The annual letter from Warren Buffett to Berkshire Hathaway’s shareholders is a cultural touchstone. In the 2015 letter released Saturday, Buffett and his longtime partner, Charlie Munger, review not just the 2014 financials of the Berkshire “conglomerate,” but look back over the last 50 years. In his avuncular style, Buffett provides plenty of advice for professional investors and “the little guy” along the way.
In the letter, Munger also addresses “the elephant in the room”: how Berkshire will proceed after Buffett departs.
While reading the entire 42-page letter is well worth it, especially for Berkshire (BRK.A) shareholders, whose annual meeting is scheduled for the weekend of May 1-3 in Omaha, Nebraska — including the annual Newspaper Toss competition — we’ve pulled out some of the gems in the form of eight warnings to advisors and investors.
Warning 1: Don’t Be Too Concentrated (or Too Bloated)
Berkshire owns a number of businesses outright and has partnerships and partial ownership of many more. However, the company also “passively” owns stakes in a number of companies. For example, in its listing of its top 15 common-stock holdings as measured by market value, there are six financial services companies: Goldman Sachs; US Bancorp; Moody’s; American Express, Munich Re and Wells Fargo. The fifteen biggest stakes have a total current market value of $117 billion (while Berkshire owns “only” 9.4% of Wells, Fargo, that stake is worth $26 billion.) Why this approach? Buffett explains:
Our flexibility in capital allocation — our willingness to invest large sums passively in non-controlled businesses — gives us a significant advantage over companies that limit themselves to acquisitions they can operate. Our appetite for either operating businesses or passive investments doubles our chances of finding sensible uses for Berkshire’s endless gusher of cash.
And in a different place in the letter, Buffett allows himself a little gloating over a lack of bloating:
Berkshire’s year-end employees … totaled a record 340,499, up 9,754 from last year. The increase, I am proud to say, included no gain at headquarters (where 25 people work). No sense going crazy.
Munger considers in the conclusion of his letter “whether Berkshire’s great results over the last 50 years have implications that may prove useful elsewhere.” Munger writes:
The answer is plainly yes. In its early Buffett years, Berkshire had a big task ahead: turning a tiny stash into a large and useful company. And it solved that problem by avoiding bureaucracy and relying much on one thoughtful leader for a long, long time as he kept improving and brought in more people like himself.
Compare this to a typical big-corporation system with much bureaucracy at headquarters and a long succession of CEOs who come in at about age 59, pause little thereafter for quiet thought, and are soon forced out by a fixed retirement age.
I believe that versions of the Berkshire system should be tried more often elsewhere and that the worst attributes of bureaucracy should much more often be treated like the cancers they so much resemble.
Warning 2: Don’t Neglect the Next Generation of Leadership
Warren Buffett is 84 years old, and Vice Chairman Charlie Munger — to whom he gives plenty of credit for Berkshire’s success — is 91. Buffett recently gave an interview in Fortune magazine where he revealed his “secret” to staying young: “If I eat 2700 calories a day, a quarter of that is Coca-Cola. I drink at least five 12-ounce servings. I do it everyday.”
Why? Fortune Senior Editor Patricia Sellers quotes Buffett as saying, “I checked the actuarial tables, and the lowest death rate is among six-year-olds. So I decided to eat like a six-year-old.”
However, Buffett is well aware of the importance of grooming successors at Berkshire, as he writes in the letter:
I’ve mentioned in the past that my experience in business helps me as an investor and that my investment experience has made me a better businessman. Each pursuit teaches lessons that are applicable to the other. And some truths can only be fully learned through experience. (In Fred Schwed’s wonderful book, Where Are the Customers’ Yachts?, a Peter Arno cartoon depicts a puzzled Adam looking at an eager Eve, while a caption says, “There are certain things that cannot be adequately explained to a virgin either by words or pictures.”
Among Arno’s “certain things,” I would include two separate skills, the evaluation of investments and the management of businesses. I therefore think it’s worthwhile for Todd Combs and Ted Weschler, our two investment managers, to each have oversight of at least one of our businesses. A sensible opportunity for them to do so opened up a few months ago when we agreed to purchase two companies that, though smaller than we would normally acquire, have excellent economic characteristics. Combined, the two earn $100 million annually on about $125 million of net tangible assets.
I’ve asked Todd and Ted to each take on one as Chairman, in which role they will function in the very limited way that I do with our larger subsidiaries. This arrangement will save me a minor amount of work and, more important, make the two of them even better investors than they already are (which is to say among the best).
Warning 3: Watch Out for Thumb-Sucking …
While touring the stellar performance of Berkshire’s investments — “It was a good year for Berkshire on all major fronts, except one” — Buffett acknowledged a misstep as well on that exception, one for which he takes full blame.
Attentive readers will notice that Tesco, which last year appeared in the list of our largest common stock investments, is now absent. An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling.
At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount.
In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)
During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.
We sold Tesco shares throughout the year and are now out of the position … Our after-tax loss from this investment was $444 million, about 1/5 of 1% of Berkshire’s net worth.
Warning 4: … But Don’t Be Afraid to Be Patient
Buffett can be patient when it comes to cashing in on a good investment. For example, in a footnote to a list of his common-stock holdings, he writes of an investment in another financial services company:
Berkshire has one major equity position that is not included in the table: We can buy 700 million shares of Bank of America at any time prior to September 2021 for $5 billion. At year-end these shares were worth $12.5 billion. We are likely to purchase the shares just before expiration of our option. In the meantime, it is important for you to realize that Bank of America is, in effect, our fourth-largest equity investment — and one we value highly.