How to Write an Effective Couchsurfing Request: Inspired by Failure

We love to put couch surfers up in our place. It’s great to have traveler’s come through because they have interesting perspectives and it’s great to make the connections. The truth is that I deny about 90% of the people who reach out to me. Why do I shut most people down? It’s because of messages like this:

Hey, i am travelling a backpacker tour from Sydney to Cairns. And i want to stay two nights in Surfers Paradise. Is it possible that i can sleep at your’s?Pleas call me, because i have not allways Internet, only when there is a free wifi. (his phone number)best regards (couch surfer)

Hey everybody, let’s count the mistakes:

  • 1st = Hey,

So this guy didn’t even bother to write my name in here, that tells me he could be copying and pasting this to everyone on the Gold Coast. Where is the improvement opportunity? Mention the person you are writing to.

  • 2nd = I am traveling a backpacker tour from Sydney to Cairns…

You know what? Everyone seeking a couch to crash on in the Gold Coast is doing that. Want to know another thing? I don’t care. Where is the improvement opportunity? Don’t say mundane, un-inspiring things that matter nothing to the person your hoping to mooch off of.

  • 3rd = I want to stay two nights in Surfers Paradise…

Great, I want a business that cashflows $10,000 a month, a ranch on the beach and a quiver of surfboards. I don’t care what you want. Where is the improvement opportunity? Start with the value you bring to the interaction. Example: “You guys would love my cooking because I make a fantastic German schnitzel ” You see what I did here? It’s not about what you want couch surfer, it’s about telling the dude with the couch that your presence isn’t going to be a friggin headache!

  • 4th = Is it possible that I can sleep at yours?

Check the profile of the couches you are surfing. We offer people a really nice queen bed dummy, not a couch. Where’s the improvement opportunity? “I read that you guys have a bed to sleep on and while I would totally appreciate that, I’m super easy and I’d be happy to sleep out back on the grass.” You see what I did here? With this statement, you make a point that you read about the couch while reaffirming that you aren’t going to be a soul sucking drain on life while you couch surf.

  • 5th = Pleas call me, because i have not allways Internet, only when there is a free wifi.

Sure dude, I’ll call you. I love calling stranger vagabonds with absolutely nothing to offer. Get lost. Where’s the opportunity for improvement? “Though my access to internet is going to be spotty over the next few days, I’d be honored to connect in anyway possible. My phone number is 0404533938 but if you just reply to this message with your number, I’ll be happy to text you when I get into town.” You see what happened here dummy? You explain the situation and offer a solution that doesn’t require the couch baron to do extra work to get your lazy tail to his place. Oh and texting is the way to go. “Please call me”? I hope you like the $30 crappy hostel in Surfers.

  • 6th = best regards,

Tips on CouchSurfingReally? best regards? You couldn’t even be bothered to put a capital letter at the front? Where’s the room for improvement? Look dummy, proper CouchSurfers sign off with better salutations. Next time try: -With Awesomeness -Wheeeeeeee -Graciously -Excitedly – YOU ROCK!

So yeah, your CouchSurfing request was a 100% failure. With luck, I hope someone else reads this and is inspired to have an excellent request and experience with CouchSurfing.
Now here’s the interaction part. Write a compelling CouchSurfer request in the commment section below. Winner gets a pizza.

I Got Robbed: Pick Pockets are Good in the Philippines

 I Got Robbed!

The other day I got my iPhone 4 stolen right out of my pocket without me even knowing. Don’t worry Mom, no violence occured… but I got duped. This is the first time I’ve ever been duped and I hate it.

Here is the Story

I was riding in a Jeepney from my home to my favorite coffee shop at the Baniland Town Center in Cebu City, Philippines. The Jeepneys are interesting old Jeeps left over from the American presence in  World War II (I film some of them in this video.) Since the 1940’s they have been outfitted with  two rows of benches running parallel with the street, pointing inwards towards each other. These are the home made passenger vehicles of the Philippines. I was listening to an internet business podcast on my iPhone with my apple earbuds, while sitting on the passengers side bench.

To signal the driver to pull over in a Jeepney, the passenger uses coins to tap the handrail which is welded to the ceiling of the vehicle. With a loud “Tack-Tack-Tack” sound, I announced to the driver that I wanted to get off. There was a commotion and I assumed the cause to be me requesting a pull over in the wrong spot.

Three little guys sitting in front of me, to my left and right began talking quickly in a strange dialect. “aba aba aba Country Mall yada  blah blah.”

