Annual letter out

[Munger_Disciple]

All I know is that this 1.2 threshold of book was publicly announced in 2013 and was never removed. So both the statements may still be valid: they can purchase below 1.2 times book, which is a price that is well below intrinsic value at the current time. In the new letter, Buffett mentioned "well below intrinsic value" when discussing The Next 50 Years at Berkshire. He does not want to tie the hands of future management for the next 50 years to the 1.2 number. But I still think they will not buy above 1.2 times book for the next few years.

[Txvestor]

Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.

I'm happy to see this reiterated.

 

Berkshire’s marvelous outcome in insurance was not a natural result. Ordinarily, a casualty insurance business is a producer of mediocre results, even when very well managed. And such results are of little use. Berkshire’s better outcome was so astoundingly large that I believe that Buffett would now fail to recreate it if he returned to a small base while retaining his smarts and regaining his youth.

 

This is a good reminder of how different the previous environment was compared to today's.

 

 

Yes but also remember that when he was running smaller sums in his partnership days, he employed the Benjamin Graham cigar butt approach in the 50s and thats when he had his greatest returns, until size became a barrier to that. For us small fry(most of us on this board), if you read between the lines, he is saying if you are sufficiently skilled the cigar butt approach is your best bet. Now thats a pretty big caveat, but nonetheless a distinction worth making.

 

I disagree completely. I often see folks pointing to Buffett's methods of the 50's to support their investment approach. First, even when he was relatively small in the 70's, he immediately switched after partnering with Munger (with a few relapses) to quality investing. Also, most of his wealth was created by a handful of investments (particularly, GEICO). Even WB stated before that if he just bought and held GEICO instead of all his other investments he would have created more value. I think you are trying too hard to fit their advice to your preferred approach. Either way, quality investing being better or worse has nothing to do with WB's opinion (though it certainly makes it worth researching), the math behind returns in general just doesn't defend your opinion. Cigar butt investing is nothing more than greater-fool theory, I don't know how anyone can view it as anything else.

 

If a company has expect future growth of 0% then each day the PV of the company is decreasing. Thus, you may get your projected higher price multiple and still realize losses!

 

On the new CEO, I think it's funny it's Jain and Abel as the final candidates, and I think Jain would be the wrong choice as the value he provides to GEICO is greater than the gap between him and Abel (if any) and Abel and his replacement. Insurance is hard and he has run circles around the industry! Every time I read about Abel I come away more impressed.

 

Below from the letter:

 

"My cigar-butt strategy worked very well while I was managing small sums. Indeed, the many dozens of free puffs I obtained in the 1950s made that decade by far the best of my life for both relative and absolute investment performance."

 

I get the view based on the above that for very small sums numbering in the single digit millions he would still look there. He rightly gives the example of Sees candy as a quality business that he almost let get away, and rightly praises Charlie's influence on him in this regard. But his roots were classic Graham cigar butt investing, and that scaled him into the tens of millions.

The environment you are working in also matters. A depressed stock market, less dispersion of public information, less investors in general, back then perhaps worked in his favor, and have probably made such net net situations a lot rarer now. Also i think getting a result also requires activism as some of those microcaps could be hurting the shareholders for the starus quo to benefit someone else.

Anyway, thats what worked for him. And based on recent statements and even what he says in this letter, I suspect he would take this approach again were he starting over.

 

 

 

[bskptkl]

"Also i think getting a result also requires activism..."

 

Activism, which WEB did with the takeover of Berkshire Hathaway in 1965 a year after getting hacked off at the chiseling tender offer.

Shows the human, emotional side of him I thought and even though he calls it a mistake, I think he is proud of it and would do it the same way again.

[benchmark]

" For software, as a big example, amortization charges are very real expenses. The concept of making charges against other intangibles, such as the amortization of customer relationships, however, arises through purchase-accounting rules and clearly does not reflect reality."

 

What does "amortization of customer relationship" means? Are these just the good will that's on the books?

 

[Otsog]

Yes, I believe he was talking about goodwill recorded from acquisitions.

 

 

Has Warren ever said what his preferred method would be to record the excess of price paid over GAAP assets received?

[giofranchi]

I don’t know if this has already been mentioned, but I really like the fact they have added the “in Per-Share Market Value of Berkshire” column in the front page. :)

 

Gio

 

[Aberhound]

Excellent letter.

