Berkshire’s Best Investments + Poster Now Available

[This is a cross post from the Explorist Productions blog. Explorist is a media company I founded that publishes content related to business, innovation, and discovery.]

The Berkshire Hathaway limited hardcover letters book and “50 Years of Berkshire” wall print are now available for purchase online. Both of these items were available at the meeting a month ago and I’ve received lots of praise about them from other shareholders, so I’m glad to finally make them available to everyone.

In the process of doing research for the visualization, I collected a lot of data on Berkshire’s financial history — much more data than could fit in the charts on the print.

So in addition to the wall print, I hope to release a few more posts further exploring the story of how Warren Buffett transformed Berkshire over the years. Once I reformat and clean-up it up, I’ll eventually release the raw data so that others can do their own analysis.

Berkshire Hathaway’s Best and Most Notable Investments

The following chart shows the cumulative contribution to book value* of selected investments over 50 years. This is a good yardstick for comparing how successful investments were over time. It doesn’t include insurance companies other than GEICO, as it’s too difficult to separate individual performance given available data.

Notes:

See’s Candy: Income for some years after 23 are estimated.
Buffalo News: No data available after year 23.
BNSF: Post-acqusition performance only (pre-2009 stock return not included).
Dividend income for stock holdings calculated in most cases on average shares held during year.

Some interesting tidbits:

One-third of Coca-Cola’s total gain to Berkshire is in dividends paid over the 27 year holding period. One-quarter of the Washington Post gains are from dividends, the remainder from realized gains in the 2014 sale/transfer.
With underwriting gains, GEICO has added 7,119% to book value since purchase in 1976. This means that had the rest of Berkshire’s investments returned 0% over those 38 years, annual book value growth would still have been 12%.

* A simple example to show the calculation: ABC Corp. is purchased in year 1, adding $100 (either in net income for subs, or change in unrealized gains + dividends for investments) that year to an initial equity base of $1,000. So contribution after year 1 would be 10%. In year 2, ABC Corp. adds another $100 to a starting equity base of $1,300. Contribution for that individual year would be 100/1300 = 7.7%, but cumulative contribution would be 20%, as ABC Corp. has contributed $200 to an initial equity base of $1,000.

This measurement puts investments on an equal footing, allowing comparison across different timeframes. It implicitly accounts for both individual return and capital allocated to the investment. What is not accounted for is excess capital reinvestment — in other words, contribution is based on GAAP net income, not true free cash flow.

A mental model education

Based off a previous #tweetstorm.

See: So Bill Gates Has This Idea for a History Class . . . by Andrew Ross Sorkin. Some relevant quotes:

Christian’s aim was not to offer discrete accounts of each period so much as to integrate them all into vertiginous conceptual narratives, sweeping through billions of years in the span of a single semester. . . . In the worldview of “Big History,” a discussion about the formation of stars cannot help including Einstein and the hydrogen bomb; a lesson on the rise of life will find its way to Jane Goodall and Dian Fossey.

“Most kids experience school as one damn course after another; there’s nothing to build connections between the courses that they take,” says Bob Bain.

“This course is a fundamental shift in how you deliver something. But there’s so many factors in American education that work against it.”

If any of this interests you, check out David Christian’s Big History Project and watch his TED talk The history of our world in 18 minutes.

Christian’s view of teaching is what I call a mental models approach that weaves narratives from all disciplines. It’s not only more interesting, but a more accurate portrayal.

Unfortunately, it is hard to introduce this into current curriculum. There are bureaucracies and “kingdoms” to protect and people set in their ways.

The easiest way is to build a new eduction system from ground up: rethink everything including:

The concept of “classes” and the compartmentalization of subjects (aka the mental model approach).
Scheduling — length and timing of the school day, length of the school year, a rigid “period” schedule vs. a more free-flowing approach…
Grade levels — why should kids born within a defined 365 day period be taught together? How could this be adjusted?
Range of subjects — what else should be taught other than the typical math, science, language, history?
Self-motivation policy — is homework useful? What should students do outside of class? How much should the school be involved in this?
. . .

There are tools that aid this kind of learning, both in and out of class. Big History is one. I believe something like Atlastory, a project I started, is another.