Mad Streets in the PhilippinesI couldn’t understand them of course, and I still had no real understanding of how this mad Jeepney system functions, but I knew the Country Mall was just a 3 minute walk down the road from where I wanted to go so I just chilled and waited for the Country Mall stop.

As the Jeep was pulling into the Country Mall Jeepney bay, one guy sitting directly across from me on the drivers-side bench reached down between my legs in, what I thought was, an effort to find a coin I had dropped from my pocket. He seemed to have a hard time picking it up and then showed me the coin and offered it to me while trying to say something. I couldn’t hear him so I took my ear buds out to listen to what he had to say. I couldn’t understand him and refused the 1 peso coin he had seemed to find between my legs.

All of the sudden, the guy next to me was pointing out that I had a piece of gum stuck to my shoulder. Again, I assumed that these were nice guys alerting me that I had leaned into a piece of chewing gum that had become stuck to my shoulder.

By this time the Jeepney had pulled up to the curb and I got out of the Jeep to pull the gum off my shoulder and toss it in the bushes.

Then I checked my pockets as I normally do to make sure I had everything in order. My heart sank. Surprise surprise, no iPhone.

Challenging Philippines SidewalkI immediately assumed it had fallen out of my pocket on the jeep so I ran over and leaped into the back of the jeep which had started pulling away. I searched around for the iPhone in the place where I was sitting. It wasn’t there and the other passengers were scared of me as I started yelling like a neanderthal. They pointed across the traffic ridden road trying to tell me that someone had taken my iPhone in that direction. I got off the jeep looking around for something to chase. I was ready to be like a lion chasing down some gazelle-like thief through the jungles of urban Cebu.

The witnesses were pointing down a dark ally surrounded by shanty style dwellings and rum vendors. What was I going to do? I don’t remember what the guys looked like. I couldn’t run after them too effectively anyways; I had a decent sized backpack on anyways. It would be like chasing a needle in a hay stack…

…no, it would be like chasing a needle in a needle stack. I was screwed.

The End

Thanks for reading. Leave some comments below and berate me for my foolishness!

🙂 -ian

Berkshire Hathaway Letters Challenge (BHLC) – MBA Hack – 10 Years of Annual Letters

WarrenBuffettBucketNotThimble

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

Go to the Source of the Berkshire Hathaway Letters Here

Progress:

  1. 1993 Letter – BHLC: 1993 Notes and Review
  2. 1994 Letter- BHLC: 1994 Notes and Review
  3. 2006 Letter- BHLC: 2006 Notes and Review
  4. 2007 Letter- BHLC: 2007 Notes and Review
  5. 2008 Letter- BHLC: 2008 Notes and Review
  6. 2009 Letter- BHLC: 2009 Notes and Review
  7. 2010 Letter- BHLC: 2010 Notes and Review
  8. 2011 Letter- BHLC: 2011 Notes and Review
  9. 2012 Letter- Coming Soon…
  10. 2013 Letter- Coming Soon…
  11. 2014 Letter- Coming Soon…
  12. 2015 Letter- Coming Soon…

Book Notes: Abundance by Peter Diamandes

Peter Diamandis Abundance Cover Header

Why Abundance?

Abundance by Peter Diamandes Notes and StoryI’m often troubled by the fact that our species is ripping the world to shreds as fast as humanly possible. To me, Earth is our home and we should be treating the atmosphere and biosphere as the most precious thing around.

After reading books like The Burning Season and endless information about Climate Change (of course Al Gore’s documentary is the most well known argument about this subject) I had a deep seeded fear that we are on a path of self destruction.

This is really, really depressing to me.

I’ve had break downs over it before and I constantly tried extra hard to not consume anything other than what I needed. Perhaps this is a subconscious reason that the sports I do require little fossil fuels and I’m constantly carrying around a handful of groceries in lew of a plastic trash bag (don’t believe the ocean is full of plastic? Check out this documentary.)

Anyways, I was in a slump and somehow I came across this book by Peter Diamandis

It’s fantastic for getting me out of the slump. Truth is the world is amazing and there are millions of fantastic things going on.

I’m of the opinion that we can innovate our way out of this ecological crisis that we find ourselves in. This book helped to get me there.

Below are my notes that I took while reading the book. Thanks for your interest and I hope this helps.

Reading Notes for Abundance:

Analogy – orange tree has fruit but if you pick all low hanging fruit, it is scarce. Not until you invent a ladder does the fruit become less scarce

The same is true with aluminum

The same could be true with solar power.

