David Rolfe Comments on Berkshire Hathaway
This was the fifth annual meeting we have attended since 2006. While the "Woodstock for Capitalist" atmosphere in the exhibition hall, at the numerous parties, gatherings, resta urants, plus investor conferences we attended were ever present (we would expect no less), the quality of the Q and A session was among the best we have experienced. The quality of the questions asked of Warren Buffett and Charlie Munger were, on the whol e, top notch. Buffett's answers, as usual, were patiently answered, detailed, informative and well communicated. Munger was his usual quick and cryptic to the point and hilarious self. While the Q and A session lasted for six hours, Buffett and Munger both focused many of their answers and replies on three key themes of Berkshire's distinct and differentiated culture and enduring competitive advantage.
The first is Berkshire's unique philosophy of decentralized management (to the point of abdication per Munger) relative to any other Fortune 500 company. Buffett and Munger's decades long history of buying companies large and small, and then allowing management significant autonomy to run all aspects of their respective companies (with exceptions to ca pital reinvestment) significantly reduces the CEO burden for Buffett (and his successors). Such guarantees of man and business permanence under the Berkshire corporate "umbrella" provide Berkshire a unique advantage in purchasing businesse s. Buffett expounded on this critical point in the telling of the story of a business owner who wanted Berkshire to buy his business . The owner desired to have the sale of his business to have as minimal of an impact to both his business and his family a s possible – particularly to his employees , as sell ing to a competitor or private equity might threaten their careers.
Buffett: " A person a few years ago came to me and he was in his 60's. He didn't want to retire. But he had experience in buying a busi ness, which had soured. And wanted to put to bed the risk of selling, that what he had built would be destroyed, or family destroyed. He thought about it a year, if I sell it to a competitor, they are logical buyer. Competitor would come in and put their people in charge. They would have synergy ideas, his people would all get sacked, and acquirer would be like Attila the Hun. He didn't want to do that to his people. Private equity should load up with debt and sell it later. So when he came to me and he said, it isn't because you are so attractive, but you are the last man standing. People who stayed with me, I'll get to sleep well at night knowing they are ok. Our competitive advantage is that we don't have many competitors. Also, shareholders are partners. That is unusual.
The second is Berkshire's willingness and rapid ability to deploy billions when opportunity knocks – most often when the markets are seized in panic. No other company of size can match Berkshire's competitive advantage on th is score.
Buffett: " My successor will have more capital than me when markets are in distress. At those times few people have capital and even fewer have willingness to commit. It is unusual to have capital at times of turbulence, when ability to say y es quickly with large sums sets you apart. I would not worry about that successor being willing to deploy and being called upon. Berkshire is the 1 800 number when there are panics in markets. It happened a couple times in 2008 and once in 2011. Not ou r main business, but if Dow falling down a 1000 points for a few days, they will call Berkshire. Our reputation will become even more solidified, when Berkshire does it when I'm not around. It becomes even more the Berkshire brand. "
Munger: " We have tri ed to stay sane when others like to go crazy. That is competitive advantage. Second, we have used golden rule, where we treat subsidiaries how we would want to be treated if we were subsidiaries. People come to us who don't wan t to go elsewhere. That is long term advantage. We have tried to be a good partner and that is an advantage. We are leaving behind a competitive place, and have gone to a place more unusual. This was a very good idea, I wish we had done it on purpose. [ laughter ] ."
The third the me is essentially the "synthesis" of Berkshire's "culture" (a favorite word of Buffet) and "system" (a favorite word of Munger).
Berkshire's conglomeration of bes t in class businesses (and investment por tfolio), prudently levered on a +$77 billion ocean o f very low cost of float and capital, has literally become a perpetual cash generating machine. Cash is currently flowing to Berkshire's coffers to the tune of approximately $1.4 billion per month. In addition, quarterly earnings have reached record leve ls at $4 billion and 2013 will likely mark the sixth consecutive year since the last recession that the Company's operating return on equity will increase – reaching a record 8%.
These three themes are Berkshire's enduring competitive advantage. They have painstakingly been built over the past +40 years. Furthermore, Berkshire has been built to survive and thrive long after Buffett and Munger have departed the scene.
Buffett was adamant that Berkshire's culture would "reject" the w rong CEO "like a fo reign tissue " and that Berkshire's corporate culture will be maintained after he's gone.
