Every year in the past 14 years or so at around this time, I have
written to friends, clients and family members a summary of Warren Buffett’s
annual letter. The 2013 letter just came out a few hours ago and here are a few
items I found interesting this year.
On Record Gain in Book
Value
“Berkshire’s gain in net worth during 2013 was $34.2 billion.” &
“Over the last 49 years (that is, since present management took over), book
value has grown from $19 to $134,973 [per share], a rate of 19.7% compounded
annually.”
On Berkshire’s New Large
Acquisitions & New Acquisition ‘Template’ with Heinz Acquisition
“[In 2013] We completed two large acquisitions, spending almost $18
billion to purchase all of NV Energy and a major interest in H.J. Heinz. Both
companies fit us well and will be prospering a century from now.”
“With the Heinz purchase, moreover, we created a partnership
template that may be used by Berkshire in future acquisition of size. Here, we
teamed up with investors at 3G Capital, a firm led by my friend, Jorge Paulo
Lemann. His talented associates – Bernardo Hess, Heinz’s new CEO, and Alex
Behring, its Chairman – are responsible for operations.
“Berkshire is the financing partner. In that role, we purchased $8
billion of Heinz preferred stock that carries a 9% coupon but also possesses
other features that should increase the preferred’s annual return to 12% or so.
Berkshire and 3G each purchased half of
the Heinz common stock for $4.25 billion.
“Though the Heinz acquisition has some similarities to a “private
equity” transaction, there is a crucial difference: Berkshire never intends to
sell a share of the company…
”With Heinz, Berkshire now owns 8½ companies that, were they
stand-alone businesses, would be in the Fortune 500. Only 491½
to go.”
Good Performances by
Berkshire’s non-insurance “Powerhouse Five”
“MidAmerican is one of our “Powerhouse Five” … had a record $10.8
billion pre-tax earnings in 2013, up $758 million from 2012. The other [four] …
are BNSF, Iscar, Lubrizol and Marmon.
“Of the five, only MidAmerican, then earning $393 million pre-tax
[Tri: Compared to $10.8 billion nine years later!!] was owned by Berkshire nine
years ago….
“If the U.S. economy continues to improve in 2014, we can expect
earnings of our Powerhouse Five to improve also – perhaps by $1 billion or so
pre-tax.”
Insurance Divisions Performing Again
“Our investment in the insurance companies
reflects a first major step in our efforts to achieve a more diversified base
of earning power [from primarily textiles
manufacturing].”
- Berkshire Hathaway’s 1967 Annual Report
“Berkshire’s extensive insurance operation again operated at an
underwriting profit in 2013 – that makes 11 years in a row – and increased its
float. During that 11-year stretch, our float (“it should be viewed… as a
revolving fund... both costless and long-enduring”)… has grown from $41 billion
to $77 billion. Concurrently, our underwriting profit has aggregated $22
billion pre-tax, including $3 billion realized in 2013. And all of this began
with our 1967 purchase of National Indemnity for 8.6 million….
“Berkshire’s great managers, premier financial strength and a
variety of business models possessing wide moats form something unique in the insurance
world.”
In Insurance, Must be
willing to say no to Unprofitable Pricing. That old line, “The other guy is
doing it, so we must as well,” spells trouble in any business
“At bottom, a sound insurance operation needs to adhere to four
disciplines. It must (1) understand all exposures
that might cause a policy to incur losses; (2) conservatively assess the
likelihood of any exposure actually causing a loss and the probable cost if it
does; (3) set a premium that, on average, will deliver a profit after both
prospective loss costs and operating expenses are covered; and (4) be willing
to walk away if the appropriate premium can’t be obtained.
“Many insurers pass the first three tests and flunk the fourth. They
simply can’t turn their back on business that is being eagerly written by their
competitors. That old line, “The other guy is doing it, so we must as well,”
spells trouble in any business, but in none more so than insurance.”
Berkshire Subsidiaries Encouraged
to Make their own value-adding, Bolt-On Acquisitions
“While Charlie and I search for elephants, our many subsidiaries are
regularly making bolt-on acquisitions. Last year we contracted 25 of these,
scheduled to cost $3.1 billion in aggregate. These transactions ranged from
$1.9 million to $1.1 billion in size.
“Charlie and I encouraged these deals. They deploy capital in
activities that fit with our existing businesses that will be managed by our
corps of expert managers.”
