Berkshire Hathaway

warren buffett

charlie munger by Charlie Powell

Berkshire Hathaway Inc. is an American multinational conglomerate holding company headquartered in Omaha, Nebraska that oversees and manages a number of partially and wholly owned subsidiary companies. The company owns Geico, Dairy Queen, Fruit of the Loom, Helzberg Diamonds, NetJets, and Heinz and has significant minority holdings in American Express, M&T Bank, Coca-Cola, Kraft Foods, Proctor & Gamble, and IBM. Berkshire Hathaway averaged an annual growth in book value of 20.3% to its shareholders for the last 44 years, while employing large amounts of capital, and minimal debt.

Berkshire Hathaway stock produced a total return of 76% from 2000–2010 versus a negative 11.3% return for the S&P 500. Warren Buffett owns 32.4% aggregate voting power of Berkshire’s shares outstanding, and vice-chairman Charlie Munger holds a stake big enough to make him a billionaire (early investments in Berkshire by David Gottesman and Franklin Otis Booth, Jr. resulted in their becoming billionaires as well). Bill Gates’ Cascade Investments LLC is the second largest shareholder of Berkshire and owns more than 5% of class B shares.

Buffett, the company’s chairman and CEO, uses the ‘float’ provided by Berkshire Hathaway’s insurance operations (paid premiums which are not held in reserves for reported claims and may be invested) to finance his investments. In the early part of his career at Berkshire, he focused on long-term investments in publicly quoted stocks, but more recently he has turned to buying whole companies. Berkshire now owns a diverse range of businesses including confectionery, retail, railroad, home furnishings, encyclopedias, manufacturers of vacuum cleaners, jewelry sales; newspaper publishing; manufacture and distribution of uniforms; as well as several regional electric and gas utilities. According to Forbes, Berkshire Hathaway is the eighth largest public company in the world

Berkshire Hathaway traces its roots to a textile manufacturing company established by Oliver Chace in 1839 as the Valley Falls Company in Rhode Island. Chace had previously worked for Samuel Slater, the founder of the first successful textile mill in America. Chace founded his first textile mill in 1806. In 1929 the Valley Falls Company merged with the Berkshire Cotton Manufacturing Company established in 1889, in Massachusetts. The combined company was known as Berkshire Fine Spinning Associates until it merged, in 1955, with the Hathaway Manufacturing Company, which was founded in 1888 (also in Massachusetts) by Horatio Hathaway with profits from whaling and the China Trade. Hathaway was successful in its first decades, but it suffered during a general decline in the textile industry after World War I. At this time, Hathaway was run by Seabury Stanton, whose investment efforts were rewarded with renewed profitability after the Depression. After the merger Berkshire Hathaway had 15 plants employing over 12,000 workers with over $120 million in revenue. However, seven of those locations were closed by the end of the decade, accompanied by large layoffs.

In 1962, Warren Buffett began buying stock in Berkshire Hathaway after noticing a pattern in the price direction of its stock whenever the company closed a mill. Eventually, Buffett acknowledged that the textile business was waning and the company’s financial situation was not going to improve. In 1964, Stanton made a verbal tender offer of $11.50 per share for the company to buy back Buffett’s shares. Buffett agreed to the deal. A few weeks later, Warren Buffett received the tender offer in writing, but the tender offer was for only $11.375. Buffett later admitted that this lower, undercutting offer made him angry. Instead of selling at the slightly lower price, Buffett decided to buy more of the stock to take control of the company and fire Stanton (which he did). However, this put Buffett in a situation where he was now majority owner of a textile business that was failing.

Buffett initially maintained Berkshire’s core business of textiles, but by 1967, he was expanding into the insurance industry and other investments. Berkshire first ventured into the insurance business with the purchase of National Indemnity Company. In the late 1970s, Berkshire acquired an equity stake in the Government Employees Insurance Company (GEICO), which forms the core of its insurance operations today (and is a major source of capital for Berkshire Hathaway’s other investments). In 1985, the last textile operations (Hathaway’s historic core) were shut down. In 2010, Buffett claimed that purchasing Berkshire Hathaway was the biggest investment mistake he had ever made, and claimed that it had denied him compounded investment returns of about $200 billion over the previous 45 years. Buffett claimed that had he invested that money directly in insurance businesses instead of buying out Berkshire Hathaway (due to what he perceived as a slight by an individual), those investments would have paid off several hundredfold.