The dawn of immersive storytelling

From a previous #tweetstorm:

Immersive storytelling will be a big industry in the near future: movies viewed on Oculus Rift, dome-like cinemas, or interactive games. We have co’s like Jaunt, Condition One & Giroptic (consumer) making 360 cameras that will be used for filming.

A new visual “grammar” will have to be discovered by filmmakers through trial and error (i.e. no fast cuts, super close-ups, etc.). Parts of the legacy film industry will rebel at first, as they have over the last 100 years since storytelling evolved from live performances to filmed, pre-recorded stories.

Just like audiences were frightened at the sight of a train barreling towards them in early theaters, there will be a learning curve for immersive experiences. Early players of demo games for the Oculus Rift have been scared to the point of ripping their headsets off. Dome cinemas could be the social alternative to VR headsets. (If you ever been on Disney’s Soarin’ Over California ride that’s an example.)

Technology-wise, I feel a complete 360 field-of-view (FOV) like this Jaunt setup won’t be the way to go. There has to be some direction to the audience’s attention. A complete FOV is too immersive and incompatible with users’ prior experiences. Maybe at some point down the road. Something like a 180-220 degree FOV + 180 up and down to allow some freedom of motion (immersion) but still directed view with surround sound.

There is lots of experimentation ahead in the near future in both technology and storytelling grammar. I look forward to both observing and participating.

1976 Buffett Letter About Geico

July 22nd, 1976

Mr. George D. Young,
National Indemnity Company,
3024 Harney Street,
Omaha, Nebraska. 68131.

Dear George:

Thanks very much for your memo of July 19th regarding GEICO which I believe summarizes well the problems attendant to the specific property treaty we are discussing, as well as the general problems associated with reinsurance of any type at GEICO. I still am willing to explore further the GEICO property treaty—if they subsequently decide that it fits their needs—and today committed to Jack Byrne that we would take a 1% quota share of their entire book. This increase from .8 of 1% was pursuant to his request in order to help him attain the 25% mark by the shareholders meeting tomorrow.

I consider the overall quota share to be an acceptable—but not exciting—piece of business. Under normal conditions we would take nothing like 1%, obviously, since that makes it by far the largest reinsurance treaty on our books, and involves substantial risks along with a limited prospect of profit. I also do not like the feature that provides for a credit to GEICO for interest earnings on funds held by us. In effect, we are making this contract number one in size for the reinsurance department, whereas the contractual terms make it less attractive than most of our other contracts.

However, I have three reasons for taking this unusually large portion of the quota share arrangement, and these same reasons also apply to my interest in the property treaty.

I hope it is not a governing factor in any way, but I do have some sentimental reasons for wishing GEICO to survive. GEICO has enumerated all of the hard headed reasons, such as the State Financial Guaranty funds, etc. I just have pulled out of the bottom drawer of my desk a statement of my net worth at the end of 1951 when I was 21 years old. I showed net assets of $19,737, of which $13,125 was in GEICO stock. That was the year when I first started selling securities, and I told everyone who would listen to me that they should put every cent they could scrape together into GEICO. A number of friends and relatives did so, and enjoyed a significant change in their financial fortunes because of this. It provided the first big boost to my own small savings, as well as an even more important boost to my reputation in the Omaha investment community.

During those early years, when I followed the company, the people involved couldn’t have been nicer. Leo Goodwin was running things then and was helpful. Even moreso was L. A. Davidson. He was personally encouraging and forthcoming with information regarding the business, which enabled me to develop a depth of conviction which I have felt few times since about any security.
At that time I felt that GEICO possessed an extraordinary business advantage in a very large industry that was going to continue to grow. Since that time they never have lost that advantage—the ability to give the policyholder back in losses a greater percentage of the premium dollar than any other auto insurance company in the country, while still providing a profit to the company. I always have been attracted to the low cost operator in any business and, when you can find a combination of (i) an extremely large business, (ii) a more or less homogenous product, and (iii) a very large gap in operating costs between the low cost operator and all of the other companies in the industry, you have a really attractive investment situation. That situation prevailed twenty-five years ago when I first became interested in the company, and it still prevails.