OPL – sustainable planning with

Think on the scarcity model of food production developed in the 1800s by British economists… They said pop growth was exponential while food production was linear. Therefore starvation would occur. They lacked the foresight of technological advancements…

Imagine a world of 9 billion people, with clean water, nutritious food, affordable housing, top tier medical care and non-polluting ubiquitous energy. – this is the stir of how we can rise to meet it.

“Abundance is a radical vision”

Abundance is about proposing people with freedom and opportunity and possibility.

Maslows heirarchy of needs.

Abundance provides his own heirarchy of needs pyramid.

Lvl 1 – nutrion, shelter & water

Better health = lower population boom

Lower infant mortality = lower population growth.

The rational optimist by Matt Riddley

Abundance is good for all – Nigerian cell phone abundance was not only good for farmers, but for Nokia too. The 1 billionth phone sold was to a Nigerian.

Dunbar’s number – 150 people close ties…. 150 is a healthy tribal number where gossip helps promote the values of the group as a whole… In the modern world we interact with less live people. We make up for it by watching tv and gossiping about that. The TV actresses gossip is largely useless to society as a whole and is probably a ancestral reaction that leads to a tremendous waste of human potential

Loss aversion bias

Acid rain an example of an overblown environmentalist breakdown.

The real value of anything is the time you exchange in order to acquire it.

Eg the price on a light now is .05 hours the price of a light in Babylon (1000bc) is 6 days

Cultured beef and verticle farms are 10-15 years away from widespread acceptance.

agro ecology – designing food systems that add to the environment rather than subtract from it

Primary productivity – the amoun of plant matter created each year. As every animal consumes plants (or consumes animals that consume plants) this number is a good metric for the impact of human consumption.

The DIY innovator – ch 10

Ken Kesy spoke about Brand in electric kool-aid acid test. Brand experienced DIY capabilities.

Whole Earth Catalogue – created by Brand – tool for creating the personal transformation and self reliance. A catalogue for hippies who won the national book award.

DIY drone potential for guarding rainforest from illegal destruction

The more we are willing to risk failure an act on our dreams, the more fearless we become.

Do not seek to change the world unless you seek it as a man who’s hair is on ire seeks a pond.

Line if Credibility – personally, how much can you declare something and people expect that it will happen.

Super Credibility – Elon Musk and someone like that who has expectations for massive success.

Funding arrived after he made the declaration of the x-prize. How important it is to make big declarations.

The awesome power of the right mindset.

You need to be a little crazy to want to change the world.

“None of our men are experts, we have most unfortunately found it necessary to get rid of a man as soon as he thinks himself an expert, because no one ever considers himself expert if he really knows his job; thinking always ahead, thinking always, “how to do more?”

Young people are the ones that change things.

3 traits to a fear of failure
1. Loss of reputation
2. Loss of money
3. Loss of time

“Failure is a gold mine” Ratan Tata

Adjacent possibles – a you expand the box, the box grows and you have new space to grows

For te first time ever we don’t need to divide our pie into smaller portions, we just make more pies.

I Hope These Notes Helped

You can get a free copy of this book by getting an Audible account through this link.

You can purchase the book on amazon here.

Puerto Rican Muscle Breakfast

Surf Breakfast in Puerto Rico

Here’s a powerhouse recipe to get your wife’s adoration while eating like a true warrior:

Puerto Rican Muscle Breakfast

Serves 2 athletes who love to eat

Ingredients:

    • 1/2 Onion
    • 3 Tablespoons of butter
    • 3 Tablespoons of coconut oil
    • 4 Leaves of Racao (AKA: “Mexican coriander,” “Puerto Rican coriander,” “thorny coriander,” or “culantro”)
    • 1/2 Can of habichuelas (AKA: red beans or kidney beans)
    • 4 Eggs (Get the Puerto Rican eggs, not the eggs shipped in from the USA with a stamp on them)
    • 1/5 Cup of coconut milk
    • 1 Tomato
    • 1 Fistfull of fresh basil
    • 2 Teaspoons of sesame seed oil
    • Lots of Salt
    • Lots of Pepper

 

Preparation Instructions:

1. Dice up the half onion and slap it in the frying pan with the coconut oil and butter

2. Cook the onions until they become clear and slap those habichuelas in there with the racao. Add salt until it tastes awesome.

