again pointing out excellence in managing partners – a common theme of the letters.

He mentioned the size of Berkshire Hathaway allows it to take $400 million risk of a Caifornia earthquake insurance (Super-cat policies – Super Catastrophe Policies.)

Too often, insurers (as well as other businesses) follow sub-
optimum strategies in order to "smooth" their reported earnings.  
By accepting the prospect of volatility, we expect to earn higher 
long-term returns than we would by pursuing predictability. - Warren Buffett

When doing long term insurance Warren Buffett expects volatility and long-term returns to be better to seek out than pursuing predictability. On this podcast, Mike Dever talks about volatility and how creating predictability is important. This also makes me think of what Nicholas Nassim Taleb says about betting against things that are resistant to volatility.

For example, were we to have super-cat losses from a large Southern California    earthquake, they might well be accompanied by a major drop in the value of our    holdings in See's, Wells Fargo and Freddie Mac. - Warren Buffett

Notice that Buffett is exposed to Freddie Mac. It will be fun to see.

We try to price, rather than time, purchases.  In our view, it 
is folly to forego buying shares in an outstanding business whose 
long-term future is predictable, because of short-term worries 
about an economy or a stock market that we know to be 
unpredictable.  Why scrap an informed decision because of an 
uninformed guess? - Warren Buffett

- He is often self deprecating.

Rather, this was a case of sloppy analysis, a lapse that may have been caused by  the fact that we were buying a senior security or by hubris.  Whatever the reason,the mistake was large. - Warren Buffett

I wonder what exactly constitutes a sloppy analysis of a company in Warren Buffett’s mind.

During this period, with the longer-term problems largely invisible but slowly    metastasizing, the costs that were non-sustainable became further embedded.       - Warren Buffett

Invisible long term problems (in this case cost issues) lead to non-sustainable business practice.

-He goes into the airline industry, deregulation and how it effected them over the long run with the USAir investment.

In an unregulated commodity business, a company must lower its costs to           competitive levels or face extinction. - Warren Buffett

Warren Buffett on commodities and competitive sustainability.

Bankruptcy court for airlines has become a health spa. - Herb Kelleher

On the fluctuations of the airline industry.

A prime rule of investing:  You don't have to make it 
back the way that you lost it. - Warren Buffett

Prime Rule of Investing

We made only one minor acquisition during 1994 - a small 
retail shoe chain - but our interest in finding good candidates 
remains as keen as ever.  The criteria we employ for purchases or 
mergers is detailed in the appendix on page 21. - Warren Buffett

In all of 1994 Warren and Charlie made one acquisition despite 422 million in undistributed earnings of major investments.

Last year we displayed some of Berkshire's products at the 
meeting, and as a result sold about 800 pounds of candy, 507 pairs 
of shoes, and over $12,000 of World Books and related publications. 
All these goods will be available again this year. - Warren Buffett

They sell lots of their own products at their annual meetings.

When you're there be sure to say hello to Mrs. B, who, at 101, will be hard at    work in our Mrs. B's Warehouse. - Warren Buffett

Here’s a great example of the hard work ethic/theme in these letters.

About 1,400 shareholders attended the event 
last year.  Opening the game that night, I had my stuff and threw a 
strike that the scoreboard reported at eight miles per hour.  What 
many fans missed was that I shook off the catcher's call for my 
fast ball and instead delivered my change-up.  This year it will be 
all smoke.   - Warren Buffett

Question I would Love Answered:

What is Warren Buffett’s research cycle when exploring new companies?

I bet he goes to meet with management teams and spends a good amount of time with each company that fits a specified criteria. Buffett is proud of the corporate jet which I’m sure enables a quicker, more enjoyable travel process than anyone doing commercial airlines in the US today.

Anyways, what are your thoughts? Do you know any information on this?

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BHLC: 1993 Notes and Reviews of Berkshire Hathaway Shareholder Letter

Notes on Berkshire Hathaway Shareholder Letter from 1993

Brief Summary of the Year:

This is an informative and very well written letter to the investors. It’s a great read. Warren Buffett is a great writer using funny jokes and embedding the content with a very deep and confident voice and company culture. He hammers down his belief in Value investing and provides laymen terms descriptions for just what exactly that means.

