Berkshire’s “Subpar” Year And Other Goodies

Warren Buffett, the most famous investor in America, really holds himself to a much higher standard than most. That’s why he describes the business year of 2012 as “subpar” even though Berkshire Hathaway made a total of $24.1 billion for its shareholders. Buffett pointed out that only for the ninth time in Berkshire Hathaway’s 48 years, their book value of 14.4% was actually less than the S&P’s gain of 16%. This is basically how Buffett kicks off his annual letter, which he released on Friday, March 1. If you are interested in investing, then this document is a must read for you and anyone else interested in this field. It’s filled with plenty of Warren Buffett’s homespun, wry style.

Putting aside the “subpar” performance of Berkshire Hathaway, Buffett’s other major regret was the “inability” to achieve a major accomplishment during 2012. “I pursued a couple of elephants, but came up empty handed,” wrote Buffett. He did find his mojo again during the early part of 2013, being part of a blockbuster 23.3 billion-dollar acquisition of H.J. Heinz Co., the ketchup giant. Berkshire Hathaway is putting up $12 billion to purchase half of the company, along with another group of investors led by Brazilian businessman Jorge Paulo, who is buying the other half of the company.

Buffett wrote that now that this deal is done, it’s time for more big game hunting. “Charlie and I have again donned our safari outfits and resumed our search for elephants.” (Charlie Munger is long-time partner to Warren Buffett and friend of many years.)

Without question, the Buffett annual letter to shareholders is quite educational in regards to his philosophy of value investing, which he learned from Benjamin Graham, his mentor and author of The Intelligent Investor, a classic business tome.

Buffett’s investing philosophy is quite simple: Invest in easy to understand companies, for the long-term, with managers who love their business, and the businesses are currently undervalued. Always disregard all flavor of the month trends.

Buffett personally loves to invest in large, extremely reliable American businesses. This explains why the four biggest Berkshire Hathaway investments are in Wells Fargo, Coca-Cola, IBM and American Express. He increased Berkshire Hathaway’s ownership stake in all of these companies during 2012. The Omaha, Nebraska-based investment firm now owns 8.9% of Coca-Cola, 6% of IBM, 13.7% of American Express and 8.7% of Wells Fargo. “Berkshire’s ownership interest in all four companies is likely to increase in the future,” wrote Buffett. “Mae West had it right: ‘Too much of a good thing can be wonderful.’”

Let’s now take a look at some of the major highlights of the Berkshire Hathaway annual letter:

Guessing about Succession: The question asked most frequently in American capitalism is this: Who is going to finally replace the 82-year-old Warren Buffett? Buffett has made it quite clear that his duties are going to be divided among an investment manager – who is responsible for the allocation of Berkshire’s money – and a CEO, ultimately in charge of running the entire $170 billion empire that is Berkshire Hathaway. Warren Buffett confirmed last year that Ted Weschler and Todd Combs, two relatively unknown hedge fund managers, will be replacing him on the investment side. Buffett was very pleased with their performance during 2012.

Weschler and Combs “have proved to be smart, models of integrity, helpful to Berkshire in many ways beyond portfolio management, and a perfect fit,” wrote Buffett. “We hit the jackpot with these two. In 2012 each outperformed the S&P 500 by double-digit margins.” Buffett then added mischievously, in a very tiny font: “They left me in the dust as well.” As a result of this excellent performance, Buffett and Berkshire Hathaway have decided to increase their investment funds to around $5 billion. “Todd and Ted are young and will be around to manage Berkshire’s massive portfolio long after Charlie and I have left the scene. You can rest easy when they take over,” wrote Buffett.

On the side of management, Warren Buffett didn’t provide any clues, but he did heavily praise Ajit Jain, a longtime favorite of Buffett who manages the reinsurance group of Berkshire Hathaway worth in the multi-billions. He is widely looked upon as one of the top candidates to take over the CEO position at Berkshire. “From a standing start in 1985, Ajit has created an insurance business with float of $35 billion and a significant cumulative underwriting profit, a feat that no other insurance CEO has come close to matching,” wrote Buffett. “He has thus added a great many billions of dollars to the value of Berkshire. If you meet Ajit at the annual meeting, bow deeply.”

Newspapers: We all know that Buffett loves newspapers, “and if the economics make sense, [Berkshire] will buy them even when they fall far short of the size threshold we would require for purchase of, say, a widget company.” Over the last 15 months, Berkshire Hathaway has acquired 28 daily newspapers and paid $344 million for the privilege, he wrote, even with his long-standing prediction that “the circulation, advertising and profits of the newspaper industry overall are certain to decline.”

