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.

BRK-individual-investments

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.

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…

Quality Without Compromise

See’s Candies, Warren Buffett and the perfect investment.

PDF Version of “Quality Without Compromise”

See's Candies

William Ramsey, an executive at Blue Chip Stamps, stood in the office of Robert Flaherty as they both awaited a call. Moments earlier, Flaherty attempted to persuade Warren Buffett, majority owner of Blue Chip, to con­sider purchasing See’s Candy Shops Inc., a popular West Coast candy maker. Buffett turned them down—up until then, he was used to buying boring businesses on the cheap: banks, textile mills and insurance companies. Ramsey however, thought See’s was a great buy, and desperately tried to get Buffett back on the phone. Their sec­retary finally got hold of Buffett at his home in Omaha. He had reviewed the numbers, and liked what he saw.

After consulting with Charlie Munger, Buffett’s friend and business partner, they were willing to make an offer. This would be Buffett’s biggest investment to date, and he wasn’t one to overpay for anything—the deal al­most fell through during negotiations, but the sellers finally accepted their proposal. The final price was $35 per share. With one million shares out­standing and $10 million in cash on the books, the net purchase price was $25 million. Blue Chip Stamps now owned 67.3 percent of See’s Candy Shops, with the remainder purchased from about 2,200 public holders in the months after. But one thing remained unfinished: who would run the com­pany? Buffett made it clear upfront that they wouldn’t be calling the shots at See’s. Suggested by the previous owner, Buffett, Munger and a friend named Rick Guerin met with Charlie Huggins—executive vice president and twenty-year veteran of See’s. After three hours of discussion, Buffett knew that Huggins was the man for the job.
Continue reading “Quality Without Compromise”