Notes For the Year:

Increase of 14.3 % of per-share book value

"Over the last 29 years (that is, since present management took over)
 book value has grown from $19 to $8,854, or at a rate of 23.3%
 compounded annually." - Warren Buffett

-Powerful Record! the last 29 years – 23.3% average? Amazing as the stock market average is 17% so they’re crushing it.

A change in GAAP caused problems at first but the change resulted in a net worth growth of $172 million.

Intrinsic value is a present-value estimate of the 
cash that can be taken out of a business during its remaining 
life. - Warren Buffett

-Wow. Warren Buffett’s Intrinsic Value (Wiki) definition.

Pulling examples from Coke’s

"In the short-run, the market is a voting 
machine - reflecting a voter-registration test that requires only 
money, not intelligence or emotional stability - but in the long-
run, the market is a weighing machine." - Ben Graham

He looks at a vast array of history to provide examples like Coke’s 1920 price and how 1 share of Coke in 1993 would, with dividends reinvested, today be worth $2.1 million.

Charlie Munger, Berkshire's Vice Chairman, and I can 
attain our long-standing goal of increasing Berkshire's per-share 
intrinsic value at an average annual rate of 15%.  We have not 
retreated from this goal. - Warren Buffett

Powerful statement. We have not retreated from our goal…

But we again emphasize, as we have for 
many years, that the growth in our capital base makes 15% an 
ever-more difficult target to hit. - Warren Buffett

The problem he’s saying is that Berkshire Hathaway is so big that their goals will likely become harder to hit due to the size of their capital base.

What we have going for us is a growing collection of good-
sized operating businesses that possess economic characteristics 
ranging from good to terrific, run by managers whose performance 
ranges from terrific to terrific.  You need have no worries about 
this group. - Warren Buffett

This is the big brag. He’s expressing confidence.

He’s saying, “We found the best investments ->

Traits Warren Buffett Looks for When  Investing: Good-Sized, Operating, good to terrific economic characteristics (?), terrific managers. Goes on to tell the story of acquiring Dexter Shoes and assuring the people that its a great company.

Dexter, I can assure you, needs no fixing:  It is one of the 
best-managed companies Charlie and I have seen in our business 
lifetimes.

He’s really proud of USA companies staying highly competitive:

As you probably know, the domestic shoe industry is generally thought to be unableto compete with imports from low-wage countries. But someone forgot to tell this  to the ingenious managements of Dexter and H. H. Brown and to their skilled labor forces, which together make the U.S. plants of both companies highly competitive  against all comers. - Warren Buffett

More about the Founding of Dexter Shoes.

"Five years ago we had no thought of getting into shoes.  Now we have 7,200       employees in that industry, and I sing "There's No Business Like Shoe Business" asI drive to work.  So much for strategic plans." Warren Buffett

He’s really proud and comical in this. It’s great. I wasn’t anticipating these letters to be so readable.

What they did, in effect, was trade a 100% interest in a single terrific business for a smaller interest in a large group of terrific businesses.  They incurred no tax on this exchange and now own a security that can be easily used for charitableor personal gifts, or that can be converted to cash in amounts, and at times, of  their own choosing.

-This is in regards to the sale of Dexter and it’s interesting how simple and straightforward they make it sound. I thought this would be legal heavy, but it’s not.

-Notice the focus on not paying taxes so the money could be used in charitable or personal gifts and cash.

"Additionally, Harold and Peter know that at Berkshire we can 
keep our promises:  There will be no changes of control or 
culture at Berkshire for many decades to come.  Finally, and of 
paramount importance, Harold and Peter can be sure that they will 
get to run their business - an activity they dearly love - 
exactly as they did before the merger.  At Berkshire, we do not 
tell .400 hitters how to swing." - Warren Buffett

Regarding the control of Dexter Shoes that Berkshire will not be enforcing. This may be what makes Berkshire Hathaway such a dominant force these days. “We do not tell .400 hitters how to swing.” They seek investments in which they need no new tasks after purchasing. Interesting questions: how do they run all these companies so easily. Ownership must not be a time suck for them.

