Warren Buffett’s Berkshire Hathaway has long been worshipped by many and its chairman lauded for his investment wisdom, laced with homespun humour.
But, for all those devotees who adore him as a disciple of the father of value investing, Ben Graham, or those who use his name to sell investment schemes and advice, this year’s version of his annual letter to shareholders was something of a revelation.
Sure, there were the usual zingers: ”You see a cockroach in your kitchen; as the days go by, you meet his relatives,” and “if horses had controlled investment decisions, there would have been no auto industry.” But, marking its 50th year, Buffett and vice chairman Charlie Munger have reflected on Berkshire Hathaway’s growth into a completely new beast.
The new order
They provide a clear view of the group’s success – and how much it has changed. Previously, it was invested in listed securities; today it emphasises owning and operating large businesses. It is now probably the world’s most successful conglomerate, with 340,500 employees and capex spending of $US15 billion. It is, in Buffett’s words, “a sprawling conglomerate – trying to sprawl further.”
Berkshire now has four main arms, headed by what Buffett calls the Powerhouse Five – the railways and utilities mainly bought in the last decade – which in 2014 contributed $12.4 billion in profits (all figures $US and pre-tax).
Then there are its smaller industrials with $5.1 billion profits, and the insurance group with $2.7 billion of profits (but more importantly generating $84 billion in its “float”).
To that add the group’s listed investments, notably IBM, Coca Cola, Amex and Wells Fargo bank, which alone had $4.7 billion of equity accounted profits, though Berkshire only recognises $1.6 billion of dividends. The top 15 listed investments had a market value of $117.5 billion (they cost only $55 billion).
As a reminder of Buffett’s investment smarts, it also has a “call” option over 700 million Bank of America shares with a market value of $12.5 billion, a deal done in the GFC when only Berkshire had capital to invest. It paid $5 billion for the option.
The 2iC
Before he met Munger, Buffett says he had Berkshire investing like someone picking up cigar butts. Then in 1959 the two were introduced (Buffett was 28 and Munger 35) and the partnership blossomed. In over 50 years they may have disagreed but never argued.
Usually, says Buffett, Charlie ends by saying: “Warren, think it over and you’ll agree with me because you’re smart and I’m right.” Munger’s philosophy produced the blue print, which has seen Berkshire develop into a major US industrial powerhouse.
Previously, it was about “buying fair businesses at wonderful prices” – Ben Graham’s recipe of buying shares well below their intrinsic value. Under Munger’s guidance that switched to ”buying wonderful businesses at fair prices.”
Berkshire’s cash-generating insurance arm and canny husbanding of cash (now around $60 billion in cash or Treasuries) has led the group into partnering other groups in acquisitions. While this continues, Buffett suggests shareholders can forget about dividends for perhaps 10 to 20 more years before cash becomes too large.
First it joined the 3G Capital group to acquire Heinz, and it expects to participate in other activities, usually as an equity partner. It also has similar partnerships with Mars and Leucadia (often called baby Berkshire Hathaway).
Now it has moved into the unfashionable field of car distribution, buying the fifth largest group in the US – and looking to expand in this area.
Buffett wants to make more “bolt on” acquisitions, both large and small, and hints that acquiring an occasional Fortune 500-size company isn’t out of the question – obviously to make a major impact to earnings.
Succession planning
And when Buffett goes? Munger says potential replacements Ajit Jain and Greg Abel are “world-leading” performers who in some important ways may be better than Buffett.
The group has been carefully grooming the executives who will take over. Of Jain who runs the reinsurance business, Buffett says his underwriting skills are unmatched and “his mind is an idea factory that is always looking for new lines of business.”
He also has given the two investment managers, Todd Combs and Ted Weschler, oversight on at least one operating business as chairman, to add business management to their investment management skills.
And just in case shareholders need an example of the advantages of buying a great business, Buffet reminds them of See’s Candy bought in 1972. Berkshire paid $25 million, invested another $65 million –and has reaped cumulative profits of $1.9 billiion. Overall, Buffett says, “listening to Charlie has paid off.”
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