If you beat the market, you might want to keep the secrets of your investing success to yourself.
Not Warren Buffett.
The chairman of Berkshire Hathaway shared his 31-page letter to investors on Saturday and didn’t hold back on what propelled the portfolio last year and what should drive future returns.
Shares ticked up 6.4 percent in 2015 (as measured by book value) vs. a 1.4 percent improvement in the S&P 500 that included dividends.
Since 1965, the compound returns of the shares have averaged 19.2 percent.
“Charlie Munger, Berkshire vice chairman and my partner, and I expect Berkshire’s normalized earning power to increase every year,” he explained in the letter.
Buffett adds that actual year-over-year earnings could decline at times due to “weakness in the U.S. economy or, possibly, because of insurance mega-catastrophes.”
He also points out that normalized gains might “be small” sometimes and “material at other times.”
The Oracle of Omaha says that last year “was a good one.”
Read on for some of the most illuminating highlights of his 2015 letter to shareholders.
1. Invest in customer service, market dominance
Buffett was quick to point out that its stake in BNSF railroad, which underperformed in 2014, “dramatically improved its service to customers last year.”
How did this happen?
Berkshire invested nearly $6 billion in capital expenditures, “a sum far and away the record for any American railroad and nearly three times our annual depreciation charge,” Buffett says.
“It was money well spent,” he stated.
The investment counts, because it helps solidify BNSF’s top position among America’s seven largest railroads.
It moves roughly 17 percent of America’s intercity freight, he says, and 45 percent more ton-miles of freight than its closest competitor.
“Consequently, our maintaining first-class service is not only vital to our shippers’ welfare but also important to the smooth functioning of the U.S. economy,” Buffett stated.
It’s worth noting that most American railroads had disappointing results in 2015. Meanwhile, BNSF, saw its pre-tax income rise by nearly $7 billion, a nice jump from some $600 million in 2014.
2. Focus on core holdings
According to Buffet, BNSF is the largest of Berkshire Hathaway’s “Powerhouse Five.”
These investments include Berkshire Hathaway Energy, Marmon, Lubrizol and International Metalworking Cos. (IMC), which are its most profitable non-insurance businesses. They earned over $13 billion last year, a jump of $650 million over 2014.
Plus, by using cash and a bit of shares, Berkshire delivered a nearly $13 billion gain in annual earnings by these five companies over 12 years with minor dilution of its shares.
“That satisfies our goal of not simply increasing earnings, but making sure we also increase per-share results,” Buffett stated.
This group, he says, is being transformed into the “Powerhouse Six” in 2016 with the recent addition of Precision Castparts Corp. (PCC), which makes aerospace parts.
PCC CEO Mark Donegan and IMC CEO Jacob Harpaz “transform very ordinary raw materials into extraordinary products that are used by major manufacturers worldwide. Each is the da Vinci of his craft,” explained Buffet.
3. Embrace a culture of excellence
Berkshire’s decision to purchase of Precision Castparts, stemmed in part from the strong performance of International Metalworking Cos.
Buffett specifically thanks investment manager Todd Combs for bringing PCC to his attention, and he notes that Combs and his colleague Ted Weschler “add major value to Berkshire… Hiring these two was one of my best moves.”
Thanks partly to their input, Berkshire (including PCC) owns 10 companies that “would populate the Fortune 500 if they were stand-alone businesses,” explains Buffett.
“That leaves just under 98 percent of America’s business giants that have yet to call us. Operators are standing by,” he said.
By collecting dozens of smaller non-insurance businesses, Berkshire, which “love[s] them all,” has put together a collection of businesses that “will expand both in number and earnings as the years go by,” according to Buffett.
4. Take care of business
“When you hear talk about America’s crumbling infrastructure, rest assured that they’re not talking about Berkshire,” Buffett stated. “We invested $16 billion in property, plant and equipment last year, a full 86 percent of it deployed in the United States.”
Investments are important, since they translate into better results, he adds.
“At the end of every year, our railroad’s physical facilities will be improved from those existing twelve months earlier,” Buffett explained.
Berkshire Hathaway Energy (or BHE) is similar.
“That company has invested $16 billion in renewables and now owns 7 percent of the country’s wind generation and 6 percent of its solar generation,” according to Buffett.
This means that the amount of wind generation owned and operated by Berkshire’s regulated utilities “is six times the generation of the runner-up utility,” he adds.
“We’re not done. Last year, BHE made major commitments to the future development of renewables in support of the Paris Climate Change Conference. Our fulfilling those promises will make great sense, both for the environment and for Berkshire’s economics,” stated Buffett.
5. Work with powerful partners
Jorge Paulo of Kraft Heinz and his associates “could not be better partners,” says Buffet. “We share with them a passion to buy, build and hold large businesses that satisfy basic needs and desires.”
Kraft Heinz’s method is to purchase companies “that offer an opportunity for eliminating many unnecessary costs and then – very promptly – to make the moves that will get the job done,” he adds.
These steps boost productivity.
“Without more output of desired goods and services per working hour – that’s the measure of productivity gains – an economy inevitably stagnates. At much of corporate America, truly major gains in productivity are possible, a fact offering opportunities to Jorge Paulo and his associates,” explained Buffett.
Berkshire craves efficiency and detests bureaucracy, according to the veteran investor. “To achieve our goals, however, we follow an approach emphasizing avoidance of bloat, buying businesses such as PCC that have long been run by cost-conscious and efficient managers.”
After a purchase, Berkshire steps back, supporting “an environment in which these CEOs – and their eventual successors, who typically are like-minded – can maximize both their managerial effectiveness and the pleasure they derive from their jobs,” says Buffett.
6. Don’t ignore older, top brands
Last year, Berkshire increased its ownership in each of its “Big Four” investments – American Express, Coca-Cola, IBM and Wells Fargo.
It also bought more shares of IBM and Wells Fargo.
“At the other two companies, Coca-Cola and American Express, stock repurchases raised our percentage ownership,” said Buffett.
Each increase of one percentage point in ownership raises Berkshire’s portion of their annual earnings by about $500 million, he points out.
“These four investees possess excellent businesses and are run by managers who are both talented and shareholder-oriented. Their returns on tangible equity range from excellent to staggering,” he continued.
Berkshire prefers to own a non-controlling but sizeable stake of “a wonderful company” rather than 100 percent of “a so-so business.”
As Buffett concluded: “It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone.”
In 2015, Berkshire’s year-end holdings of these four companies represented $4.7 billion of earnings. The dividends alone were about $1.8 billion last year.
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