The company managed to nullify this advantage—and even more than nullify it—by inadequate recognition of loss costs through poor techniques of loss reserving. This led to improper pricing of product with the result that a product which *could* have been sold at a profit *was* sold at a loss.But the important point to note is that the company had not lost its position as a low cost operator; they merely had mismanaged their loss information which caused the product to be priced inadequately. I believe the advantages of a 13% acquisition cost ratio are as important as ever. I also believe that practically no other companies are going to achieve costs near that figure in the future. Therefore, GEICO, properly managed, should prosper if they can pull themselves back from the financial precipice.

I like very much what Jack Byrne says about reducing policies in force. It seems to me that such an approach a rather than an obsession with growth is very likely to reconstruct the situation whereby they can give the policyholder an unusually high percentage of the dollar back in losses and still make good profits for themselves.
The crucial factor, then, becomes whether they can get past their present financial difficulties. Much of the press –witness Time last week—assumes that they can’t. Until recently, I was unclear myself as to their possibilities in this regard. If they had been at all wishy-washy in obtaining rate increases or biting the bullet generally, I don’t think they would have made it. However, the size of the rate increases they have instituted, along with the underwriting results they have published for April and May, have convinced me that their combined ratio will come down to tolerable limits within a fairly short time.

Even this would not have been enough if Mr. Wallach were inclined to put them into receivership because of the unwillingness of the industry to accept his 40% plan. When he did not move to do so after the June 23rd deadline, it convinced me that he was not going to act precipitously to terminate a business that fundamental economic logic still dictated had a bright future ahead of it. When he did not bow his back over the non-subscription to his 40% plan, I believe the company’s future became assured. I decided then to buy stock, which is the most tangible evidence I can give you as to my assessment of the Company’s chances for survival.

Therefore, George, I will take the responsibility for making the decision that GEICO survives as a business entity. You should make any underwriting judgments that you wish, with this as the premise—if I am wrong about their survival, it will be my fault and not yours. I do not want to go overboard because of sentiment, but I certainly want us to make every effort to come up with proposals that make business sense to us and are useful to them. I do not want mare of the overall quota share because I consider the terms too disadvantageous to the reinsurer, all things considered. But, if a property treaty can be put together with a prospect of gain that more than balances the risk of loss, let’s proceed.

Sincerely,

Warren E. Buffett

WEB/glk

Book Notes: Benjamin Graham

As with my other book notes, some passages are direct quotes and others are my own paraphrasing/summaries. Any footnotes or [brackets] are my personal comments.

The Intelligent Investor (1973) + Security Analysis (1934), by Benjamin Graham

To invest intelligently in securities one should be forearmed with an adequate knowledge of how the various types of bonds and stocks have actually behaved under varying conditions—some of which, at least, one is likely to meet again in one’s own experience.

An investment operation is one which, upon thorough analysis promises safety of principle and an adequate return. Operations not meeting these requirements are speculative. An investment operation is one that can be justified on both qualitative and quantitative grounds.

We speak of an investment operation rather than an issue or a purchase, for several reasons. An investment might be justified in a group of issues, which would not be sufficiently safe if made in any one of them singly. In our view it is also proper to consider as investment operations certain types of arbitrage and hedging commitments which involve the sale of one security against the purchase of another. The safety sought in investment is not absolute or complete; the word means, rather, protection against loss under all normal or reasonably likely conditions or variations. A safe stock is one which holds every prospect of being worth the price paid except under quite unlikely contingencies.

Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook. There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are: (1) speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and (3) risking more money in speculation than you can afford to lose.

The defensive (or passive) investor will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance, and the need for making frequent decisions. The determining trait of the enterprising (or active, aggressive) investor is his willingness to devote time and care to the selection of securities that are both sound and more attractive than average.

Obvious prospects for physical growth in a business do not translate into obvious profits for investors. The future of security prices is never predictable.