 

The following quote made me wonder why Buffett thinks banks are such good businesses now that newly-written derivatives have required full collateralization. Doesn't this magnify the risk for banks as well?

 

"Some years ago, we became a party to certain derivative contracts that we believed were significantly mispriced and that had only minor collateral requirements. These have proved to be quite profitable. Recently, however, newly-written derivative contracts have required full collateralization. And that ended our interest in derivatives, regardless of what profit potential they might offer. We have not, for some years, written these contracts, except for a few needed for operational purposes at our utility businesses."

 

I do note the Wells Fargo has far less derivative exposure and BAC shares are held mostly as warrants reducing downside risk. Should those of us who hold BAC, JPM or Citi favour warrants and leaps over common? Or perhaps we should sell the banks and buy Berkshire then let Warran worry about the banks.

 

My second thought is to wonder why Buffett, unlike Prem, doesn't mention India. Berkshire's model should work even better in India where there is more future growth and a relative shortage of capital and capable businessmen compared to the US.

 

To your first point, (though this question/issue of banks and derivatives deserves a much longer discussion) - one important point related to this is that the banks you mention are likely the parties who are now requiring collateralization.  Thus, the situation is the inverse, to some extent, to the way your question seems to suppose it is.  Collateralization reduces risk for these banks - it does not enhance it.  They are the parties requiring increased collateral being posted for any alternative assets they transact with.

 

I was wondering if JPM might call up Citi one day and demand some huge amount of collateral be posted to cover some interest rate move on the interest rate swaps. Perhaps I have a misunderstanding because of my second assumption that most of the derivative trades are between the big banks? The reason I think they are mostly bank to bank is that the numbers are so large in the quadrillions and because most private sector bets are likely grouped such as insurance against a rise in interest rates and finally because I believe that banks are involved in the desire to manage market prices most notably, their desire to prevent the free  market from setting interest rates. Someone has to write the opposite side of each trade so if an attempt is made to distort the free market then there is an exponential rise in derivatives betting against the direction the free market seeks to go until the market cycle reverses. Basically if you choose to suppress the free market cycle with derivatives the same pressures that would have moved the free market price instead causes the derivatives positions to grow increasingly into one way bets until the free market cycle reverses. We saw this in 2008 when JPM and Goldman Sachs required billions in MBS default insurance to protect their portfolios and AIG was the fall guy selling the paper. AIG became insolvent due to collateral calls. Near the end of cycles the derivative imbalances must get massive so I was wondering how banks could write fully collateralized derivatives near the end of a cycle. Banks already have the borrow short lend long problem so it is not like they will have available cash during a crisis.

[LC]

leverage: if you know what you're doing, you don't need it. if you don't know what you're doing, you definitely don't need it.

[Guest longinvestor]

All I know is that this 1.2 threshold of book was publicly announced in 2013 and was never removed. So both the statements may still be valid: they can purchase below 1.2 times book, which is a price that is well below intrinsic value at the current time. In the new letter, Buffett mentioned "well below intrinsic value" when discussing The Next 50 Years at Berkshire. He does not want to tie the hands of future management for the next 50 years to the 1.2 number. But I still think they will not buy above 1.2 times book for the next few years.

I fully expect them to change the 1.2x to something more. When, have no idea, but the ever widening gap to IV makes it likely along with a repeat of "single transaction" opportunities like before. (Estate sale)

[Guest longinvestor]

Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.

I'm happy to see this reiterated.

 

Berkshire’s marvelous outcome in insurance was not a natural result. Ordinarily, a casualty insurance business is a producer of mediocre results, even when very well managed. And such results are of little use. Berkshire’s better outcome was so astoundingly large that I believe that Buffett would now fail to recreate it if he returned to a small base while retaining his smarts and regaining his youth.

 

This is a good reminder of how different the previous environment was compared to today's.

 

 

Yes but also remember that when he was running smaller sums in his partnership days, he employed the Benjamin Graham cigar butt approach in the 50s and thats when he had his greatest returns, until size became a barrier to that. For us small fry(most of us on this board), if you read between the lines, he is saying if you are sufficiently skilled the cigar butt approach is your best bet. Now thats a pretty big caveat, but nonetheless a distinction worth making.

