Category Archives: Warren Buffett lessons

How Berkshire Hathaway selects a new director

Berkshire Hathaway’s four long-standing criteria in selecting a new board director: owner-oriented, business-savvy, interested and truly independent.

Chairman Warren Buffett said: “I say “truly” because many
directors who are now deemed independent by various authorities and observers are far from that, relying
heavily as they do on directors’ fees to maintain their standard of living. These payments, which come in
many forms, often range between $150,000 and $250,000 annually, compensation that may approach or
even exceed all other income of the “independent” director. And – surprise, surprise – director
compensation has soared in recent years, pushed up by recommendations from corporate America’s
favorite consultant, Ratchet, Ratchet and Bingo. (The name may be phony, but the action it conveys is

“Charlie and I believe our four criteria are essential if directors are to do their job – which, by law,
is to faithfully represent owners. Yet these criteria are usually ignored. Instead, consultants and CEOs
seeking board candidates will often say, “We’re looking for a woman,” or “a Hispanic,” or “someone from
abroad,” or what have you. It sometimes sounds as if the mission is to stock Noah’s ark. Over the years
I’ve been queried many times about potential directors and have yet to hear anyone ask, “Does he think like
an intelligent owner?”

“The questions I instead get would sound ridiculous to someone seeking candidates for, say, a
football team, or an arbitration panel or a military command. In those cases, the selectors would look for
people who had the specific talents and attitudes that were required for a specialized job. At Berkshire, we
are in the specialized activity of running a business well, and therefore we seek business judgment.
“That’s exactly what we’ve found in Susan Decker, CFO of Yahoo!, who will join our board at the
annual meeting. We are lucky to have her: She scores very high on our four criteria and additionally, at 44,
is young – an attribute, as you may have noticed, that your Chairman has long lacked. We will seek more
young directors in the future, but never by slighting the four qualities that we insist upon.”

Source: Chairman Warren Buffett’s FY2006 letter to Berkshire Hathaway shareholders

When it comes to stocks, Berkshire Hathaway looks for wonderful companies

“Woody Allen once explained that the advantage of being bi-sexual is that it doubles your chance of finding a date on Saturday night,” Warren Buffett said in his FY2015 letter to Berkshire Hathaway. Why did the Berkshire Hathaway chairman say this?

“In like manner – well, not exactly like manner – our appetite for either operating businesses or passive investments doubles our chances of finding sensible uses for Berkshire’s endless gusher of cash. Beyond that, having a huge portfolio of marketable securities gives us a stockpile of funds that can be tapped when an elephant-sized acquisition is offered to us,” Mr Buffett continued.

A stockpile of funds from marketable securities?

Yes a stockpile. “Berkshire increased its ownership interest last year in each of its “Big Four” investments – American Express, Coca-Cola, IBM and Wells Fargo. We purchased additional shares of IBM (increasing our ownership to 8.4% versus 7.8% at yearend 2014) and Wells Fargo (going to 9.8% from 9.4%). At the other two companies, Coca-Cola and American Express, stock repurchases raised our percentage ownership. Our equity in Coca-Cola grew from 9.2% to 9.3%, and our interest in American Express increased from 14.8% to 15.6%. In case you think these seemingly small changes aren’t important, consider this math: For the four companies in aggregate, each increase of one percentage point in our ownership raises Berkshire’s portion of their annual earnings by about $500 million.”

The legendary investor’s subsequent FY2016 letter to Berkshire Hathaway shows the stakes in these Big Four as at end-2016 were: American Express 16.8%, Coca-Cola 9.3%, IBM 8.5% and Wells Fargo 10%. Apple Inc stocks also came into Berkshire Hathaway’s radar screen, with the group owning a stake of 1.1%, which, according to a CNBC report on Feb 27, 2017, had grown in January 2017 to 2.5%. “At this point, Buffett owns US$17 billion worth of the tech giant’s stock,” said the report.

What does Berkshire Hathaway look for in marketable securities?
On the Big Four in the FY2015 letter, Mr Buffett said that the four investees possess excellent businesses and are run by managers who are both talented and shareholder-oriented. “Their returns on tangible equity range from excellent to staggering. At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business. It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone,” said Mr Buffett.

The Berkshire Hathaway chairman said that if Berkshire’s yearend holdings were used as the marker, its portion of the “Big Four’s” 2015 earnings amounted to US$4.7 billion. “In the earnings we report to you, however, we include only the dividends they pay us – about $1.8 billion last year. But make no mistake: The nearly $3 billion of these companies’ earnings we don’t report are every bit as valuable to us as the portion Berkshire records.”

