It’s that time of year again – the release of Berkshire Hathaway’s annual shareholder letter.
I jotted down a few notes and thoughts as I went through it:
- On the first page showing the historical performance of BRK, they have now started including BRK stock performance, in addition to per-share book value and S&P 500 + dividends returns. Buffett’s commentary is that in the long-term, stock prices and intrinsic value will invariably converge, and both he and Munger believe that is true with BRK. In the last three years, however, it’s interesting to note that BRK’s stock performance has outpaced the growth in BRK’s intrinsic value, and even the performance of the S&P 500.
- The emphasis continues to shift to acquiring whole operating businesses, particularly finding assets where they can effectively and efficiently deploy the vast amounts of cash (~$15B in capex) that the other businesses throw off. The most recent foray is in auto dealerships with the purchase of Van Tuyl Automotive, a group of 78 automotive dealerships (they’d be the 5th largest group in the U.S.), in October 2014. I’m not too familiar with this segment, but Buffett makes it sound as though there is quite a bit of runway for consolidation. There are 17,000 dealerships in the U.S., and they plan on acquiring additional dealerships at sensible prices. I’m unclear as to the margin profile of these businesses as well as how they are valued, but it looks like Buffett thinks this is a good way to further deploy capital: “we will build a business that before long will be multiples the size of Van Tuyl’s $9 billion in sales.”
- Speaking of reinvestment, it’s interesting that there was a referendum as to whether Berkshire should consider paying out a meaningful annual dividend. The wording of the resolution was consider, not actually pay out. The response from the shareholder base, for both the A and B shares, was overwhelmingly negative. Essentially, 98% of the shareholder base voted in favor for Berkshire to continue reinvesting in Berkshire and deferring to Buffett to find effective ways to allocate capital. As long as Buffett is running BRK, this really shouldn’t be a question at all. The embedded premium in BRK has always been that you are hiring Buffett to make investment decisions on your behalf – for free (no absurd 2%+ management fees here). This will be interesting to revisit once Buffett inevitably is no longer making those investment and allocation decisions, and hopefully that day is still a long way away. Perhaps his successor might not get the same latitude from the shareholders as Buffett, and the dividend option becomes more compelling.
- Buffett’s response to whether or not the conglomerate structure is warranted: if the conglomerate form is used judiciously, it is an ideal structure for maximizing long-term capital growth for the following reasons: (1) it’s the perfect structure to allocate capital rationally; (2) provides the ability to deploy capital across businesses in a tax-efficient manner; (3) provides flexibility to buy pieces of businesses rather than whole businesses; and (4) enables them to be the preferred buyer for certain owners (particularly family businesses) that want to exit but wish to preserve their company and culture.
- Per-share investments value of $140,123. The big 4 investments remain the same: IBM, KO, AXP, and WFC. BAC should also be included on the list as Berkshire has an option through 2021 to purchase 700M shares for $5B, with a current market value of ~$11B (net value of ~$6B). Although the media continues to scrutinize Berkshire Hathaway’s stock investments, the reality is that the company has long moved away from that. IBM has been the one stock in which Buffett has actively increased share purchases. The stake increases in the other stocks resulted from dividend repurchases. It would be interesting to see if there were a dynamic intrinsic value calculator for BRK, at least for the stock investments. Whitney Tilson at Kase Capital puts out a very good, comprehensive look at the intrinsic value of Berkshire Hathaway. There are periodic updates to this deck, and the last update was back in September 2014.
- A bit more color on Buffett’s successor. Apart from the capital allocation and manager selection and retention responsibilities, Buffett mentions that his successor will need one particular strength: “the ability to fight off the ABCs of business decay, which are arrogance, bureaucracy and complacency.” This criterion seems a bit ironic given how he has trumpeted IBM as a major stock pick. The concern around Buffett’s successor has typically centered on whether that person would provide the same level of investment acumen, which seems to me a bit misplaced. Buffett hasn’t really scoured the stock tables for cigar butt investments for quite some time. The reality is that he gets his pick of investments, bets and mega-insurance deals to choose from, often at ridiculously sweet terms. He’s not entering positions in Goldman Sachs or Bank of America through the open market like the rest of us. This is the luxury of having built up an unparalleled reputation and a stellar collection of businesses and earnings power over the past several decades. When he leaves, this legacy will still be there. Deals might not happen over a handshake at first, but I could definitely see that issue quickly dissipating. Berkshire will continue to have the pick of the litter of investments; there just isn’t any other comparable entity that can do what they do.
- A welcome appearance from Munger. Having eagerly read these letters for many years now, I feel fairly well-versed in how Buffett thinks. When watching Buffett in action, I often find myself summoning the same examples that Buffett would mention in response to certain interview questions. As a result, Munger’s contribution was quite refreshing.
All of this discussion of Buffett’s successor and the reasons for Berkshire’s success brings me to the key risk to Berkshire once Buffett departs. In my mind, the key secret to Berkshire Hathaway’s success has been how Buffett has managed to repeatedly convince great managers to stay and run his collection of businesses. Moreover, he also privately knows who is the likely successor for those businesses. He has somehow determined the right incentive structure and compensation scheme to encourage long-term decision making and relatively minimal turnover among his manager ranks. Getting this right is extremely critical as Buffett will routinely admit that he has neither the motivation nor ability to manage any of these businesses himself.
Berkshire evidently has a roster of superstar talent, but it’s relatively rare to see new CEOs of other companies with Berkshire in their background. It seems much more common to see a GE or a top tier investment bank or consulting firm be the proving ground for an executive. It’s also come to be sort of an accepted fact that such “talent” deserves a mind-blowing compensation package. This has alarmingly led to the growing disparity in earnings between the top and bottom.
There must be some intangible benefits to working at Berkshire, but will the same caliber of managers still be attracted to run those businesses once Buffett leaves? Is it possible that external opportunities become more attractive to those managers under different circumstances? How would the incentive structures and compensation schemes have to change if Buffett is no longer in charge of capital allocation (supposing that some of the compensation is tied to Berkshire stock performance)? These would be great questions for the shareholder meeting.