 

I disagree completely. I often see folks pointing to Buffett's methods of the 50's to support their investment approach. First, even when he was relatively small in the 70's, he immediately switched after partnering with Munger (with a few relapses) to quality investing. Also, most of his wealth was created by a handful of investments (particularly, GEICO). Even WB stated before that if he just bought and held GEICO instead of all his other investments he would have created more value. I think you are trying too hard to fit their advice to your preferred approach. Either way, quality investing being better or worse has nothing to do with WB's opinion (though it certainly makes it worth researching), the math behind returns in general just doesn't defend your opinion. Cigar butt investing is nothing more than greater-fool theory, I don't know how anyone can view it as anything else.

 

If a company has expect future growth of 0% then each day the PV of the company is decreasing. Thus, you may get your projected higher price multiple and still realize losses!

 

On the new CEO, I think it's funny it's Jain and Abel as the final candidates, and I think Jain would be the wrong choice as the value he provides to GEICO is greater than the gap between him and Abel (if any) and Abel and his replacement. Insurance is hard and he has run circles around the industry! Every time I read about Abel I come away more impressed.

+ 1. There are many out here who are stuck with "forget old Buffett, I'm just like young B".

Re; the succession, IMO, the person who will play Munger in the spoiler role of capital allocation is perhaps far more important than the next CEO. To me, Jain will be the only person fit for this.

Ted W, Todd C, Tracy C all serving as Chairpersons. Jain is most likely Chairman in chief. Makes most sense since capital allocation is all but certain going to be lead by BHE. Abel for CEO

[HJ]

leverage: if you know what you're doing, you don't need it. if you don't know what you're doing, you definitely don't need it.

 

Sounded good, I very much disagree.  Leverage is integral to too much newly created wealth over the past 20 years for this statement to be true.  Real estate, private equity, media/telecom, gaming, ...  Even Buffet is leveraged in the form of insurance float.  Although I agree that business positioning and operator acumen is as important a piece of the equation, but leverage shouldn't be so easily dismissed as something you don't need if you know what you are doing.  It's a necessary, but insufficient condition for success.

 

[undervalued]

leverage: if you know what you're doing, you don't need it. if you don't know what you're doing, you definitely don't need it.

 

Sounded good, I very much disagree.  Leverage is integral to too much newly created wealth over the past 20 years for this statement to be true.  Real estate, private equity, media/telecom, gaming, ...  Even Buffet is leveraged in the form of insurance float.  Although I agree that business positioning and operator acumen is as important a piece of the equation, but leverage shouldn't be so easily dismissed as something you don't need if you know what you are doing.  It's a necessary, but insufficient condition for success.

 

The leverage used by Berkshire has a different characteristics than those used in Real estate, PE, Media/Telecom. As WEB mentioned in the letter, no one has the ability to demand these float right away even when the company value dropped 50%. This characteristic is not true for the other kinds of leverage.

[netnet]

leverage: if you know what you're doing, you don't need it. if you don't know what you're doing, you definitely don't need it.

 

Sounded good, I very much disagree.  Leverage is integral to too much newly created wealth over the past 20 years for this statement to be true.  Real estate, private equity, media/telecom, gaming, ...  Even Buffet is leveraged in the form of insurance float.  Although I agree that business positioning and operator acumen is as important a piece of the equation, but leverage shouldn't be so easily dismissed as something you don't need if you know what you are doing.  It's a necessary, but insufficient condition for success.

 

HJ you are right in the sense that LC's comment really only (should) apply to on demand, recourse leverage. Undervalued's comment re: float is spot on.

The leverage used by Berkshire has a different characteristics

Leverage never make a bad idea good, so float invested in rabbit turds doesn't turn them into raisins, to paraphrase Munger, who by the way developed real estate using leverage, in his earlier years.

 

And to go back to the original meaning, as Archimedes said, with leverage you can move the Earth.  So leverage your talents, your situation and and your friends, but your money, stick to non demand, non recourse!

[HJ]

 

Leverage never make a bad idea good, so float invested in rabbit turds don't turn into raisins, to paraphrase Munger, who by the way developed real estate using leverage, in his earlier years.

 

And to go back to the original meaning, as Archimedes said, with leverage you can move the Earth.  So leverage your talents, your situation and and your friends, but your money, stick to non demand, non recourse!

