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BRK's 2009 Annual Report/Chairman Letter to Owners


Guest ValueCarl
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Good letter - enjoyed reading it. Explains the growth in float, the derivatives contracts, the rationale for buying BNI.

 

I was expecting the investment income and book value gain to be slightly higher than was reported. Never the less, a good report and I think the stock is still undervalued but not as much as it was two months back  ;D

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Key things from the report:

 

1. Netjets now profitable.

2. Increase in float despite soft insurance market

3. Explains the derivatives and why it is not a problem for berkshire derivatives

4. Good explanation of some of the subsidiary businesses

5. Investments around 131 billion, earnings at 8 billion

6. Berkshire the best large insurer in the world - first time I saw him make that claim

7. Explains BNI deal rationale

8. Thinks BRK will do well for decades, highlights some of the CEOs of subsidiaries, huge toast to Ajit Jain

9. Generally explained a lot of things not explained otherwise

 

The book value came in lower than my range, strictly going by 1.6 times book value measure for BRK, the stock is worth 135K/A share. But this is looking in the rear view mirror.

 

 

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And now a painful confession: Last year your chairman closed the book on a very expensive business fiasco entirely of his own making.

 

For many years I had struggled to think of side products that we could offer our millions of loyal

GEICO customers. Unfortunately, I finally succeeded, coming up with a brilliant insight that we should market our own credit card. I reasoned that GEICO policyholders were likely to be good credit risks and, assuming we offered an attractive card, would likely favor us with their business. We got business all right – but of the wrong type.

 

Our pre-tax losses from credit-card operations came to about $6.3 million before I finally woke up. We

then sold our $98 million portfolio of troubled receivables for 55¢ on the dollar, losing an additional $44 million.

 

GEICO’s managers, it should be emphasized, were never enthusiastic about my idea. They warned me

that instead of getting the cream of GEICO’s customers we would get the – – – – – well, let’s call it the

non-cream. I subtly indicated that I was older and wiser.

I was just older.

Interesting that he should have pushed this on GEICO.
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I know this is old hat, but with the bottom two quotes from the recent letter, am I correct in assuming that Warren tries to predict the future earnings and profitability of a business on a bottom up basis, but that he never tries to predict the market, industry or macro outlook at all (despite the fact that he has made some top-down calls in the past)?

 

Quote 1:

http://i163.photobucket.com/albums/t314/ripleyx/berk1.jpg

 

 

Quote 2:

 

http://i163.photobucket.com/albums/t314/ripleyx/berk2.jpg

 

My take on it is ... that Warren is looking for businesses where he can reliably predict the future earnings stream the company produces with high probability, and that he is looking for solid, stable, predictable earnings ... and as a bonus ... a growing earnings stream into the future as far as the eye can see ... much like a bond and its respective interest payments.

 

Hence why he bought Burlington Northern ... because the future earnings is predictable ... and also b/c Burlington is a large company, which he needs to move the needle. Many people have been confused by his purchase of BNSF, myself included given its valuation, however when you look at it from this angle, it makes a bit more sense i.e. predictable earnings stream.

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I know this is old hat, but with the bottom two quotes from the recent letter, am I correct in assuming that Warren tries to predict the future earnings and profitability of a business on a bottom up basis, but that he never tries to predict the market, industry or macro outlook at all (despite the fact that he has made some top-down calls in the past)?

 

Quote 1:

http://i163.photobucket.com/albums/t314/ripleyx/berk1.jpg

 

 

Quote 2:

 

http://i163.photobucket.com/albums/t314/ripleyx/berk2.jpg

 

My take on it is ... that Warren is looking for businesses where he can reliably predict the future earnings stream the company produces with high probability, and that he is looking for solid, stable, predictable earnings ... and as a bonus ... a growing earnings stream into the future as far as the eye can see ... much like a bond and its respective interest payments.

