Friday, June 5, 2015

Warren Buffett: On 50 Years of Running Berkshire Hathaway

This year was the 50th anniversary for Warren Buffett in running Berkshire Hathaway. Each year, he writes a letter to his shareholders, and this year's letter has the theme of looking back over the past 50 years and looking ahead to the next 50. Over the years, Buffett has the knack of saying things in these letters that are willing to admit past mistakes and often wryly humorous. (Here's a snippet from last year's letter, where Buffett of all people extols the virtues of index fund investing.) Here are a few snippets from Buffett's 50th anniversary letter that caught my eye.

Apparently, Buffett originally took over Berkshire in a fit of pique, because he felt that the earlier owners tried to chisel him out of one-eight of a point:
"On May 6, 1964, Berkshire Hathaway, then run by a man named Seabury Stanton, sent a letter to its shareholders offering to buy 225,000 shares of its stock for $11.375 per share. I had expected the letter; I was surprised by the price.  Berkshire then had 1,583,680 shares outstanding. About 7% of these were owned by Buffett Partnership Ltd. (“BPL”), an investing entity that I managed and in which I had virtually all of my net worth. Shortly before the tender offer was mailed, Stanton had asked me at what price BPL would sell its holdings. I answered $11.50, and he said, “Fine, we have a deal.” Then came Berkshire’s letter, offering an eighth of a point less. I bristled at Stanton’s behavior and didn’t tender. That was a monumentally stupid decision. Berkshire was then a northern textile manufacturer mired in a terrible business. The industry in which it operated was heading south, both metaphorically and physically. And Berkshire, for a variety of reasons, was unable to change course. ...
"The price that Stanton offered was 50% above the cost of our original purchases. ...  Instead, irritated by Stanton’s chiseling, I ignored his offer and began to aggressively buy more Berkshire shares. By April 1965, BPL owned 392,633 shares (out of 1,017,547 then outstanding) and at an early-May board meeting we formally took control of the company. Through Seabury’s and my childish behavior – after all, what was an eighth of a point to either of us? – he lost his job, and I found myself with more than 25% of BPL’s capital invested in a terrible business about which I knew very little. I became the dog who caught the car.
After struggling for some years, Buffett argues that his investment philosophy evolved between two different kinds of value investing, a change which he attributes to advice from his long-time associate Charlie Munger: "Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices."

For many economists and finance professionals, Berkshire Hathaway is an anomaly and even an anachronism, because it looks a lot like an old-style conglomerate firm. Such firms have gone out of favor, with the argument that it's better for firms to focus on their "core competence." In response, Buffett argues:

"Conglomerates, it should be acknowledged, have a terrible reputation with investors. And they richly deserve it. Let me first explain why they are in the doghouse, and then I will go on to describe why the conglomerate form brings huge and enduring advantages to Berkshire. Since I entered the business world, conglomerates have enjoyed several periods of extreme popularity, the silliest of which occurred in the late 1960s. ... The resulting firestorm of merger activity was fanned by an adoring press. Companies such as ITT, Litton Industries, Gulf & Western, and LTV were lionized, and their CEOs became celebrities. (These once-famous conglomerates are now long gone. As Yogi Berra said, “Every Napoleon meets his Watergate.”) ...
"At Berkshire, we can – without incurring taxes or much in the way of other costs – move huge sums from businesses that have limited opportunities for incremental investment to other sectors with greater promise. Moreover, we are free of historical biases created by lifelong association with a given industry and are not subject to pressures from colleagues having a vested interest in maintaining the status quo. That’s important: If horses had controlled investment decisions, there would have been no auto industry. Another major advantage we possess is the ability to buy pieces of wonderful businesses – a.k.a. common stocks. That’s not a course of action open to most managements. Over our history, this strategic alternative has proved to be very helpful; a broad range of options always sharpens decision-making. The businesses we are offered by the stock market every day – in small pieces, to be sure – are often far more attractive than the businesses we are concurrently being offered in their entirety. "

With regard to the investing in Berkshire Hathaway, Buffett offers various warnings:
 "If an investor’s entry point into Berkshire stock is unusually high – at a price, say, approaching double book value, which Berkshire shares have occasionally reached – it may well be many years before the investor can realize a profit. In other words, a sound investment can morph into a rash speculation if it is bought at an elevated price. Berkshire is not exempt from this truth. ...  Since I know of no way to reliably predict market movements, I recommend that you purchase Berkshire shares only if you expect to hold them for at least five years. Those who seek short-term profits should look elsewhere. ...
"The bad news is that Berkshire’s long-term gains – measured by percentages, not by dollars – cannot be dramatic and will not come close to those achieved in the past 50 years. The numbers have become too big. I think Berkshire will outperform the average American company, but our advantage, if any, won’t be great. Eventually – probably between ten and twenty years from now – Berkshire’s earnings and capital resources will reach a level that will not allow management to intelligently reinvest all of the company’s earnings. At that time our directors will need to determine whether the best method to distribute the excess earnings is through dividends, share repurchases or both.