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Berkshire Hathaway’s 15 owner-related business principles

Source: Berkshire Hathaway Annual Report 2016

1.  Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as ownerpartners, and of ourselves as managing partners. (Because of the size of our shareholdings we are also, for better or worse, controlling partners.) We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets.

2.  In line with Berkshire’s owner-orientation, most of our directors have a major portion of their net worth invested in the company. We eat our own cooking.

3.  Our long-term economic goal (subject to some qualifications mentioned later) is to maximize Berkshire’s average annual rate of gain in intrinsic business value on a per-share basis. We do not measure the economic significance or performance of Berkshire by its size; we measure by per-share progress. We are certain that the rate of per-share progress will diminish in the future – a greatly enlarged capital base will see to that. But we will be disappointed if our rate does not exceed that of the average large American corporation.

4. Our preference would be to reach our goal by directly owning a diversified group of businesses that generate cash and consistently earn above-average returns on capital. Our second choice is to own parts of similar businesses, attained primarily through purchases of marketable common stocks by our insurance subsidiaries. The price and availability of businesses and the need for insurance capital determine any given year’s capital allocation.

5.  Because of our two-pronged approach to business ownership and because of the limitations of conventional accounting, consolidated reported earnings may reveal relatively little about our true economic performance. Charlie and I, both as owners and managers, virtually ignore such consolidated numbers. However, we will also report to you the earnings of each major business we control, numbers we consider of great importance. These figures, along with other information we will supply about the individual businesses, should generally aid you in making judgments about them.

6. Accounting consequences do not influence our operating or capital-allocation decisions. When acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under standard accounting principles than to purchase $1 of earnings that is reportable. This is precisely the choice that often faces us since entire businesses (whose earnings will be fully reportable) frequently sell for double the pro-rata price of small portions (whose earnings will be largely unreportable). In aggregate and over time, we expect the unreported earnings to be fully reflected in our intrinsic business value through capital gains.

7.  We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long-term fixed-rate basis. We will reject interesting opportunities rather than over-leverage our balance sheet. This conservatism has penalized our results but it is the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders, lenders and the many equity holders who have committed unusually large portions of their net worth to our care. (As one of the Indianapolis “500” winners said: “To finish first, you must first finish.”)

8.  A managerial “wish list” will not be filled at shareholder expense. We will not diversify by purchasing entire businesses at control prices that ignore long-term economic consequences to our shareholders. We will only do with your money what we would do with our own, weighing fully the values you can obtain by diversifying your own portfolios through direct purchases in the stock market.

9. We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely.

10.  We will issue common stock only when we receive as much in business value as we give. This rule applies to all forms of issuance – not only mergers or public stock offerings, but stock-for-debt swaps, stock options, and convertible securities as well. We will not sell small portions of your company – and that is what the issuance of shares amounts to – on a basis inconsistent with the value of the entire enterprise.

11.  You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior. ( To clean up some confusion voiced in 2016, we emphasize that the comments here refer to businesses we control, not to marketable securities)

12.  We will be candid in our reporting to you, emphasizing the pluses and minuses important in appraising business value. Our guideline is to tell you the business facts that we would want to know if our positions were reversed. We owe you no less. Moreover, as a company with a major communications business, it would be inexcusable for us to apply lesser standards of accuracy, balance and incisiveness when reporting on ourselves than we would expect our news people to apply when reporting on others. We also believe candor benefits us as managers: The CEO who misleads others in public may eventually mislead himself in private.

13. Despite our policy of candor, we will discuss our activities in marketable securities only to the extent legally required. Good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisition ideas are. Therefore we normally will not talk about our investment ideas. This ban extends even to securities we have sold (because we may purchase them again) and to stocks we are incorrectly rumored to be buying. If we deny those reports but say “no comment” on other occasions, the no-comments become confirmation.