Our intent is to supply you with the financial information that we would wish you to give us if our positions were reversed. - Warren Buffett

The Golden Rule – Do to others as you would have them do unto you – The Warren Buffett approach to communicating with investors.

In the past, we've criticized the managerial practice of shooting the arrow of    performance and then painting the target, centering it on whatever point the arrowhappened to hit.  We will instead risk embarrassment by painting first and        shooting later. - Warren Buffett

Warren Buffett’s commitment to goal setting, the importance of honesty when striving to reach goals.

There's no use running if you're on the wrong road. - Warren Buffett

As always, he sums it up excellently in non-investor terms. This is his explanation saying that: “it makes no sense to invest simply because you have cash in the bank”

Going into TAXES

Charlie and I have absolutely no complaint about these taxes.  We know we work in a market-based economy that rewards our efforts far more bountifully than it does the efforts of others whose output is of equal or greater benefit to society.     Taxation should, and does, partially redress this inequity.  But we still remain  extraordinarily well-treated. - Warren Buffett

Powerful statement on taxes, and how people are living amazing lives and the taxes help the less “bountiful.”

Charlie and I would follow a buy-and-hold policy even if we ran a tax-exempt      institution.  We think its the soundest way to invest, and it also goes down the  grain of our personalities. - Warren Buffett

Charlie and Warren are just good old people purchasing companies that have long term value.

Appassionatta Van Climax

Great story of a comic book that reflects the nature of exponential investing power and the mindset to really get it. Story of the temptress – guy wants to marry her but needs 1 million – the double your money once a year lesson –  still it’s a call to the importance of Long Term – Buy and Hold policy.

Mentions the nominal nature of the effect on the fund by the Los Angeles Earthquake.

But if the quake had been a 7.5 instead of a 6.8, it would have been a different  story. - Warren Buffett

He uses big meta data packed phrases like this to really go deep without boring the audience for the article (e.g. describing the statistics related in trusting/not trusting Earthquake data.

All in all, we have a first-class insurance business.  Though its results will be highly volatile, this operation possesses an intrinsic value that exceeds its bookvalue by a large amount - larger, in fact, than is the case at any other Berkshirebusiness. - Warren Buffett

-Big explanation about the state of Berkshires’s favorable insurance standing

...it is usually foolish to part with an interest in a business that is both      understandable and durably wonderful. - Warren Buffett

Again, on the value of buy and hold on the basis of intrinsic value. What makes a intrinsic business? It is “understandable and durably wonderful.”

In our view, what makes sense in business also makes sense in stocks:  An investorshould ordinarily hold a small piece of an outstanding business with the same     tenacity that an owner would exhibit if he owned all of that business.            - Warren Buffett

On staying with a company religiously – true relationship to the idea of “investing.” They place importance in being a new partner for the company. Their trust is a pillar of the companies they purchase likely.

Indeed, we'll now settle for one good idea a year.  (Charlie says it's my turn.)

On the irregularities of their purchases. 1 a year between the two of them.

In fact, the true investor welcomes volatility.  Ben Graham explained why in      Chapter 8 of The Intelligent Investor.  There he introduced "Mr. Market"

Get a copy of The Intelligent Investor by Ben Graham on Amazon.

Mr. Market is the guy at your door everyday ready to buy and sell. The crazier that Dude looks, the more opportunities are on offer. But it shouldn’t stress you out, you can always just buy nothing and sell nothing.

The primary factors bearing upon this evaluation [of real risk] 
are:

     1) The certainty with which the long-term economic 
        characteristics of the business can be evaluated;

     2) The certainty with which management can be evaluated, 
        both as to its ability to realize the full potential of 
        the business and to wisely employ its cash flows;

     3) The certainty with which management can be counted on 
        to channel the rewards from the business to the 
        shareholders rather than to itself;

     4) The purchase price of the business;

     5) The levels of taxation and inflation that will be 
        experienced and that will determine the degree by which 
        an investor's purchasing-power return is reduced from his 
        gross return. - Warren Buffett

My sum up of the rules for evaluating risk:

1. Long term growth potential (Blockbuster no Good)

2. Can the team do what the company needs to survive

3. Trust in Managers to not be greedy

4. The price

5. Taxes

Moreover, both Coke and Gillette have actually increased their 
worldwide shares of market in recent years.  The might of their 
brand names, the attributes of their products, and the strength of 
their distribution systems give them an enormous competitive 
advantage, setting up a protective moat around their economic 
castles.