In his endeavor to select the most promising stocks wither for the near term or the longer future, the investor faces obstacles of two kinds—the first stemming from human fallibility and the second from the nature of his competition. He may be wrong in his estimate of the future; or even if he is right, the current market price may already fully reflect what he is anticipating. In the area of near-term selectivity, the current year’s results of the company are generally common property on Wall Street; the next year’s results, to the extent they are predictable, are already being carefully considered. Hence the investor who selects issues chiefly on the basis of this year’s superior results, or on what he is told he may expect for next year, is likely to find that others have done the same thing for the same reason. To enjoy a reasonable chance for continued better than average results, the investor must follow policies which are (1) inherently sound and promising, and (2) not popular on Wall Street. Continue reading “Book Notes: Benjamin Graham” →

Book Notes: Innovation and Entrepreneurship

As with my other book notes, some passages are direct quotes and others are my own paraphrasing/summaries. Any footnotes or [brackets] are my personal comments.

Innovation & Entrepreneurship (1985), by Peter Drucker

Innovation and Entrepreneurship “The entrepreneur,” said the French economist J. B. Say around 1800, “shifts economic resources out of an area of lower and into an area of higher productivity and greater yield.”

All new small businesses have many factors in common. But to be entrepreneurial, an enterprise has to have special characteristics over and above being new and small. Indeed, entrepreneurs are a minority among new businesses. They create something new, something different; they change or transmute values. An enterprise also does not need to be small and new to be an entrepreneur. Indeed, entrepreneurship is being practiced by large and often old enterprises.

The entrepreneur upsets and disorganizes. As Joseph Schumpeter formulated it, his task is “creative destruction.” They see change as the norm and as healthy. Usually, they do not bring about the change themselves. But—and this defines entrepreneurship—the entrepreneur always searches for change, responds to it, and exploits it as an opportunity.

When shifting resources to a more productive area, there is a risk the entrepreneur may not succeed. But if they are even moderately successful, the returns should be more than adequate to offset whatever risk there might be. One should thus expect entrepreneurship to be considerably less risky than optimization. Indeed, nothing could be as risky as optimizing resources in areas where the proper and profitable course is innovation, that is, where the opportunities for innovation already exist. Theoretically, entrepreneurship should be the least risky rather than the most risky course. [There are “hidden” risks of not being an entrepreneur.]

“Innovation,” then, is an economic or social rather than a technical term. It can be defined the way Say defined it, as changing the yield of resources. Or, as modern economists would tend to do, it can be defined in demand terms rather than in supply terms: changing the value and satisfaction obtained from resources by the consumer. Continue reading “Book Notes: Innovation and Entrepreneurship” →

Warren Buffett on Pensions (1975)

This is the full text letter from Warren Buffett to Katherine Graham discussing pensions, as released by Fortune. I find this easier to read on things like Instapaper than the PDF version.

PENSIONS

There are two aspects of the pension cost problem upon which management can have a significant impact: (1) maintaining rational control over pension plan promises to employees and (2) increasing investment returns on pension plan assets.

The Irreversible Nature of Pension Promises

To control promises rationally, it is necessary to understand the basic arithmetic and practical rules governing pension plans.

The first thing to recognize, with every pension benefit decision, is that you almost certainly are playing for keeps and won’t be able to reverse your decision subsequently if it produces subnormal profitability.

As a practical matter, it is next to impossible to decrease pension benefits in a large profitable company—or even a large marginal one. The plan may embody language unequivocally declaring the company’s right to terminate at any time and providing that contributions shall be solely at the option of the company. But the law has eroded much of the significance such “out” clauses were presumed to have, and operating practicalities render any residual rights to terminate moot.

So, rule number one regarding pension costs has to be to know what you are getting into before signing up. Look before you leap. There probably is more managerial ignorance on pension costs than any other cost item of remotely similar magnitude. And, as will become so expensively clear to citizens in future decades, there has been even greater electorate ignorance of governmental pension costs. Actuarial thinking simply is not intuitive to most minds. The lexicon is arcane, the numbers seem unreal, and making promises never quite triggers the visceral response evoked by writing a check.

In no other managerial area can such huge aggregate liabilities—which will be reflected in progressively increasing annual costs and cash requirements—be created so quickly and with so little immediate financial pain. Like pressroom labor practices, small errors will compound. Care and caution are in order. Continue reading “Warren Buffett on Pensions (1975)” →