Outperformance...
Buffett notes at the outset of the letter that Berkshire Hathaway has outperformed the S&P 500 Index in every five-year period since 1965 when he assumed control of the company (Page 3). At the same time, Berkshire Hathaway tends to underperform in a rising market. As such, Buffett indicates that if the markets continue their unprecedented rise that they have been enjoying since the bottoms of 2009, the S&P 500 may actually achieve a five-year outperformance against him.
One thing I enjoy most about Buffett is that he sets a target (such as outperforming the S&P 500 Index) and sticks to it. Year over year, his tune remains much the same and we never need worry about being surprised by him shifting his alleged goals to make himself appear in a better light. This yardstick that he uses is a clear indicator of his job as a manager. In his view, if he cannot beat a simple benchmark index, then the average investor would be no better served by trusting him with their money than simply buying the index.
Due to Berkshire’s financial strength, I would prefer to have a position in it rather than the broader S&P 500 Index. To me, it is how an investor performs in a lagging or declining market that counts most. The comfort of knowing that my wealth will not be wiped out with one catastrophic event is worth more to me than trying to outpace everyone else during a “good” market or rising tide.
Major Acquisitions...
This year, Berkshire assumed a fifty percent stake in a holding company that now owns all of Heinz, which is best known for its ketchup (Page 4). While Berkshire certainly “paid up” for this acquisition, Heinz is a stable business and this meshes perfectly with Buffett’s overall strategy of being willing to pay a fair price for a solid, well-positioned brand.
America’s Future...
Time was spent in this year’s letter with the hopeful note of Buffett offering his view that American business will continue to do well long into the future. Uncertainty will always be there to rear its head at investors, but that is what makes the market. Different parties taking different sides is what moves the ticker, but Buffett is willing to continue to bet on business fundamentals and the American dream of future prosperity. I tend to agree with him.
Railroads...
Buffett discusses the economy of railroads at length, and this section is well worth reading in its entirety. One statistic that truly stands out is that Burlington Northern Santa Fe (owned by Berkshire) actually moves a ton of freight around 500 miles on one gallon of fuel while “trucks taking on the same job guzzle about four times as much fuel” (Page 10). That is certainly efficient both in terms of dollars on Berkshire’s end and also a big plus on the environmental side of things.
Further, once tracks are down, it is very unlikely for new entrants to enter the market and compete. So, once a railroad has their line set, they do not need to fear constant competition eroding their ability to sustain profitability (they have a moat, as Buffett would say).
The railroad business offers one extra advantage to Berkshire Hathaway as well; a place to invest its free cash flow. Berkshire has many businesses that kick off loads of excess cash. Owning a capital-intensive railroad offers the perfect outlet for some of that cash flow.
Changing of the guard...
Berkshire’s stock portfolio, which notably has large stakes in The Coca-Cola Company (NYSE: KO) and the American Express Company (NYSE: AXP), has always been managed by Buffett. Given that Buffett is getting older, Berkshire has taken steps to assure the company will continue into the future on a well-guided path. As such, Todd Combs and Ted Weschler now have been given the reins to make investments of their own, on behalf of Berkshire (Page 15). This is a relatively newer development for Berkshire and one to watch closely in order to discern the money management style of these two investors.
Dividends...
This year’s letter included a section explicitly on dividends and a discussion as to why Berkshire does not pay one. Buffett discusses each of the intelligent uses of capital that a company may employ, including share repurchases, reinvesting in businesses already owned, purchasing businesses outside of their current industries, as well as paying out a dividend.
Buffett ultimately concludes that shareholders of Berkshire are currently best served by the company retaining all earnings to build future growth as they have in the past (Pages 19-21). That said, he leaves the door open to the possibility of future dividends should those within Berkshire believe it to be in the best interest of shareholders at some point in time. Though I am generally largely in favor of dividends being paid, I am willing to grant Buffett the benefit of the doubt given his extensive and successful track record. Without such a dividend, however, I have not yet initiated any position Berkshire – though it is a possibility down the road.
You can find all of these Letters to Shareholders at www.BerkshireHathaway.com. Please read them.
Full Disclosure: Long KO. No position in BRK.B or AXP and no intention to initiate one within the next 72 hours.
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