The summary points that I found of interest from Warren Buffett's 2012 Annual Letter to Berkshire Hathaway shareholders are:
- Total gain in 2012 for shareholders = $24.1 billion, or effectively 14.4% per-share book value increase.
Heinz:
- In Feb 2012, Buffett agreed for Berkshire to buy 50% of a holding company that will own all of H.J. Heinz. Each of the 50% shareholder of this holding company will contribute $4 billion of common equity, and on top of this, Berkshire will invest $8 billion in preferred shares that pay a 9% dividend.
- Two special features of this preferred: at some point it will be redeemed at a significant premium price, and the preferred also comes with warrants [i.e., effectively, "convertible to equity"] permitting Berkshire to buy 5% extra of the holding company's common stock for a nominal sum.
Main 5 Operating Divisions (non-insurance):
- Berkshire's "powerhouse five" (BNSF, Iscar, Lubrizol, Marmon Group and Midamerican Energy) had an aggregate earnings of $10.1 billion pre-tax, about $600 million more than 2011.
- Of these five, only MidAmerican was owned by Berkshire eight years ago (then earning $393 million pre-tax).
Acquisitions:
- Though he failed to land a major acquisition at head office level, the managers of Berkshire did far better: They had a record year for "bolt-on" purchases, spending $2.3 billion for 26 companies that were melded into existing businesses (& completed without Berkshire issuing any shares).
- They are "low-risk, burden headquarters not at all, and expand the scope of our proven managers."
Insurance Operations: Berkshire's core business; propelled expansion over the years. Record year in 2012, providing Berkshire with $73 billion of 'free' money to invest, + they also delivered $1.6 billion underwriting profit, the 10th consecutive year of profitable underwriting (not always the case in insurance; e.g., State Farm, by far the largest insurer in the US and a well-managed company, incurred underwriting losses in eight of the past eleven years ending in 2011).
- GEICO led the way for Berkshire, with its market share since 1995 growing from 2.5% to 9.7%, and its premium volume increasing from $2.8 billion to $16.7 billion, despite Hurricane Sandy (GEICO's largest single loss in history).
- BH Reinsurance Group, led by Ajit Jain, also did well. "Ajit insures risks that no one else has the desire or the capital to take on."
Two new "young" investment managers (Todd Combs and Ted Weschler): are working out. In 2012, each outperformed the S&P500 by double-digit margins. Buffett said: "They left me in the dust as well" in small print. Consequently, the fund allocation to each (to manage) has increased by almost $5 billion.
- They will (are expected to) manage Berkshire's massive portfolio long after Charlie Munger and Warren Buffett have left the scene.
- Total number of employees at year-end 2012 = 288,462, up 17,604 from last year. Berkshire's headquarter count = 24. "No sense going crazy", he said.
Equity Investments:
- Berkshire's "Big Four" investments - American Express, Coca-Cola, IBM and Wells Fargo - all had a good year in 2012. Berkshire's ownership interests have gone up in these, due to further purchases and re-purchases at some of the companies. Buffett said, "At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful business to owning 100% of a so-so business." and
- "Our flexibility in capital allocation [i.e., equity investments vs 100% operational acquisitions] gives us a significant advantage over companies that limit themselves only to acquisitions they can operate."
Bullish "capex" in 2012 (and 2013): Berkshire spent a record sum of $9.8 billion on plant and equipment ("worthwhile projects") in 2012, about 88% of it in the USA. That's 19% more spent than in 2011, previous high. "We will keep our foot to the floor and will most certainly set still another record for capital expenditures in 2013. Opportunities abound in America." .... "American business will do fine over time." .... "Since the basic game is so favorable, Charlie and I believe it's a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the prediction of "experts," or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it."
Berkshire's strategy to build per-share intrinsic value by:
1. Improving the earning power of Berkshire's many subsidiaries,
2. Further increasing their earnings through bolt-on acquisitions,
3. Participating in the growth of our investees [i.e., equity investments such as Coca-Cola etc.],
4. Repurchasing Berkshire shares when they are available at a meaningful discount from intrinsic value, and
5. Making occasional large acquisitions.
How to measure the economics of businesses: "The crowd of companies in [Berkshire's manufacturing, service and retail operations] sell products ranging from lollipops to jet airplanes. Some of the businesses enjoy terrific economics, measured by earnings on unleveraged net tangible assets that run from 25% after-tax to more than 100%. Others produce good returns in the areas of 12-20%. A few, however, have very poor returns, a result of some serious mistakes I made in my job of capital allocation."
One caveat: "Of course, a business with a terrific economics can be a bad investment if the price paid is excessive."
Other interesting comments:
- "More than 50 years ago, Charlie told me that it was far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price."
- "In Berkshire's 1986 annual report, I described how twenty years of management effort and capital improvement in our original textile business were an exercise of futility. I wanted the business to succeed and wished my way into a series of bad decisions. (I even bought another New England textile company.) But wishing makes dreams come true only in Disney movies; it's poison in business."
Book Recommendations:
"The Outsiders" by William Thorndike Jr. ("an outstanding book about CEOs who excelled at capital allocation.")
"The Clash of Cultures" by Jack Bogle
"Investing between the Lines" by Laura Rittenhouse
- Annual meeting on May 4th this year, with the associated shareholder events.
Regards
Tri I. Suseno
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