The earnings of Berkshire’s investees retain are often used for repurchases of their own stock – a move that increases Berkshire’s share of future earnings without requiring it to lay out a dime. “The retained earnings of these companies also fund business opportunities that usually turn out to be advantageous. All that leads us to expect that the per-share earnings of these four investees, in aggregate, will grow substantially over time. If gains do indeed materialize, dividends to Berkshire will increase and so, too, will our unrealized capital gains.”

This investment philosophy gives Berkshire Hathaway a significant edge, explained by Mr Buffett this way: “Our flexibility in capital allocation – our willingness to invest large sums passively in non-controlled businesses – gives us a significant edge over companies that limit themselves to acquisitions they will operate.”

Warren Buffett loves Apple

Warren Buffett’s FY2016’s letter dated February 25, 2017, to Berkshire Hathaway shareholders showed the group had 61,242,652 Apple Inc shares, a stake of 1.1 per cent costing US$6.747 billion and worth a market value of US$7.093 billion. This has since doubled. According to a CNBC report on Feb 27, 2017, the stake had doubled in January 2017 to 2.5 per cent. “At this point, Buffett owns US$17 billion worth of the tech giant’s stock,” said the report.
Berkshire Hathaway also has stake in IBM. The FY2016 shareholder letter showed that it had 81,232,303 IBM shares as at Dec 31, 2016, a holding of 8.5 per cent costing US$13.815 billion and having a market value of US$13.484 billion.

How Warren Buffett picks stocks

“Excellent business results by corporations will translate over
the long term into correspondingly excellent market value and
dividend results for owners, minority as well as majority,” Warren Buffett once said.

How true this is even today although Mr Buffett said this as far back as 1978 in a letter to Berkshire Hathaway shareholders for FY1977.

When it comes to marketable equity securities, the Berkshire Hathaway chairman selects them in much the same way as he would evaluate a business for full acquisition.

Mr Buffett lists four criteria for selecting securities:
(1) the business of the company must be one that he can understand;
(2) it must have favorable long-term prospects;
(3) it must be operated by honest and competent people; and
(4) the securities must be available at a very attractive price.

Notice the emphasis on long term?

In the words of the Berkshire Hathaway chairman: “We ordinarily make no attempt to buy equities for anticipated
favorable stock price behavior in the short term. In fact, if
their business experience continues to satisfy us, we welcome
lower market prices of stocks we own as an opportunity to acquire
even more of a good thing at a better price.”

In a point that underscores value investment, he said: “Our experience has been that pro-rata portions of truly
outstanding businesses sometimes sell in the securities markets
at very large discounts from the prices they would command in
negotiated transactions involving entire companies.
Consequently, bargains in business ownership, which simply are
not available directly through corporate acquisition, can be
obtained indirectly through stock ownership. When prices are
appropriate, we are willing to take very large positions in
selected companies, not with any intention of taking control and
not foreseeing sell-out or merger, but with the expectation that
excellent business results by corporations will translate over
the long term into correspondingly excellent market value and
dividend results for owners, minority as well as majority.”

Misleading ‘record’ earnings

When companies say they achieve record earnings, be wary how they define “record” earnings.

Warren Buffett said in a March 14, 1978, shareholder letter: “Most companies define ‘record’ earnings as a new high in
earnings per share. Since businesses customarily add from year
to year to their equity base, we find nothing particularly
noteworthy in a management performance combining, say, a 10%
increase in equity capital and a 5% increase in earnings per
share. After all, even a totally dormant savings account will
produce steadily rising interest earnings each year because of

How true this statement is even today, some 39 years after Mr Buffett, the chairman of Berkshire Hathaway, said it.

The legendary value investor went on to say: “Except for special cases (for example, companies with
unusual debt-equity ratios or those with important assets carried
at unrealistic balance sheet values), we believe a more
appropriate measure of managerial economic performance to be
return on equity capital. In 1977 our operating earnings on
beginning equity capital amounted to 19%, slightly better than
last year and above both our own long-term average and that of
American industry in aggregate. But, while our operating
earnings per share were up 37% from the year before, our
beginning capital was up 24%, making the gain in earnings per
share considerably less impressive than it might appear at first

Bottom line: When a company boasts record earnings using earnings per share as a basis, look at how much it has added to its equity base in the relevant period.