 

I didn't mean to be argumentative.  But certainly as it applies to my immediate surroundings (and it's a formerly well paid Wall Street fixed income crowd), I feel we were all so jaded with the financing process that we have plenty of "fearful when others are greedy", no where near enough of "greedy when others are fearful".  Way too many errors of omission, with the artificial self imposed goal of zero error of commission. 

 

There is no one strategy that fits everybody's circumstance, but I felt there need to be some balance to the discussion rather than a one sided "don't borrow to buy stocks".  Of course borrowing with mark to market triggers need to be done with extra caution.  But people shouldn't just sit back and admire how Valeant became a 10 bagger in 5 years while failing to acknowledge the role leverage played in the whole wealth creation process.  Deciding how to borrow, when to borrow and what terms to borrow on to acquire an asset is every bit as important as analyzing and understanding fundamental operating drivers of that asset.  Even in the personal finance context, you can chose to be leveraged in a deep in the money call, for example.  The public common equity world is almost too efficient to squeeze out any meaningful outperformance over time.

 

 

[LC]

Can I amend my post?? I agree with HJ :D

 

He is right: in certain spaces, debt is necessary. Here in NYC you can't hope to make an adequate return on RE without leverage.

 

I've used leverage in my portfolio before but for me it puts me on edge too much, psychologically, and in retrospect I don't think it was worth the stress.

[Liberty]

http://brooklyninvestor.blogspot.ca/2015/03/berkshire-hathaway-annual-report-2014.html

[netnet]

 

Leverage never make a bad idea good, so float invested in rabbit turds don't turn into raisins, to paraphrase Munger, who by the way developed real estate using leverage, in his earlier years.

 

And to go back to the original meaning, as Archimedes said, with leverage you can move the Earth.  So leverage your talents, your situation and and your friends, but your money, stick to non demand, non recourse!

 

I didn't mean to be argumentative.  But certainly as it applies to my immediate surroundings (and it's a formerly well paid Wall Street fixed income crowd), I feel we were all so jaded with the financing process that we have plenty of "fearful when others are greedy", no where near enough of "greedy when others are fearful".  Way too many errors of omission, with the artificial self imposed goal of zero error of commission. 

 

There is no one strategy that fits everybody's circumstance, but I felt there need to be some balance to the discussion rather than a one sided "don't borrow to buy stocks".  Of course borrowing with mark to market triggers need to be done with extra caution.  But people shouldn't just sit back and admire how Valeant became a 10 bagger in 5 years while failing to acknowledge the role leverage played in the whole wealth creation process.  Deciding how to borrow, when to borrow and what terms to borrow on to acquire an asset is every bit as important as analyzing and understanding fundamental operating drivers of that asset.  Even in the personal finance context, you can chose to be leveraged in a deep in the money call, for example.  The public common equity world is almost too efficient to squeeze out any meaningful outperformance over time.

 

Okay, it's a post and nuances get lost or rather I did not include them.  My ultimate point was only to be prudent: for some people that means no leverage, for some it means non-recourse, and for others who are willing to go out on a limb then full recourse debt prudently done.  Now, as Munger has said when you are rich there is no reason to gamble what you have and need for what you want, (see current annual report).  Remember his colleague and friend Peter Guerin was flattened.  Although, Guerin is now quite well off, thank you very much, but way, way poorer than Munger as  a result of his leverage and setback .  Of course you can lever up, just as you can light a campfire without setting yourself on fire.  But somethings you do not do, like running through a dynamite factory with a lit match.

 

By the way HJ, I was curious about your comment about wealth creation and leverage.  is this a reference to PE?

[HJ]

By the way HJ, I was curious about your comment about wealth creation and leverage.  is this a reference to PE?

 

Sure, PE is one way to think about it, they literally borrow money to buy stocks for a living, and plenty of one percenters came out of the process, granted that wealth was not well distributed across the society in this form.

 

But I guess I think of leverage quite broadly.  The operators of the cable / satellite business in the early days, for example, are in fact quite reckless with leverage.  Same goes for the shale oil drillers of today, Las Vegas casino builders of yesterday, Ted Turner, the list goes on and on. The nature of the market economy makes it such that the good ones all compete very hard, and understand how to use financial leverage very well.

 

I think that the money management industry caters to people and institutions who have plenty of money.  The overwhelming desire to not lose it, or for that matter, the prudent man standard does a great job of ingraining the fear of leverage into people's psyche.  But in reality, much of the new wealth of our society is created by people who embrace leverage rather than shy away from it.