3. Dice up the tomato, basil and slap it in a bowl with sesame seed oil, salt and pepper. Mix it up really well with your hand and set to the side or in la refrigerador until your done cooking

4. Break 4 eggs into a bowl, pour in the coconut milk and beat with a fork until well mixed

5. When the beans are starting to break down and the onions are well cooked, pour in the egg mixture

6. Use a spatula to break up the scrambled eggs into bite sized chunks. Then allow for some browning on the outside of each bite.

7. Taste and add salt until you say to yourself, “she’s going to love this.”

8. Serve the scrambled eggs in a pretty mound in the middle of the plate and spoon the cold tomato/basil concoction on the top so it looks really pretty.

Nutrition notes:

This should meet the requirements of Tim Ferriss’s Slow Carb Diet. It’s a high fat, high protein breakfast which will last you most of the day and make you think to yourself, “wow, that was delicious.”

This breakfast is named Puerto Rican Muscle Breakfast because of the delicious racao herb which causes food to jump off the plate and slap you in the mouth. I’m pretty sure it’s a unique herb to Puerto Rico but I don’t really know. The muscle part owes to the fact that we ate this while building a business in Puerto Rico and doing CrossFit 6 times a week. After working on the business all day, we religiously went to the gym to increase weightlifting max lifts and finish intense workouts. With this breakfast, we generally skipped lunch so I figure it must be a muscle breakfast.

The best thing about this breakfast, it makes you feel awesome. Go tackle the day.

Want another recipe? Please say so in the comments below.

BHLC: 2011 Notes and Reviews of Berkshire Hathaway Shareholder Letter

Notes on Berkshire Hathaway Shareholder Letter from 2011

Brief Summary of the Year:

Page 18 and 19 are probably some of the best investing advice I’ve ever heard. He covers inflation, value and the shenanigans in a quick fast 2 pages. Check them out.

This is, to me, a very regular year for Berkshire Hathaway. Insurance did phenomenally, everything else did well and they’ve got some new family members like Lubizol.

Notes For the Year:

“…we’ve now had nine consecutive years of underwriting profits, totaling about $17 billion.” – Warren Buffett

Wowza. How about getting paid $17 billion for hold someone else’s money.

“…our primary focus is on building operating earnings.” – Warren Buffett

That’s my primary focus too. Buffett is playing at a bit higher scale though. 😉

First rule of capital allocation – What is smart at one price, is dumb at another.

“Picking up that book was one of the luckiest moments in my life.” – Warren Buffett

Ben Graham’s The Intelligent Investor is the book Buffett credits for teaching him to have a love for low stock prices.

“That old line, “The other guy is doing it so we must as well,” spells trouble in any business” – Warren Buffett

As always, Buffett loves float and Ajit Jain -> Charlie would be happy to trade me for another Ajit. 🙂

“…our primary objectives of redundant liquidity and unquestioned financial strength.” – Warren Buffett

Objective of unquestioned financial strength. That’s what Berkshire does for the businesses it holds. The unquestioned financial strength helped them to turn around BNSF and NetJets. I think that’s their real value add for the companies they acquire. They never sell and they can take any financial requirements your business could possibly need. Especially if you’ve proven yourself as a powerful manager who can turn investment into returns.

“‘In God We Trust’ may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human.” – Warren Buffett

 

“You can fondle the cube, but it won’t respond.” – Warren Buffett

This one requires context. In the letter Buffett is describing 3 types of investment. 1. Financial products like mutual funds and cash 2. Buy to sell at higher price things like gold or fine art 3. productive assett. The cube is alluding the all the worlds gold melted into a 68 foot block of pure gold worth $9 trillion +. You could have the Cube or the equivalent value in productive assets (all US agricultural land and 16 Exxon’s.) Which would you choose?

Productive assets are made up of Real Estate, Businesses and Agricultural properties. Buffett and Berkshire Hathaway choose Businesses. Makes me wonder where I should invest….

“What motivates most gold buyers is the belief that the ranks of the fearful will grow.” – Warren Buffett

Buffett really tears into the gold hoarders in this letter. It’s great to hear because I’ve been influenced in the past to think having gold on hand is a valuable way to retain wealth. Now it’s not. There is no way I’ll buy gold… I’d rather have a farm that makes apples or a company that makes money.

Continue reading “BHLC: 2011 Notes and Reviews of Berkshire Hathaway Shareholder Letter”

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: 2010 Notes and Reviews of Berkshire Hathaway Shareholder Letter”

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: 2009 Notes and Reviews of Berkshire Hathaway Shareholder Letter”

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: 2008 Notes and Reviews of Berkshire Hathaway Shareholder Letter”