Interesting mindset: The brand, product and distribution systems of medium companies are the attractive attributes as they provide long term “economic castles.”

The theoretician bred on beta has no mechanism for 
differentiating the risk inherent in, say, a single-product toy 
company selling pet rocks or hula hoops from that of another toy 
company whose sole product is Monopoly or Barbie.

On the Power of Brand – It’s hard for purely data guys to see the difference between a hula hoop and a barbie.

Why search for a needle buried in a haystack when one is sitting in plain sight?  - Warren Buffett

Optimal Minimalism – Sometimes the easy road is the better one followed.

Corporate Governance section going into what happens if Buffett is hit by a truck.

For the boards just discussed, I believe the directors ought 
to be relatively few in number - say, ten or less - and ought to 
come mostly from the outside.  The outside board members should 
establish standards for the CEO's performance and should also 
periodically meet, without his being present, to evaluate his 
performance against those standards.

This about the attributes of a quality team of board members (few in number, come from outside the business) and have a structure in which the board reports to the CEO.

The requisites for board membership should be business savvy, 
interest in the job, and owner-orientation.  Too often, directors 
are selected simply because they are prominent or add diversity to 
the board.  That practice is a mistake. - Warren Buffett

What it takes to be on the board at Berkshire Hathaway.  Also, he calls out the practice of having predominant directors simply because they are predominant. They should be experts in the space and be able to produce value in the company based on the work they will do for the organization.

If the controlling owner is intelligent and self-confident, he will make decisionsin respect to management that are meritocratic and pro-shareholder. Moreover - andthis is critically important - he can readily correct any mistake he makes.       - Warren Buffett

On why people in the industry should be heading the companies. Also, he focuses on the incentive for the controlling owner to be in charge.

All in all, we're prepared for "the truck." - Warren Buffett

Warren Buffett has created a systems of governance so if he dies tomorrow, Berkshire Hathaway will continue on without him.

Indeed, our entire corporate overhead is less than half the size of our charitablecontributions.  (Charlie, however, insists that I tell you that $1.4 million of   our $4.9 million overhead is attributable to our corporate jet, The Indefensible.)

This consistent message in the letter, “We are giving away a lot and very frugal… but we are doing just fine.”

-A Big list on charitable givings to places like churches and synagogues, colleges and universities, k-12 schools, art humanities, religious social-service organizations, secular social-service organizations, hospitals & health related organizations. – NOTE: These are the donations from Berkshire Investors who give money to charities.

To participate in future programs, you must make sure your 
shares are registered in the name of the actual owner, not in the 
nominee name of a broker, bank or depository.  Shares not so 
registered on August 31, 1994 will be ineligible for the 1994 
program.

They enjoy working with investors 1 on 1 and not having a bank or broker between them.

Mrs. B - Rose Blumkin - had her 100th birthday on December 3, 
1993.  (The candles cost more than the cake.)  That was a day on 
which the store was scheduled to be open in the evening.  Mrs. B, 
who works seven days a week, for however many hours the store 
operates, found the proper decision quite obvious:  She simply 
postponed her party until an evening when the store was closed.

Incredible stories of personal notes but with a hint of the frugality and hard work that is core to their company culture.

Our part in all of this began ten years ago when Mrs. B sold control of the       business to Berkshire Hathaway, a deal we completed without obtaining audited     financial statements, checking real estate records, or getting any warranties.  Inshort, her word was good enough for us.
Don Keough, as an individual, invariably increases the happiness of those around  him.  It's impossible to think about Don without feeling good.

What elegant words. Don Keough must be a great guy.

