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Nicolas73
Nicola Guida
Articles (20)  | Author's Website |

Why Berkshire Hathaway's Future Is Safe

The company's culture represents its best asset

April 08, 2020 | About:

Introduction

As many of us already know, Warren Buffett will turn 90 this year. He was born in Omaha, Nebraska on Aug. 30, 1930.

Although he is still in good condition and in good spirits at an age in which most people are obviously in decline, in recent years there have been countless discussions about his succession plan.

While some of them are coming from worried Berkshire shareholders who are concerned about how the company future will unfold without its glorious captain at the helm, most of them, in my opinion, simply arise from human curiosity. As Oscar Wilde once pointed out, “The public have an insatiable curiosity to know everything, except what is worth knowing.”

Buffett must also think the same, as he got to the point by addressing both meddlers and worried shareholders in the most recent Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) letter to shareholders:

"Three decades ago, my Midwestern friend, Joe Rosenfield, then in his 80s, received an irritating letter from his local newspaper. In blunt words, the paper asked for biographical data it planned to use in Joe’s obituary. Joe didn’t respond. So? A month later, he got a second letter from the paper, this one labeled “URGENT.” 

Berkshire is fully prepared

In the letter, Buffett explained that he and Charlie Munger (Trades, Portfolio) think that Berkshire is fully prepared for their departure and, to support his belief, provides five basic reasons:

"First, Berkshire’s assets are deployed in an extraordinary variety of wholly or partly-owned businesses that, averaged out, earn attractive returns on the capital they use. Second, Berkshire’s positioning of its “controlled” businesses within a single entity endows it with some important and enduring economic advantages. Third, Berkshire’s financial affairs will unfailingly be managed in a manner allowing the company to withstand external shocks of an extreme nature. Fourth, we possess skilled and devoted top managers for whom running Berkshire is far more than simply having a high-paying and/or prestigious job. Finally, Berkshire’s directors – your guardians – are constantly focused on both the welfare of owners and the nurturing of a culture that is rare among giant corporations."

First, we have "Berkshire’s assets are deployed in an extraordinary variety of wholly or partly-owned businesses that, averaged out, earn attractive returns on the capital they use."

While Buffett's aversion to extremely diversified portfolios is well known (just think about the famous 20-slot punchcard advice), there's no doubt that, as his and Munger's circle of competence enlarged over time, more companies would potentially fall into it. Couple this with the habit of holding shares of a good company for a very long time (potentially indefinitely) and you'll know why Berkshire owns such a vast amount of different businesses. Return on capital is also a common denominator of BRK holdings, at least since Buffet was convinced by his business partner that “it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

Second is "Berkshire’s positioning of its “controlled” businesses within a single entity endows it with some important and enduring economic advantages."

As Buffett wrote in the 2018 letter to shareholders, “[.. ]Berkshire’s value is maximized by our having assembled the five groves into a single entity. This arrangement allows us to seamlessly and objectively allocate major amounts of capital, eliminate enterprise risk, avoid insularity, fund assets at exceptionally low cost, occasionally take advantage of tax efficiencies, and minimize overhead."

Third is "Berkshire’s financial affairs will unfailingly be managed in a manner allowing the company to withstand external shocks of an extreme nature."

Being prudent has always been Buffett's tenet. This means planning for the worst and hoping for the best. Even the most complicated reinsurance contracts (the ones regarding big disasters like earthquakes, tornados or pandemics), handled by Ajit Jain, are designed in a way to prevent Berkshire from being permanently damaged by adversities.

Foruth, Buffett wrote, "We possess skilled and devoted top managers for whom running Berkshire is far more than simply having a high-paying and/or prestigious job."

In other words, Berkshire directors put the company's interests first on the list of priorities. As we know, we normally tend to attract people who have a similar view. Undoubtedly, Berkshire is filled with people who, even if coming from different places and backgrounds, share the same mental approach to life and investing (just like the famous investors of Graham and Doddsville).

They are already very rich, so money can't be the most important incentive for them. They have been working with Buffett and Munger for many years, so they must be honest, transparent and collaborative, and, of course, they must have a special gift for discovering and understanding profitable investment opportunities.

Fifth, Buffett wrote, "Berkshire’s directors – your guardians – are constantly focused on both the welfare of owners and the nurturing of a culture that is rare among giant corporations."

Berkshire's board interest is aligned to that of shareholders and will always protect and bring forward the founders' culture. This is really the most important point, which sustains all the previous ones. The board of directors, including the CEO, the three vice Chairmen (Munger, Jain and Greg Abel) and Buffett's son Howard Buffett, will ensure that Berkshire's culture will remain intact for many years to come.

Some years ago, Buffett also declared that he would like Howard to succeed him as a non-executive Chairman exclusively to help the company to preserve his father's moral integrity. Although the company is extremely asset rich, we assert that Berkshire's culture is its best (and probably most durable) asset, even if it's an intangible one.

Conclusion

While Buffett's succession plan deserves a separate discussion, Berkshire's shareholders can feel reassured that they will not have to unload their beloved shares when he eventually steps down.

If we also consider the fact that the company owns a cash hoard of around $128 billion and that some of Berkshire's potential targets are available at a sensibly lower price than just some weeks ago (Berkshire's stock is also selling for less than the price at which Buffett repurchased shares recently), it's not difficult to imagine that the company could emerge stronger and better positioned from the current downturn, even in the highly probable case of an approaching recession.

Disclosure: The author owns shares of Berkshire Hathaway.

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About the author:

Nicola Guida
I'm a Software Engineer with a big passion for Value Investing. I love looking for undervalued companies both to feed my investment pipeline and to write articles in order to share my investment thoughts.

Visit Nicola Guida's Website


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