[Jurgis]

much of the new wealth of our society is created by people who embrace leverage rather than shy away from it.

 

Not in technology.  8)

[benchmark]

Buffet's record is declining, though still better than most, which bring the question that when he leaves, will the return be even worse that it is now?

 

http://www.nytimes.com/2015/03/08/your-money/warren-buffetts-awesome-feat-at-berkshire-hathaway-revisited.html?action=click&contentCollection=DealBook&region=Footer&module=MoreInSection&pgtype=article

[Guest longinvestor]

Munger's commentary on the next 50 years at BRK

 

The next to last task on my list was: Predict whether abnormally good results would continue at Berkshire if Buffett

were soon to depart. The answer is yes. Berkshire has in place in its subsidiaries much business momentum grounded in much durable

competitive advantage. Moreover, its railroad and utility subsidiaries now provide much desirable opportunity to invest large sums in new

fixed assets. And many subsidiaries are now engaged in making wise “bolt-on” acquisitions.

Provided that most of the Berkshire system remains in place, the combined momentum and opportunity now present

is so great that Berkshire would almost surely remain a better-than-normal company for a very long time even if

(1) Buffett left tomorrow, (2) his successors were persons of only moderate ability, and (3) Berkshire never again

purchased a large business.

 

The last point about never needing to purchase a large business to keep the momentum going is a big statement, no? Reinvestments, tuck-in's and share repurchases enuff? If this is true, #2 above, the moderate ability of the CEO is indeed true, like knowing how to calculate when the stock falls below 1.2xBV, ha.

 

Heaven forbid if the next CEO is of more than moderate ability.

[jay21]

Munger's commentary on the next 50 years at BRK

 

The next to last task on my list was: Predict whether abnormally good results would continue at Berkshire if Buffett

were soon to depart. The answer is yes. Berkshire has in place in its subsidiaries much business momentum grounded in much durable

competitive advantage. Moreover, its railroad and utility subsidiaries now provide much desirable opportunity to invest large sums in new

fixed assets. And many subsidiaries are now engaged in making wise “bolt-on” acquisitions.

Provided that most of the Berkshire system remains in place, the combined momentum and opportunity now present

is so great that Berkshire would almost surely remain a better-than-normal company for a very long time even if

(1) Buffett left tomorrow, (2) his successors were persons of only moderate ability, and (3) Berkshire never again

purchased a large business.

 

The last point about never needing to purchase a large business to keep the momentum going is a big statement, no? Reinvestments, tuck-in's and share repurchases enuff?

 

That was my favorite quote. I can't think of a bigger endorsement for the current assets and team at BRK (which I agree with as evidenced by my sizable position).

[Jurgis]

https://finance.yahoo.com/news/jamie-dimon-and-warren-buffett-s-secret-party-195155764.html

 

Good last sentence.

[JBird]

https://finance.yahoo.com/news/jamie-dimon-and-warren-buffett-s-secret-party-195155764.html

 

Good last sentence.

 

Hahaha

[Charlie]

"Munger's commentary on the next 50 years at BRK

 

The next to last task on my list was: Predict whether abnormally good results would continue at Berkshire if Buffett

were soon to depart. The answer is yes. Berkshire has in place in its subsidiaries much business momentum grounded in much durable

competitive advantage. Moreover, its railroad and utility subsidiaries now provide much desirable opportunity to invest large sums in new

fixed assets. And many subsidiaries are now engaged in making wise “bolt-on” acquisitions.

Provided that most of the Berkshire system remains in place, the combined momentum and opportunity now present

is so great that Berkshire would almost surely remain a better-than-normal company for a very long time even if

(1) Buffett left tomorrow, (2) his successors were persons of only moderate ability, and (3) Berkshire never again

purchased a large business.

 

The last point about never needing to purchase a large business to keep the momentum going is a big statement, no? Reinvestments, tuck-in's and share repurchases enuff?

 

That was my favorite quote. I can't think of a bigger endorsement for the current assets and team at BRK (which I agree with as evidenced by my sizable position)."

 

+1 very interesting quotes.  :)

 

Munger repeated his bullishness about Berkshire from the Daily Journal annual meeting:

 

"Part of what we did should be done by others, but it isn’t. There are vast institutional pressures on people to do it differently. 

Will it continue?  I think Berkshire’s going to continue way better than most people think. Way better."