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.

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.

  1. 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.

  2. 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.

  3. 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

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)”

Why Buffett Didn’t Buy the Post

There have been many speculations about why Warren Buffett — a long time shareholder, admirer, and one-time delivery boy of the Washington Post — opted not to purchase the company. Berkshire Hathaway has over $35 billion in cash and they’ve been purchasing local papers recently, so passing on the Post is curious at first glance.

Followers of Buffett have pointed to the fact that he has a policy of not buying into money-losing businesses in a shrinking industry.

But I think the real reason is that Buffett believes the Post will be better off in the hands of Bezos. For the Post to stop losing money, it needs some serious changes — changes that would be difficult for Berkshire to provide. The company would be only a tiny part of the massive conglomerate, and there wouldn’t be a figurehead leader to guide the paper during such a turnaround.

Buffett admires and respects Jeff Bezos.* He also loves the Washington Post enough to look past his own desires so it can have a brighter future. Don Graham no doubt sought Buffett’s advice before making this decision, and I’d like to believe this is what he told him.

* It’s also worth noting that the admiration is mutual. One of the major aspects of Buffett’s success is his ability to realize talent in others. It’s easy to see that talent in someone who knows strategy, history, product, and capital allocation so well.

Dear Mrs. Graham

In 1973, the Washington Post Company couldn’t have been a more widely revered media company. The Watergate scandal, which Bob Woodward and Carl Bernstein begun reporting on in mid-1972, came to a spectacular end with President Nixon’s resignation in August 1974. But the reverence of the publication didn’t match the company’s popularity on Wall Street. The Post—along with many other stocks at that time—was trading at historic lows.

Below is the letter that Warren Buffett wrote to Katharine Graham in June 1973 after he had acquired over 5% of the stock. By the end of the year his stake had increased to 10%. The letter gives a lot of insight into how Buffett viewed the Post—not only as an investment, but as a business with noble purposes that brings out his sentimental side.

This purchase represents a sizable commit ment to us—and an explicitly quantified compliment to the Post as a business enterprise and to you as its chief executive. Writing a check separates conviction from conversation. I recognize that the Post is Graham-controlled and Graham-managed. And that suits me fine.

Some years back, a partnership which I managed made a significant investment in the stock of Walt Disney Productions. The stock was ridiculously cheap based upon earnings, asset values and capability of management. That alone was enough to make my pulse quicken (and pocketbook open), but there was also an important extra dimension to the investment. In its field, Disney simply was the finest—hands down. Anything that didn’t reflect his best efforts—anything that might leave the customer feeling short-changed—just wasn’t acceptable to Walt Disney. He melded energetic creativity with a discipline regarding profitability, and achieved something unique in entertainment.

I feel the same way about The Washington Post. The stock is dramatically undervalued relative to the intrinsic worth of its constituent properties, although that is true of many securities in today’s markets. But, the twin attraction to the undervaluation is an enterprise that has become synonymous for quality in communications. How much more satisfying it is going to be to watch an investment in the Post grow over the years than it would be to own stock in some garden variety company which, though cheap, had no sense of purpose.

I am additionally impressed by the sense of stewardship projected by your communications to fellow shareholders. They are factual, complete and interesting as you bring your established newspaper standards for integrity to the newer field of corporate reporting.

You may remember that I was in your office about two years ago with Charles Munger, discussing the New Yorker. At the time I mentioned to you that I had received my financial start delivering the Post while attending Woodrow Wilson High in the mid 1940’s. Although I delivered about 400 Posts per day, my record of loyalty is slightly tarnished in that I also had the Times-Herald route (much smaller—my customers were discriminating) in the Westchester. This was perhaps the first faint sign to keenly perceptive Washingtonians that the two organizations eventually would get together.

I should mention that Berkshire Hathaway has no radio or television properties, so that we will not be a complicating factor with the FCC. Our only communications property is the ownership of Sun Newspapers of Omaha, a group of financially (but not editorially) insignificant weekly newspapers in the metropolitan Omaha area. Last month our whole organization, seventy people counting printing, went into orbit when we won a Pulitzer for our reporting on Boys Town’s undisclosed wealth. Incidentally, Newsweek and Time used approximately equal space in covering the story last year, but Newsweek’s reporting job was far superior.

You can see that the Post has a rather fervent fan out in Omaha. I have hopes that, as funds become available, we will add to our holdings, at which time I will send along amended 13-D filings.

Cordially,
Warren E. Buffett

This letter was taken from Katharine Graham’s wonderful autobiography, Personal History.

Berkshire Hathaway Letters to Shareholders

Berkshire Letters CoverI’m excited to announce the release of a book I’ve been working on for about 6 months now, and first started in 2010.

It’s a compilation of every letter Warren Buffett wrote to the shareholders of Berkshire Hathaway. I first created it a few years ago for myself and friends. Last year I got Buffett’s endorsement — plus a few non-public letters — to publish the book for the benefit of fans and shareholders of Berkshire.

Here is the official page with all the details. There you can find a more detailed description, plus some sample pages and a chart detailing the performance of Berkshire’s insurance operations. (For any programmers out there, the chart was created with D3. You can check out the development version on GitHub.)

Features of the book:

  • Berkshire Hathaway annual shareholder letters from 1965 to 2012 (706 pages), including the 11 earliest letters not available on Berkshire’s website
  • Tabulated letter years so you can easily flip to the desired letter
  • Topics index
  • Company index
  • Person index
  • Charts of:
    • The growth in Berkshire’s book value and market price relative to benchmarks
    • Insurance float and performance
    • The operating businesses of Berkshire

The entire book is paginated, and has easy-to-flip-to labels for each letter’s year.

It is available for pre-order now. The first batch will be sold at the Berkshire Hathaway Annual Meeting on May 4 in the convention center. The rest of the copies will be available on Amazon on May 7.

Future projects

  • The obvious next step is to publish a digital version, easily readable on iPads or potentially Kindles. This is normally an easy transfer, but that’s not the case with this book due to the many tables that have to be converted. So no timeline on this but it will be forthcoming.
  • A book of letters to the partners of Buffett Partnership, Ltd., Buffett’s hedge fund he ran from 1957 to 1970. This will be a similar format to the Berkshire book, with indexes, page numbers, etc.

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”