 

Hence why he bought Burlington Northern ... because the future earnings is predictable ... and also b/c Burlington is a large company, which he needs to move the needle. Many people have been confused by his purchase of BNSF, myself included given its valuation, however when you look at it from this angle, it makes a bit more sense i.e. predictable earnings stream.

 

 

I believe WEB is saying that rapidly changing industries are unpredictable, not only for which companies will be the most successful, but for the aggregate profits of the entire industry if any.

 

He looks for companies that have a long track record of producing substantial owner's earnings in an industry that is also conducive to producing substantial owner's earnings.  This is WEB's open secret that few other investors focus on.

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Web is supersmart - but those are guidelines, with exceptions.

 

For example, byd fits none of the normal criteria.  My understanding is that byd was munger's idea, but regardless...

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I think Sanjeev was right on the BNI deal - BRK is looking to invest large amounts of money for reasonable returns not outrageous returns. I think the utility segment generally is like that. It was interesting for Buffett to note that BRK got slightly more than what it gave away.

 

I think BRK will do fine. BRK book value compounded at 8.8% (arithmetic mean) clip for the past decade which isn't bad. The business value has grown faster than that according to Buffett & Gates - we may be looking at around 10-12% gain/year (arithmetic mean). Buying of pacificorp, fixing gen re, tuck in acquisitions and the increase in competitive strength of BRK businesses through the recession should have helped.

 

cheers!

Shalab

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I am not a huge fan of the BNI deal, but by no means is it a disaster.  You can see where BRK is headed - utilities, railroads, pipelines, etc.  They all have the toll booth type feel to them.

 

BRK will always be in great shape with WEB at the helm - now a giant cash flow machine.

 

I was a little surprised he didn't buy more common stock during the crisis - we all now he bought preferreds and they were great investments.  But I would have thought that some equities were super attractive with all BRK's cash.  But really - who are any of us to second guess the master.

 

Some people on this site make a good point - where else can you put all that capital?  Interesting discussion?  Buy more Coke?  Buy more P&G?  We all know he prefers wholly owned businesses. 

 

Any thoughts on next moves?  I think AES would be attractive to WEB.  A lot of debt though.

 

 

 

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I was a little surprised he didn't buy more common stock during the crisis - we all now he bought preferreds and they were great investments.  But I would have thought that some equities were super attractive with all BRK's cash.  But really - who are any of us to second guess the master.

 

I think it comes down to a risk/reward for Berkshire. If you look back at 1987, he did basically the same thing, investing in a number of preferred / convertible securities. These kinds of bets probably make sense for a business the size of Berkshire because all he has to do is bet on survival and get paid handsomely at rates well above the market's.

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Turiq - agreed.  It has to be risk/reward.  But it doesn't stop us from playing monday morning QB.

 

He did quite well with Gillette preferreds a while back.  GS and GE preferreds will probably pay off big as well.  Still, it just seems he would have bought something that was down big - but you are right...risk / reward and more constant FCF to BRK shareholders.

 

 

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Turiq - agreed.  It has to be risk/reward.  But it doesn't stop us from playing monday morning QB.

 

He did quite well with Gillette preferreds a while back.  GS and GE preferreds will probably pay off big as well.  Still, it just seems he would have bought something that was down big - but you are right...risk / reward and more constant FCF to BRK shareholders.

 

 

 

 

Web likes to get paid while he waits.  Ex.  He lent out his USG shares for a few years to the shorts during their cpt 11 , collecting an extra 3% or so per year, caring little for the market price of the stock in the meantime.  He wrote the index puts because he got paid up front and didn't have to post collateral.

Therefore, it's not surprising that he chose to buy solid, dividend paying preferreds with convertible optionality, rather than common during the financial crisis.  :)

 

I suspect that he also got a large number of Brownie points from GS, GE etc. While being paid to wait for the market to turn.  

 

Plus, buying preferreds is likely to produce less pressure for downgrades by rating agencies than buying more volatile common-- an especially sticky wicket in view of his equity puts that boomeranged and greatly constrained his flexibility during the crisis.

 

 

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