Buffett: " We worry all the time. Culture and the businesses we own are very important. After I'm gone, the trains will still be running and people will still buy GEICO insurance. The key is preserving the culture and having a successor at CEO with more passion and brains than I have. We are solidly in agreement about who that individual should be. The culture has intensified. We always knew what we were about. Making sure that everyone who joined us thought the same. Everyone who bought into this, that took time. It is one of a kind now and will remain one of a kind. Any foreign type behavior would be cast out. It would be rejected like a foreign tissue if we got the wrong person. We have a board that is especially dedicated. We have people who ha ve brought their companies to Berkshire Hathaway . People have self selected in. Whoever succeeds me, there will be newspaper headlines saying it is not the sam e thing, but it will be the same thing. "
Munger chimed in on the matter as, well...as only Munger can: Munger:
"I want to say to the many Munger's in the audience, don't be so stupid as to sell these shares."
Buffett : "That goes for the Buffet's too!"
As always, we had hoped (clamor?!) for as much information and minutiae on Berkshire's key businesses. If we had any disappointment in the 2013 meeting, it was on this score. Though Buffett specifically noted GEICO at the outset of the meeting on GEICO 's terrific policy growth. Buffett noted that GEICO might reach one million in new auto policies in 2013 – or 2/3rds of all industry growth. GEICO is also on the verge of passing Allstate to become the industry's second largest auto insurer.
Buffett: " One highlight in the quarter was the pick up at GEICO . The strengths I mentioned in 2012 have gotten even stronger. A lot of it is seasonality related to month on month policy gains, but our closure ratio and persistency have improved significantly. The rise in persistency equals pure gold. The number of people who get a quote from us and go on to get a policy, the closure rate, is rising. Mathematically each policy is worth about $1,500 to us. If we get 1 million policies we will see a $1.5 b illion i n gain in intrinsic value that isn't captured in our accounts."
Other meeting item s of note and interest to us were Buffett and Munger's disquisitions on the matters of corporate profits, the Fed's monetary policy and D.C.'s fiscal policies. On the whole the two generally shared the same concerns that we have on the same as we outlined in our last Client Letter (linked on our website). Buffett's words were certainly more sanguine than Munger's more dire tone, but we did note both of their admonitions – p articularly on the Fed's "huge experiment" in expanding their balance sheet to $3.4 trillion and the likely consequences of the end of this expansion, as well as the concomitant consequences of unwinding of the Fed's balance sheet.
Buffett: "My basic ans wer is I don't know... It will be the shot heard around the world when the central bank first indicates it will stop buying financial assets or start selling from their now enormous $3.4 trillion balance sheet...we're in uncharted territory... that's a lot of securities...There's all this liquidity that's been created...It hasn't really hit the market because the banks have let it sit there...We really are in uncharted territory....It certainly has the potential to be inflationary...It hasn't been so far...My guess is some Fed members are probably disappointed they haven't seen more inflation."
Munger: " What has happened has surprised everyone who thought they knew the answers, in particular the economists. Who thought Japan would have twenty years of stasis? Economists should have more caution that they know how to stay out of trouble ...They should therefore be humble about further predictions on the effects of the money printing."
In terms Berkshire's current valuation, the stock at $113 remains reasonably attractive at just over a 17% premium to Buffett's stated stock buy back level of 1.2X book value ($96.43). The graphics below are in s tructive. Since 2000 there has been two periods of distinct valuation ranges. From 2000 through 200 8, the stock traded between 1.5X an d 2.0X book. Long time Berkshire shareholders will recall the great bargain Mr. Market offered up in early 2000 when the shares fell to nearly 1.0X book. (Buffett offered to buy back shares in his 1999 Chairman's Letter. No one would ever take him up on his gracious offer.) Since 2008 the shares have largely traded between 1.0X and 1.5
It is important to note that 1.2X book should not be construed as a valuation "floor" in the stock. While Buffett has been quite vocal in communicating his desire to make large, multi billion stock purchases at 1.2X, such desire is not a gu arantee. We could easily envision a scenario whereby the stock market could be once again in a general bear market – and Buffett could choose to expend the Company's cash hoard for better ba rgains. 2008 and early 2009 were instructive on this score. Exc luding his $34 billion acquisition (60% in cash) of Burlington Northern in late 2009, Buffett spent a cool $46 billion on investments and acquisitions in 2008. Please notice the behavior of Professor Buffett – investing tens of billions in the teeth of a bear market, while today, as the stock market begins its 5 th year of the current bull market, Buffett's cash/liquidity sits relatively idle at a n even " cool er" $50 billion. Class dismissed...
From Wedgewood Partners' second quarter 2013 letter.