TWO ADDED PRINCIPLES

14.  To the extent possible, we would like each Berkshire shareholder to record a gain or loss in market value during his period of ownership that is proportional to the gain or loss in per-share intrinsic value recorded by the company during that holding period. For this to come about, the relationship between the intrinsic value and the market price of a Berkshire share would need to remain constant, and by our preferences at 1-to-1. As that implies, we would rather see Berkshire’s stock price at a fair level than a high level. Obviously, Charlie and I can’t control Berkshire’s price. But by our policies and communications, we can encourage informed, rational behavior by owners that, in turn, will tend to produce a stock price that is also rational. Our it’s-as-bad-to-be-overvalued-as-to-be-undervalued approach may disappoint some shareholders. We believe, however, that it affords Berkshire the best prospect of attracting long-term investors who seek to profit from the progress of the company rather than from the investment mistakes of their partners.

15. We regularly compare the gain in Berkshire’s per-share book value to the performance of the S&P 500. Over time, we hope to outpace this yardstick. Otherwise, why do our investors need us? The measurement, however, has certain shortcomings that are described in the next section. Moreover, it now is less meaningful on a year-to-year basis than was formerly the case. That is because our equity holdings, whose value tends to move with the S&P 500, are a far smaller portion of our net worth than they were in earlier years. Additionally, gains in the S&P stocks are counted in full in calculating that index, whereas gains in Berkshire’s equity holdings are counted at 65% because of the federal tax we incur. We, therefore, expect to outperform the S&P in lackluster years for the stock market and underperform when the market has a strong year.

 

 

How Berkshire Hathaway treats company’s new information

In his February 27, 2016, letter to Berkshire Hathaway for FY2015, chairman Warren Buffett said: “While I’m on the subject of our owners’ gaining knowledge, let me remind you that Charlie and I believe all shareholders should simultaneously have access to new information that Berkshire releases and, if possible, should also have adequate time to digest and analyze it before any trading takes place.”

Explaining the reason, he said: “That’s why we try to issue financial data late on Fridays or early on Saturdays and why our annual meeting is always held on a Saturday.”

Berkshire Hathaway is also against giving institutional investors or analysts privileged information, with Warren Buffett saying: “We do not follow the common practice of talking one-on-one with large institutional investors or analysts, treating them instead as we do all other shareholders. There is no one more important to us than the shareholder of limited means who trusts us with a substantial portion of his savings.”

Does Warren Buffett or Berkshire Hathaway hold certain stocks forever?

Does Warren Buffett or Berkshire Hathaway hold certain stocks forever?

To answer this question, one needs to go back to Berkshire Hathaway’s 2016 Annual Report 2016, in which chairman Warren Buffett said:  “Sometimes the comments of shareholders or media imply that we will own certain stocks “forever.” It is true that we own some stocks that I have no intention of selling for as far as the eye can see (and we’re talking 20/20 vision). But we have made no commitment that Berkshire will hold any of its marketable securities forever.”

What could have prompted the implication by shareholders and the media that Warren Buffett holds certain stocks forever?

Warren Buffett said in Berkshire Hathaway’s 2016 Annual Report said: “Confusion about this point may have resulted from a too-casual reading of Economic Principle 11 on pages 110 – 111, which has been included in our annual reports since 1983. That principle covers controlled businesses, not marketable securities. This year I’ve added a final sentence to #11 to ensure that our owners understand that we regard any marketable security as available for sale, however unlikely such a sale now seems.”

What is Warren Buffett’s Economic Principle 11 and what is the final sentence that was added in 2016 to this principle? Let’s explore.

Background: In June 1996, Berkshire’s chairman Warren Buffett  issued a booklet entitled “An Owner’s Manual” to Berkshire’s Class A and Class B shareholders. The purpose of the manual was to explain Berkshire’s broad economic principles of operation.

There were originally 13 economic principles which Warran Buffett set up in 1983. The 2016 Annual Report provided an updated version of “An Owner’s Manual”.

Economic Principle 11 goes like this:

You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior.
“We continue to avoid gin rummy behavior. True, we closed our textile business in the mid-1980’s after 20 years of struggling with it, but only because we felt it was doomed to run never-ending operating losses. We have not, however, given thought to selling operations that would command very fancy prices nor have we dumped our laggards, though we focus hard on curing the problems that cause them to lag. To clean up some confusion voiced in 2016, we emphasize that the comments here refer to businesses we control, not to marketable securities.”

