Don’t expect the next 50 years of Berkshire Hathaway to be like the first 50 – and perhaps not even the next 10 to 20 years, according to founder and chairman, Warren Buffett.
In an unusually blunt set of letters to shareholders, Buffett has warned that Berkshire Hathaway (BH) will eventually become too big for its own good – but he has also ruled out the prospect of asset sales or spin offs of businesses.
But he and Vice chairman, Charlie Munger say they have settled on a successor for Buffett as CEO – the replacement chairman will be Buffett’ son Howard, in a non-executive role.
Buffett also reveals that his directors have no directors and officers insurance (he could choose from one of his huge insurers for the cover if he wanted to), to protect themselves. That’s a startling admission seeing practically every company these days has what’s called D&O insurance.
His comments are included in the usual shareholder letter in the BH annual report, along with bonus letters from himself and Vice Chairman, Charlie Munger about how they see the next 50 years for the company.
Berkshire Hathaway is turning 50 this year – it’s an important birthday, but just a date, so forget it and also forget how Berkshire Hathaway performed in the 4th quarter of 2014 and throughout last year (solidly in both cases).
The real story is the letters from Buffett and Charlier Munger. There’s great deal of sense in both.
In Buffett’s letters are a litany of failures and disasters which Charlie Munger estimates have cost Berkshire at least $US50 billion in lost market value over time.
But there was a bigger mistake admitted to by Buffett, the original structuring of the Berkshire takeover and why he did it – all of which cost untold billions – perhaps $US100 billion – in benefits shared with other shareholders in the company over time.
Buffett wrote at the weekend Berkshire has grown so large – 751,000 times its original net worth per share – that the future pace of gains “will not come close” to those of the past.
"The numbers have become too big," Buffett wrote. "I think Berkshire will outperform the average American company, but our advantage, if any, won’t be great."
"The bad news is that Berkshire’s long-term gains – measured by percentages, not by dollars – cannot be dramatic and will not come close to those achieved in the past 50 years. The numbers have become too big. I think Berkshire will outperform the average American company, but our advantage, if any, won’t be great,“ Buffet wrote.
"Eventually – probably between ten and twenty years from now – Berkshire’s earnings and capital resources will reach a level that will not allow management to intelligently reinvest all of the company’s earnings.
"At that time our directors will need to determine whether the best method to distribute the excess earnings is through dividends, share repurchases or both. If Berkshire shares are selling below intrinsic business value, massive repurchases will almost certainly be the best choice. You can be comfortable that your directors will make the right decision,” he said.
But succession, or rather, who will replace him when he goes, is the big question (and will get another long airing at the Berkshire annual meeting in Omaha on May 2) and Buffett, also addressed this in his two letters, saying he and his board of directors “believe we now have the right person to succeed me as CEO,” likely for a decade or more, and who in some respects “will do a better job than I am doing.”
While Buffett did not name that person (and he didn’t limit it to a man, saying it could be female), Vice Chairman Charlie Munger, wrote in his letter that Greg Abel and Ajit Jain, two top Buffett lieutenants, would be prime candidates.
Abel, 52, runs Berkshire Hathaway Energy, one of the company’s recent growth areas, especially in renewables. Jain, 63, has been Buffett’s top insurance executive for three decades and runs Berkshire Hathaway Reinsurance Group, the key company in the entire group as it generated billions of dollars a year for investment by the group.
The report contains another strong defence of Berkshire’s conglomerate structure (something that remains out of favour on Wall Street), writing "So what do Charlie and I find so attractive about Berkshire’s conglomerate structure? To put the case simply: If the conglomerate form is used judiciously, it is an ideal structure for maximizing long-term capital growth.”
He told existing and potential shareholders he could not see of a situation where BH would suffer serious financial problems, adding that people should not to borrow to buy Berkshire shares and to take a longer term view
"Since I know of no way to reliably predict market movements, I recommend that you purchase Berkshire shares only if you expect to hold them for at least five years. Those who seek short-term profits should look elsewhere,“ he wrote
"I can promise you that long after I’m gone, Berkshire’s CEO and Board will carefully make intrinsic value calculations before issuing shares in any acquisitions. You can’t get rich trading a hundred-dollar bill for eight tens (even if your advisor has handed you an expensive “fairness” opinion endorsing that swap).
"Another warning: Berkshire shares should not be purchased with borrowed money. There have been three times since 1965 when our stock has fallen about 50% from its high point. Someday, something close to this kind of drop will happen again, and no one knows when.
"Berkshire will almost certainly be a satisfactory holding for investors. But it could well be a disastrous choice for speculators employing leverage.
"I believe the chance of any event causing Berkshire to experience financial problems is essentially zero. We will always be prepared for the thousand-year flood; in fact, if it occurs we will be selling life jackets to the unprepared.
"Berkshire played an important role as a “first responder” during the 2008-2009 meltdown, and we have since more than doubled the strength of our balance sheet and our earnings potential. Your company is the Gibraltar of American business and will remain so,” he wrote. Indeed he said BH provided over $US15 billion in cash to US companies in the first weeks of the GFC in late 2008.
"Despite our conservatism, I think we will be able every year to build the underlying per-share earning power of Berkshire. That does not mean operating earnings will increase each year – far from it.
"The U.S. economy will ebb and flow – though mostly flow – and, when it weakens, so will our current earnings. But we will continue to achieve organic gains, make bolt-on acquisitions and enter new fields. I believe, therefore, that Berkshire will annually add to its underlying earning power.
"In some years the gains will be substantial, and at other times they will be minor. Markets, competition, and chance will determine when opportunities come our way.
"Through it all, Berkshire will keep moving forward, powered by the array of solid businesses we now possess and the new companies we will purchase. In most years, moreover, our country’s economy will provide a strong tailwind for business. We are blessed to have the United States as our home field.
"We have an extraordinarily knowledgeable and business-oriented board of directors ready to carry out that promise of partnership. None took the job for the money: In an arrangement almost non-existent elsewhere, our directors are paid only token fees.
"They receive their rewards instead through ownership of Berkshire shares and the satisfaction that comes from being good stewards of an important enterprise.
"The shares that they and their families own – which, in many cases, are worth very substantial sums – were purchased in the market (rather than their materializing through options or grants). In addition, unlike almost all other sizable public companies, we carry no directors and officers liability insurance. At Berkshire, directors walk in your shoes,” Mr Buffett wrote.