New Young(er) Investment “Successor”
Managers Delivering
“In a year in which most equity managers found it impossible to
outperform the S&P 500, both Todd Combs and Ted Weschler handily did so.
Each now runs a portfolio exceeding $7 billion. They’ve earned it.
“I must again confess that their investments outperformed mine.
(Charlie says I should add “by a lot.”)”
Berkshire’s
Dual-Flexibility in Capital Allocation – in the Stock Market vs Operating
Companies
“Our flexibility in capital allocation – our willingness to invest
large sums passively in non-controlled businesses [such as, Coca-Cola, IBM,
Wells-Fargo, American Express] – gives us a significant advantage over
companies that limit themselves to acquisitions they can operate… our appetite
for either operating businesses or
passive investments doubles our chances of finding sensible uses for our
endless gusher of cash.”
Reiterating Buffett’s and
Munger’s Objectives at Berkshire
“…Charlie and I hope to build Berkshire’s per-share intrinsic value
by (1) constantly improving the basic earning power of our many subsidiaries;
(2) further increasing their earnings through bolt-on acquisitions; (3)
benefiting from the growth of our investees; (4) repurchasing Berkshire shares
when they are available at a meaningful discount from intrinsic value; and (5)
making an occasional large acquisition.”
Buffett praising Nebraska
Furniture Mart and its late founder, Mrs. B
“See that store,” Warren says, pointing at
Nebraska Furniture Mart. “That’s a really good business.”
“Why don’t you buy it?” I
said.
“It’s privately held,” Warren
said.
“Oh,” I said.
“I might buy it anyway,”
Warren said. “Someday.”
from the book Supermoney by
Adam Smith (1972)
“I think back to August 30, 1983 – my birthday – when I went to see
Mrs. B (Rose Blumkin), carrying a 1¼-page purchase proposal for NFM that I had
drafted… Mrs. B was 89 at the time and worked until 103 – definitely my kind of
woman. Take a look at NFM’s financial statements from 1946 on pages 116-117 [of
the 2013 Annual Report – available from www.berkshirehathaway.com].
Everything NFM now owns comes from (a) that $72,264 of net worth and $50 – no zeros omitted – of cash the company
then possessed, and (b) the incredible talents of Mrs. B, her son, Louie, and
his sons Ron and Irv. …
“Aspiring business managers should look hard at the plain, but rare,
attributes that produced Mrs. B’s incredible success. Students from 40
universities visit me every year, and I have them start the day with a visit to
NFM. If they absorb Mrs. B’s lessons, they need none from me.”
One Mistake
“In addition to equities, we also invest substantial sums in bonds.
Usually, we’ve done well in these. But not always.
“Most of you have never heard of Energy Future Holdings. Consider
yourselves lucky; I certainly wish I hadn’t. The company was formed in 2007 to
affect a giant leveraged buyout of electric utility assets in Texas. The equity
owners put up $8 billion and borrowed a massive amount in addition. About $2
billion of the debt was purchased by Berkshire, pursuant to a decision I made
without consulting with Charlie. That was a big
mistake.
“Unless natural gas prices soar, EFH will almost certainly file for
bankruptcy in 2014. Last year, we sold our holdings for $259 million. While
owning the bonds, we received $837 million in cash interest. Overall,
therefore, we suffered a pre-tax loss of $873 million. Next time I’ll call
Charlie.”
One Previously-Thought
Mistake that Turned out OK
“It can be remembered that soon after we purchased General Re
[Berkshire’s large insurance division], the company was beset by problems that
caused commentators – and me as well, briefly – to believe that I had made a
huge mistake. That day is long gone. General Re is now a gem.”
Dark Clouds coming for
U.S. Local and State Financial Problems (particularly about Pension Plans)
“Local and state financial problems are accelerating, in large parts
because public entities promised pensions they couldn’t afford... Investment
policies, as well, play an important role in these problems... During the next
decade, you will read a lot of news – bad
news – about public pension plays…”
Some Thoughts about
Investing
“Investment is most
intelligent when it is most businesslike.”
-
The Intelligent Investor by Benjamin
Graham
Buffett went through some of his minor real estate investments – to
explain sound investing principles, which are also reproduced in the following
Fortune magazine link: http://finance.fortune.cnn.com/2014/02/24/warren-buffett-berkshire-letter/
Some interesting quotes from this section:
- “Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on.”
- “If you instead focus on the prospective price change of a contemplated purchase, you are speculating…. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.”
- “Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.”