The last sentence in Berkshire Hathaway Economic Principle 11 made it clear that Warren Buffett’s comments refer to businesses that Berkshire Hathaway owns and not to marketable securities.

Investment versus Speculation

“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

Benjamin Graham, “The Intelligent Investor”

Benjamin Graham, widely known as the  father of value investing, said that “outright speculation  is neither illegal, immoral, nor (for most people) fattening to the pocketbook”. He acknowledged speculation is necessary and unavoidable, saying that in many common-stock situations there are substantial possibilities of both profit and loss, and the risks must be assumed by someone. But there is intelligent speculation as there is intelligent investing. He mentioned three ways in which speculation is unintelligent: (1) speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and (3) risking more money in speculation that you can afford to lose.

Benjamin Graham went on to say that every non-professional who operates on a  margin should recognize that he is ipso facto speculating. Also, everyone who buys a so-called “hot” common-stock issue , or makes a purchase in any way similar thereto, is either speculating or gambling.

His advice: If you want to try your luck at it, put aside a portion – the smaller the better – of your capital in a separate fund for the purpose. Never add money to this account just because the market has gone up and the profits are rolling in.  (That is the time to think of taking money out of your speculative fund.)

Berkshire Hathaway ‘A’ and ‘B’ shares

A new release by Berkshire Hathaway dated 10 July 2017 said that chairman Warren Buffett  that day converted 12,500 of his Class A shares into 18,750,000 Class B shares.

“Of these Class B shares, 18,628,189 have been donated to five foundations: Bill & Melinda Gates Foundation, Susan Thompson Buffett Foundation, Sherwood Foundation, Howard G.
Buffett Foundation and NoVo Foundation. These shares have a current value of $3.17 billion.”

The new release said that Mr  Buffett had never sold any shares of Berkshire. “With the current gift, however, more than
40% of his 2006 holdings have been given to the five foundations. Their value at the time of the gifts, including the 2017 gift, totals $27.54 billion.”

“Mr  Buffett intends to have all of his Berkshire shares given to philanthropy through annual gifts that will be completed ten years after his estate is settled. In all cases, his A shares will be
converted into B shares immediately prior to the gift. ”

This post seeks to explain the difference between Berkshire A and B shares. For this, Buffettpedia refers to a post dated 5 December 2014 in which it was said: Berkshire Hathaway chairman Warren Buffett said in a memo dated February 2, 1999 (updated on July 3, 2003 and on January 20, 2010) that Berkshire Hathaway Inc has two classes of common stock designated Class A and Class B.

The memo made  it clear on the differences between the two classes of shares. “A share of Class B common stock has the rights of 1/1,500th of a share of Class A common stock except that a Class B share has 1/10,000th of the voting rights of a Class A share (rather than 1/1,500th of the vote).”
Another point to note in the memo was the “convertible” aspect: “Each share of a Class A common stock is convertible at any time, at the holder’s option, into 1,500 shares of Class B common stock. This conversion privilege does not extend in the opposite direction. That is, holders of Class B shares are not able to convert them into Class A shares.”
“Both Class A & B shareholders are entitled to attend the Berkshire Hathaway Annual Meeting which is held the first Saturday in May,” said the memo.

 

 

Warren Buffett: Two things to remember during scary periods

“The years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks,” Warren Buffett said in his FY2016 letter to Berkshire Hathaway shareholders.

“No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: “We spend a lot of time looking for systemic risk; in truth, however, it tends to find us,” said Mr Buffett.

What should investors do during such scary periods?

“…you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well,” said Mr Buffett, who is chairman and CEO of Berkshire Hathaway.

Mr Buffett started his thought on this subject by saying: “America’s economic achievements have led to staggering profits for stockholders. During the 20th century the Dow-Jones Industrials advanced from 66 to 11,497, a 17,320% capital gain that was materially boosted by steadily increasing dividends. The trend continues: By yearend 2016, the index had advanced a further 72%, to 19,763.

” American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that.”

Taking a dig at naysayers, Mr Buffett said: “Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle. ”

Then driving home a point about reality, Mr Buffett said: “Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. ”

Mr Buffett went on to talk about the two things that investors should not forget during such scary periods.