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.



  • 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.

Companies I admire

Here’s a short list of modern companies I admire, in no particular order:

I admire each for different reasons, but primarily it is their culture, processes, and organizational structure. All of these also maintain “smallness” in their own way, a topic I’ll probably discuss in a future post.

Stakeholder Value & The Dynamic Pie

A recent article by Forbes contributor Steve Denning reviewed Roger Martin’s new book, Fixing the Game. It was a good review and I plan on reading the book.

The gist of the article is that managers of public companies focus too much on the expectations behind their stock price, and in turn “maximizing shareholder value.” [1] According to Martin, the causes stem from misaligned incentives and the business culture that has developed over the past 30 years. This focus on shareholders usually comes at the expense of customers and employees. “If you try to take care of shareholders, customers don’t benefit and, ironically, shareholders don’t get very far either.” When managers are working in the expectations market, they’re much more likely to make short term decisions that benefit only themselves and a (vocal) subset of shareholders—traders. This includes seemingly harmless activities like giving quarterly or annual earnings guidance, or for retailers reporting monthly same-store sales figures.

Martin proposes a few remedies to the problem, like improving board governance and eliminating both safe harbor provisions and stock-based compensation. These would go a long way to nudge corporate behavior in the right direction. But for managers who want to take it upon themselves, here’s my proposal: think of your company as a Dynamic Pie.

Continue reading “Stakeholder Value & The Dynamic Pie”

On Buffett’s 2010 Letter to Shareholders

Warren BuffettHere is Warren Buffett’s 2010 Letter to Shareholders if you haven’t seen it already.

It was a very good letter overall, with Buffett providing his usual wisdom and wit. This year, he didn’t have to review the basics as he did in 2009 for the new Burlington Northern shareholders, so there was even more wisdom about Buffett’s methodologies and Berkshire’s businesses than usual.

He spends some time in the letter talking about Berkshire’s culture, which is an extremely important yet overlooked part of their past and future success. It is this culture that will allow Buffett to continue to “run” the company for many years after his death. That’s what Berkshire shareholders and the media should focus on instead of worrying so much about succession.

One thing is clear: Buffett may not run the companies that Berkshire owns, but he knows the numbers cold. Of course, that’s always been the case. For every kind of business, he knows the metrics that matter most and the determinants that drive success over time. Sometimes, he even knows it better than the managers themselves (and he’s a much better manager than he’d like to admit in his letters).

For investors, one of the most insightful parts of both Buffett’s letters and annual meetings is how he thinks about and evaluates businesses. In this letter, he didn’t disappoint by providing more insight on how he evaluates Berkshire’s holdings. GEICO was one specific example. The value of policyholders for many insurance companies is zero or even less than zero — these companies are worth tangible book value and no more. But GEICO, according to Buffett’s evaluation, has an extremely valuable base of policyholders: worth about $14 billion, or 97% of annual premium volume.

Number-wise, Buffett provided his estimate of the normalized earnings power of Berkshire’s operations — which at $17 billion, is higher than the reported amount in 2010. These earnings alone would give Berkshire a current pre-tax yield of over 8%, and that doesn’t include any new investments or future gains on their $158 billion in investments.

This valuation compares very favorably to many large-caps in the S&P 500. I think Berkshire is worth at least $100 per “B” share, if not more if Buffett can continue to deploy capital into good, growing businesses.

You can see the above comments in addition to commentary from other Berkshire shareholders in this WSJ blog post: “Here is What People Are Saying About Buffett’s Letter

Braewick Holdings LP owns shares in Berkshire Hathaway. We reserve the right to buy or sell them at any time.

Berkshire’s Intelligent Acquisitions

Just going through the book “The Innovator’s Dilemma” by Clayton Christensen. I have a few posts I’ll likely write that relate to the book — this is one of them.

::amazon(“0060521996”, “The Innovators Dilemma”):: talks a lot about a company’s culture, and why incumbent leaders of a certain technology are restrained from participating in a disruptive technology’s upside. Christensen names these attributes as the incumbent’s downfall: (1) Current customers aren’t served by new market; (2) New market is too small for large companies; (3) Use of new technology isn’t fully known yet; (4) Processes that help them with current business hurt them with new business; and (5) New technology isn’t good enough yet to meet higher-end market demand.

One solution to the above issues is to acquire another company that can take advantage of the disruptive technology. If done correctly, this can solve numbers 1, 2, 4, and 5 above.

Christensen breaks down the factors that affect what a company can and cannot do into Resources, Processes, and Values. Resources are people, equipment, brands, technology, customers, etc. Processes are how companies transform those resources into products or services of greater value. Values are standards by which employees make and prioritize decisions (think of a company’s “Core Values” of the Jim Collins variety).

Continue reading “Berkshire’s Intelligent Acquisitions”

Berkshire Part 2: Selling Puts

Buffett has pulled it off again. He’s made a creative, favorable bet that may pay off handsomely for long-term Berkshire shareholders.

