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.
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;
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
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.