The impressions I formed in those days about Don were a factor 
in my decision to have Berkshire make a record $1 billion 
investment in Coca-Cola in 1988-89.  Roberto Goizueta had become 
CEO of Coke in 1981, with Don alongside as his partner.  The two of 
them took hold of a company that had stagnated during the previous 
decade and moved it from $4.4 billion of market value to $58 
billion in less than 13 years.  What a difference a pair of 
managers like this makes, even when their product has been around 
for 100 years.

Addressing great managers Keough and Roberto Goizueta.

Details on the Annual Meeting – Where it’s held, 2,200 people turning up, will have the holding’s consumer products displayed.

Funny Note:

At the Meeting they have a ferry to the Nebraska Furniture Mart.

He tells everyone about the baseball game the day before the event (mentions a probably unsuccessful investment in the Royals.)

 I will throw the first pitch on the 23rd, and it's a certainty 
that I will improve on last year's humiliating performance.  On 
that occasion, the catcher inexplicably called for my "sinker" and 
I dutifully delivered a pitch that barely missed my foot.  This 
year, I will go with my high hard one regardless of what the 
catcher signals, so bring your speed-timing devices.  The proxy 
statement will include information about obtaining tickets to the 
game.  I regret to report that you won't have to buy them from 
scalpers.

Ends on a funny note.

Wow. Great Article really.

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Seeking No-Fee Small Business Banking Ideal for Location Independent Entreprenerus

So I’m documenting my search for a Small Business Checking Account that doesn’t charge fees for non-value added activity. This post will evolve over time as I find more information.

Note: This is not for a personal checking account. If you want the best personal checking account for location independent entrepreneurs go with this one (no fees, reimburses international ATM charges, connects with investing, on the fly mobile deposits, friendly easy to reach people and easy to operate mobile and internet banking.)

Why Am I Switching From Small Business Banking with Bank of America?

Leave Bank of America as a Small Business BankI’ve had to call and wait on the phone multiple times this year to get over $200 dollars worth of fees reversed. So that’s unacceptable. I recently went into the branch to try to sort it out and I still feel like they are set up to pull fees. As a small business I’m all about reinvesting every penny into making the business grow on without me and having a system where I serve the bank isn’t going to promote my vision for the company. I need a bank that wants to help, and keep fees at $0, unless I need to borrow money.

So I’m moving in the direction of an inexpensive, lightweight bank that fills my needs.

My Small Business Banking Needs:

I’m in need of the following:

  • No Minimum Balance
  • No Monthly Fees
  • Accepts Credits from PayPal
  • Accepts Debits from Various Credit Cards
  • Allows me to Pay myself at my Personal Bank w/o fees
  • No ACH Transfer fee (Learn about the ridiculous nature of ACH transfer fees here in America.)
  • Free Remote Check Deposits
  • Has an API that Connects to my Business Book Keeping Software (WaveApps)
  • Online interface that is easy to understand and updates automatically
  • Free international withdrawals no matter where I am

The Search for a Lightweight, Location Independent Bank:

Again, the challenge is in finding an account to open as property of the LLC. Personal accounts like can be found here (thanks Ramit.)

Here are some options I’ve found:

  1. Bank of the Internet ( Exploring now, looks promising May 8th 2014)
  2. SmallBusinessBank.com ( Applying now, Branch of Gardner Bank - May 8th 2014 )
  3. PNC ( No Monthly Fee with a 1.5k Minimum)
  4. SunTrust ( Exploring )
  5. CitiBank ( Fees all over, 5k minimum to do away with fee )
  6. Simple ( Not for Businesses )
  7. UnionBank ( Big monthly service fee )
  8. Charles Schwab ( Need a Million to Join)
  9. US Bank ( Fees galore)
  10. Chase ( Fees Everywhere )
  11. Bank of the West ( 3k daily balance to avoid $10 Monthly Service Fee )
  12. Capital One ( 2k minimum to avoid $12 monthly fee )

I’m still seeking results so stay tuned.

If you’re reading this and you have any insight, I’d love to hear your insight or resources to help me make this better. Please just leave a comment blow or e-mail me at ian (at) ianrobinson.net

With Appreciation,