This past weekend, I was lucky enough to attend my fourth Berkshire Hathaway (BRK.B) shareholder meeting in Omaha, Nebraska. A few readers that I regularly talk with wanted to know how it went in addition to my takeaways from the weekend’s events; those are the things the remainder of this article will focus on.
My weekend started Thursday night with a dinner at the University of Nebraska at Omaha put together by Value Investor Conference. The speaker at the event was Tom Russo (Trades, Portfolio), portfolio manager at Gardner Russo & Gardner, an investor that I’ve considered well worth listening to for some time; unsurprisingly, he didn’t disappoint. Much of his speech focused on the concept of “capacity to suffer” – essentially, the willingness of management (in this case, at publicly held corporations) to act in a manner that may negatively impact short-term results.
He provided examples of both ways that this can play out: a willingness to make investments that can be detrimental to short-term earnings for some time but with an attractive long-term NPV, as well as (on the other side of the coin) a willingness to forgo short-term income attained by questionable means. Let me provide an example or two for both to give these ideas some context.
On the first point, Mr. Russo pointed to GEICO, among others. He noted that GEICO in the early 1990s was in a position where new policies came with a one year operating loss of roughly $250, but were likely to have a net present value to the corporation of roughly $2,000 over the life of the customer. He argued that the company was not in a financial position to sustain that operating loss in large numbers in the early 1990s, a constraint that limited growth and share gains. Mr. Russo made the argument that this largely changed when Berkshire Hathaway acquired the remainder of GEICO in 1995, a move that allowed the company to pursue attractive policy growth regardless of the short term impact on reported earnings. While we can’t put our fingers on the exact cause, he’s certainly right about one thing: GEICO took off when it became a wholly owned subsidiary of Berkshire Hathaway. GEICO added more than 1.5 million net new customers in its first two years as part of Berkshire (1996 and 1997) – an annual average that nearly doubled the gains reported in its final three years as a public company (average of 1993-1995). As I’ve discussed previously, GEICO has more than quadrupled its market share since 1995, moving from seventh in the industry to second.
As a second example, Mr. Russo pointed to General Electric (GE). While I don’t remember the exact details, he essentially argued that GE was financing certain assets with short-term commercial paper in the years leading up to the financial crisis as opposed to long-term debt; the rationale for doing so was at least partially attributable to the lower impact to short-term earnings from issuing commercial paper versus long-term debt. However, when the commercial paper market dried up in 2008, General Electric found themselves in a precarious position with few options. They were ultimately forced to seek a bailout (of sorts) from Berkshire Hathaway; Mr. Russo stated that he thinks the interest rate on the Berkshire funds may have been as high as 12%, in addition to the warrants that GE issued to Berkshire. Ultimately, GE paid a much higher cost than they would have otherwise; their focus on short term results came back to bite them in the long run.
Mr. Russo’s presentation included other useful ideas and examples for long term investors; if you ever have the chance to see him speak, don’t pass up the opportunity to do so.
Friday was a day of shopping (the exhibit hall in the CenturyLink Center was open early for investors), which included lots of See’s Candy and Dilly Bars. The beauty of this new setup (I think this was the first year that they’ve opened up the exhibits on Friday) was that it left all of Saturday available for shareholders who didn’t want to miss a minute of the Q&A.
The next morning was the big day; I arrived an hour before the doors opened, and was still pretty far back in one of the many lines waiting for access to the CenturyLink Center. As I waited, Omaha World-Herald in hand, two executives from Justin Boots came riding by on two huge Texas Longhorns. They were followed by a Wells Fargo (WFC) stagecoach and a marching band, as well as University of Nebraska cheerleaders. It was quite a spectacle for 6:30 in the morning.
The question-and-answer session got under way a few hours later. Without rehashing the entire Q&A (live blogs and transcripts are online), here are a few of my takeaways.
First, Warren and Charlie did a great job explaining the issues raised about Clayton Homes’ business practices. Beyond highlighting errors in the report, they noted that Clayton transparently suggests that borrowers should consider multiple lenders (one of whom is Clayton); in the event that they choose to finance with Clayton’s financing arm, the loan will be retained on Clayton’s books – directly aligning the borrowers and the lenders interests. Finally, Clayton has been proactive in removing practices that can be problematic for borrowers, such as 30-year mortgages at steep interest rates (many borrowers don’t qualify for FHA loans due to sub-620 FICO scores, the usual designation for “subprime”). My takeaway from the discussion was that the company’s dominant position in the industry (roughly 45% of all manufactured homes sold in the U.S. in 2014) is the result of a quality product at a fair price and deserved trustworthiness in the eyes of consumers.
My second takeaway relates to 3G, a topic that received a lot of attention at the meeting. The first point to note, as a Berkshire Hathaway shareholder, is that we’ll be owning Heinz and Kraft indefinitely; this is a clear distinction between the interests of a normal private equity playbook (where the cockroaches can potentially be hidden under the fridge for some time) and 3G’s approach. Any cuts made by 3G to boost short-term profits that impact the company’s long term financial success are clearly a net negative. Warren noted that he expects 3G to stick around long term – but even if they don’t, that doesn’t change Berkshire’s interests. Personally, I trust that Warren will monitor the situation and will ensure things are handled appropriately.
The final takeaway I have from the meeting relates to Berkshire’s culture – primarily its ability to endure in the years and decades ahead; Warren said that he believed Berkshire’s culture “runs as deep as any large company” and that it will “continue and become even stronger” over time; he went so far as to say it will continue “for decades and decades and decades to come.”
Here’s a short anecdote from the weekend that I think supports Warren’s point: on Sunday, Berkshire had a 5K run for meeting participants. As I was finishing the race, I noticed that Ted Weschler was standing 50 yards from the finish line; I was waiting for someone to finish the run, so I decided to stake out a spot right next to Mr. Weschler. Over the next 15 minutes, Mr. Weschler spent his time cheering on strangers, encouraging at least 20 runners that he personally knew by name, and talking with annoying people like myself. In that short period of standing near and chatting with him, I left with the impression that he couldn’t be a nicer or more genuine person; as we all know, he has proven his prowess as an investment manager as well.
These are the type of people that Warren and Charlie will continue to attract to the upper ranks of Berkshire Hathaway; in addition, the company is already home to multiple competitively advantaged businesses like GEICO, BNSF, and BH Energy that have decade-long runways of investment opportunities and earnings growth ahead.
Warren put it perfectly in his 2014 letter to shareholders:
“I believe that the chance of permanent capital loss for patient Berkshire shareholders is as low as can be found among single-company investments. That’s because our per-share intrinsic business value is almost certain to advance over time.”
After another weekend in Omaha, I’m as confident as ever in the future of Berkshire Hathaway.
