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.

-Thanks for Reading. I hope you found this helpful. Please feel free to leave a comment and contribute to the conversation.

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