Berkshire’s class A shares sold for $140,803.06 in 2013, making them the highest-priced shares on the New York Stock Exchange, in part because they have never had a stock split and have only paid a dividend once since Warren Buffett took over, retaining corporate earnings on its balance sheet in a manner that is impermissible for private investors and mutual funds. Shares closed over $100,000 for the first time in 2006 and closed at an all-time high of $150,000 in late 2007. Despite its size, Berkshire has not been included in broad stock market indices such as the S&P 500 due to the lack of liquidity in its shares; however, following a 50-to-1 split of Berkshire’s class B shares in 2010, Burlington Northern was replaced by Berkshire in the S&P 500. Buffett’s annual chairman’s letters are widely read and quoted. ‘Barron’s Magazine’ named Berkshire the most respected company in the world in 2007 based on a survey of American money managers.

Berkshire Hathaway is notable in that it has never split its Class A shares, which not only contributed to their high per-share price but also significantly reduced the liquidity of the stock. This refusal to split the stock reflects the management’s desire to attract long-term investors as opposed to short-term speculators. However, Berkshire Hathaway has created a Class B stock, with a per-share value originally kept (by specific management rules) close to 1⁄30 of that of the original shares (now Class A) and 1⁄200 of the per-share voting rights, and after the 2010 split, at 1⁄1,500 the price and 1⁄10,000 the voting rights of the Class-A shares. Holders of class A stock are allowed to convert their stock to Class B, though not vice versa. Buffett was reluctant to create the class B shares, but did so to thwart the creation of unit trusts that would have marketed themselves as Berkshire look-alikes. As Buffett said in his 1995 shareholder letter: ‘The unit trusts that have recently surfaced fly in the face of these goals. They would be sold by brokers working for big commissions, would impose other burdensome costs on their shareholders, and would be marketed en masse to unsophisticated buyers, apt to be seduced by our past record and beguiled by the publicity Berkshire and I have received in recent years. The sure outcome: a multitude of investors destined to be disappointed.’

Berkshire’s annual shareholders’ meetings in Nebraska are routinely visited by 20,000 people. The meetings, nicknamed ‘Woodstock for Capitalists,’ are considered Omaha’s largest annual event along with the baseball College World Series. Known for their humor and light-heartedness, the meetings typically start with a movie made for Berkshire shareholders. The 2004 movie featured Arnold Schwarzenegger in the role of ‘The Warrenator’ who travels through time to stop Buffett and Munger’s attempt to save the world from a ‘mega’ corporation formed by Microsoft-Starbucks-Wal-Mart. Schwarzenegger is later shown arguing in a gym with Buffett regarding Proposition 13 (California’s real estate tax cut). The 2006 movie depicted actresses Jamie Lee Curtis and Nicollette Sheridan lusting after Munger. The meeting, scheduled to last six hours, is an opportunity for investors to ask Buffett questions.

The salary for the CEO is US$100,000 per year with no stock options, which is among the lowest salaries for CEOs of large companies in the United States. In May 2010, Buffett, months away from his 80th birthday, said he would be succeeded at Berkshire Hathaway by a team consisting of a CEO and three or four investment managers; each of the latter would be responsible for a ‘significant portion of Berkshire’s investment portfolio.’ Five months later, Berkshire announced that Todd Combs, manager of the hedge fund Castle Point Capital, would join them as an investment manager. In September 2011, Berkshire Hathaway announced that 50-year-old Ted Weschler, founder of Peninsula Capital Advisors, will join Berkshire in early 2012 as a second investment manager.

In Berkshire Hathaway’s annual shareholder letter for 2012, Buffett said that his successor as CEO had been chosen internally but not named publicly. While the intent of this message was to bolster confidence in the leadership of a ‘Buffett-less Berkshire,’ critics have noted that this strategy of choosing a successor without a concrete exit strategy for the sitting CEO often leaves an organization with fewer long term options, while doing little to calm shareholder fear. In reaction to the announcement, Stephen A. Miles, a leadership consultant who specializes in CEO succession, noted, ‘You see this more often with successful founder CEOs. Because they’re so good, they want to take the lead in choosing their replacement, [but] most boards try to avoid what [Buffett] did.’

In 2008, Berkshire invested in preferred shares of Goldman Sachs as part of a recapitalization of the investment bank. Buffett defended Goldman CEO Lloyd Blankfein’s $13.2 million pay package when the company had taken and not yet paid back $10 billion in Troubled Asset Relief Program (TARP) money from the United States Department of Treasury. Berkshire made $3.5 billion on its investment. In 2010 at the Berkshire shareholders meeting, Buffett also defended Goldman over $1 billion in collateralized debt obligation fraud allegations saying that its clients made a calculated risk. Additionally, the Gates Foundation (of which Buffett is a major contributor) expressed concern about Berkshire Hathaway’s investments in Sudan, where they hold a $3.3 billion stake in PetroChina. Bill Gates is on Berkshire Hathaway’s board of directors.

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