Here’s Warren Buffett’s logic: “News, to put it simply, is what people don’t know that they want to know,” wrote Buffett. “And people will seek their news – what’s important to them – from whatever sources provide the best combination of immediacy, ease of access, reliability, comprehensiveness and low cost.” Buffett will readily admit that the Internet has been a disruption on the traditional newspaper business model, causing a drastic decline in revenues and readership. But there’s one particular area in this industry where Buffett sees an opportunity:

Newspapers continue to reign supreme, however, in the delivery of local news. If you want to know what’s going on in your town – whether the news is about the mayor or taxes or high school football – there is no substitute for a local newspaper that is doing its job. A reader’s eyes may glaze over after they take in a couple of paragraphs about Canadian tariffs or political developments in Pakistan; a story about the reader himself or his neighbors will be read to the end. Wherever there is a pervasive sense of community, a paper that serves the special informational needs of that community will remain indispensable to a significant portion of its residents. […]

Charlie and I believe that papers delivering comprehensive and reliable information to tightly-bound communities and having a sensible Internet strategy will remain viable for a long time. We do not believe that success will come from cutting either the news content or frequency of publication. Indeed, skimpy news coverage will almost certainly lead to skimpy readership. And the less-than-daily publication that is now being tried in some large towns or cities – while it may improve profits in the short term – seems certain to diminish the papers’ relevance over time. Our goal is to keep our papers loaded with content of interest to our readers and to be paid appropriately by those who find us useful, whether the product they view is in their hands or on the Internet.

Uncertainty: In one of the more surprising parts of the annual Berkshire letter, Warren Buffett called out a few of his fellow US CEOs who have “cried ‘uncertainty’ when faced with capital allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash).” Buffett is an optimist for America, who wrote that he is not in agreement with their concerns. “If you are a CEO who has some large, profitable project you are shelving because of short-term worries, call Berkshire. Let us unburden you,” wrote Buffett.

American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor. (The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions. And don’t forget that shareholders received substantial dividends throughout the century as well.)

Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it. My own history provides a dramatic example: I made my first stock purchase in the spring of 1942 when the U.S. was suffering major losses throughout the Pacific war zone. Each day’s headlines told of more setbacks. Even so, there was no talk about uncertainty; every American I knew believed we would prevail.

The country’s success since that perilous time boggles the mind: On an inflation-adjusted basis, GDP per capita more than quadrupled between 1941 and 2012. Throughout that period, every tomorrow has been uncertain. America’s destiny, however, has always been clear: ever-increasing abundance.

Omaha, Nebraska, Next Stop: The Berkshire Hathaway annual shareholders meeting is known as the Woodstock of capitalism – and for very good reason. Each year, tens of thousands of the Berkshire Hathaway faithful make a pilgrimage to the annual meeting of the company, which takes place in Omaha, Nebraska on May 4 this year. It is quite the spectacle: imagine for a moment a Grateful Dead concert populated by hard-core, and in certain cases, the very wealthy, true believers in capitalism. Everyone is always in a great mood. Among this year’s highlights are:

  • Berkshire Hathaway’s second annual international newspaper tossing challenge. “Last year I successfully fought off all challengers,” wrote Buffett. “But now Berkshire has acquired a large number of newspapers and with them came much tossing talent (or so the thrower’s claim). Come see whether their talent matches their talk.”
  • The “Berkshire 5K” race will start at CenturyLink Center, the arena that holds 19,000 seats and is also the location of the annual meeting. “We will have plenty of categories for competition, including one for the media,” wrote Buffett. “Regretfully, I will forgo running; someone has to man the starting gun.”
  • On Sunday, May 5, they hold the Borsheims Fine Jewelry gala. (Berkshire has owned Borsheims, the Omaha-based company, since 1989.) “Around 1 PM on Sunday, I will begin clerking at Borsheims,” wrote Buffett. “Last year my sales totaled 1.5 million. This year I won’t quit until I hit the $2 million. Because I need to leave well before sundown, I will be desperate to do business. Come take advantage of me. Ask for my ‘Crazy Warren’ price.”

The annual Berkshire Hathaway meeting is always a very memorable experience. Buffett can seem like he’s ageless at times, but unfortunately, that just isn’t the case. So if you happen to be a Berkshire Hathaway shareholder in the area of Omaha during the first weekend of May, you never know who you’re going to run into at Piccolo’s or Gorat’s. “These restaurants are my favorites, and I will eat at both of them on Sunday evening,” wrote Buffett. If you decide to go to Piccolo’s, “order a giant root beer float for dessert,” advises Buffett. “Only sissies get the small one. (I once saw Bill Gates polish off two of the giant variety after a full course dinner; that’s when I knew he would make a great director.)”

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