Over the past year, Berkshire Hathaway sold put options on the S&P 500 and three foreign indices. Expiration of these puts range from 12 to 20 years out, and Berkshire collected $4.5 billion in premiums. Unlike regular puts, these are exercisable only at their expiration dates. On those dates, Berkshire makes a payment only if the index has lost money over the period of the option.

Selling these puts is essentially saying: In 15 years, I promise to buy the S&P 500 from you at a price of $1,468 (closing 2007), if it trades below that price. In exchange, you give me $4.5 billion right away.

Buffett doesn’t disclose the size of the actual options. The $4.5 billion in premiums tells you they are big, but apparently not big enough relative to Berkshire to cause any problems.

The counterparties (the people who made the agreement and paid the premium) are most likely large financial institutions who are hedging their long-term bets in favor of the market. So it may turn out to be a dumb bet for them, but they’re essentially purchasing insurance on what they have or will have in the market.

For Berkshire to lose money, a few things have to happen. To keep it simple, let’s just talk about the S&P 500, because we don’t know which foreign indices were used.

  1. First, over the next 12 to 20 years, the market would have to have a negative cumulative return.
  2. Second, that negative return would have to be large enough to overcome the premiums received.

How large? Once again, we don’t know the size of the options. But the premiums, which were $4.5 billion at the time they were written, will have compounded for more than 15 years by the time of expiration. If Buffett (or future Berkshire managers) can achieve 15% annual returns, the premium cash will have grown to over $36 billion. So the aggregate losses on the put options—the size of the options times the amount of negative returns—would have to exceed $36 billion for any profits to be erased.

Because of their long-term length, it mitigates the risk of a short-term Black Swan-type event affecting the options. A “Black Monday” one day anomaly would have little effect, other than a temporary quarterly adjustment. Something could still happen (i.e. a long depression, or a nuclear war, God forbid) that would cause losses. But this bet seems pretty favorable as long as the world economy does alright in the long run. Chalk one up for the Oracle of Omaha.

Berkshire Part 1: See’s and PetroChina

You’ve probably read Warren Buffett’s 2007 letter to shareholders that was released a week ago. If not, stop everything you’re doing, and read it now.

Below are a few comments I have on some of the things Buffett mentions in the letter. The second part of this post should be up later today.

On See’s Candy

The best part of the letter is the section entitled “Businesses – The Great, The Good, and the Gruesome.” In it, Buffett talks about the qualities of a great business using See’s Candy as an example.

Six months ago I wrote a two part story on See’s Candy. In Part I of Quality Without Compromise I talk about the history and background of the See’s acquisition. In Part II, I discuss some of the technical and qualitative aspects of the purchase. (Click here for a single PDF version of the articles.)

In the letter, Buffett reveals some interesting new information about See’s and his mindset regarding the business.

Fun with numbers:

  • Pre-tax profits in 2007 were $82 million.
  • Over the years, total profits distributed come to $1.32 billion.
  • Current Return on Capital is 205%.
  • Since the purchase, only $32 million in additional capital was required.
  • Profits at acquisition were about $5 million, so total increase has been $77 million over the 35 year period. This comes out to a return on incremental capital invested of 241% ($77/$32).
  • For every $1.00 Berkshire sent to See’s, they got back $41.19.

Talking about some of the reasons for the high Return on Capital, Buffett made the comment: “First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was sort, which minimized inventories.” Working capital is one of the major reasons businesses must invest more capital to keep up with sales growth. Fixed assets are another requirement where See’s has advantages. There are relatively few production facilities. More recently, the internet has allowed See’s to sell more pounds of candy (to anywhere in the country) with little to no additional capital expenditures.

Low volume is a problem at See’s, but the ability to raise prices made up for it: “Last year See’s sold 31 million pounds [of candy], a growth rate of only 2% annually.” In See’s early years (the 11 years after Buffett’s purchase), prices per pound of chocolate were raised about 10% per year. These increases accounted for 86% of sales gains over the period. Small volume gains accounted for the rest.

See also: Shai Dardashti asks if See’s Candy is a Magic Formula Stock from 1972. I like Shai’s conclusion that “See’s Candy is effectively a (rising) royalty on love men pay, annually, in the state of California.

On PetroChina

Buffett goes into a little more detail on the sale of Berkshire’s stake in PetroChina. In October I wrote up a short case study on the investment in PTR, which you can see here. He confirms in writing that when they sold PTR back in September, he believed it was fairly valued. This echoes the research I did on the gap between price and value over the years (and the effect of oil prices on that value).

“By 2007, two factors had materially increased its value: the price of oil had climbed significantly, and PetroChina’s management had done a great job in building oil and gas reserves. … We paid the IRS tax of $1.2 billion on our PetroChina gain. This sum paid all costs of the U.S. government – defense, social security, you name it – for about four hours.”

On Selling Market Puts

Stay tuned for Part 2…