Warren Buffett on Risk, Optimism, and Ketchup

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Warren Buffett released his latest annual letter to Berkshire Hathaway (NYSE: BRK-B  ) shareholders on Friday. You can read the whole thing here, but I pulled out some of the best quotes below.

On performance: "For the ninth time in 48 years, Berkshire's percentage increase in book value was less than the S&P's percentage gain (a calculation that includes dividends as well as price appreciation). In eight of those nine years, it should be noted, the S&P had a gain of 15% or more. We do better when the wind is in our face. To date, we've never had a five-year period of underperformance, having managed 43 times to surpass the S&P over such a stretch."

On Berkshire's future leaders: "Todd Combs and Ted Weschler, our new investment managers, have proved to be smart, models of integrity, helpful to Berkshire in many ways beyond portfolio management, and a perfect cultural fit. We hit the jackpot with these two. In 2012 each outperformed the S&P 500 by double-digit margins. They left me in the dust as well. ...Todd and Ted are young and will be around to manage Berkshire's massive portfolio long after Charlie and I have left the scene. You can rest easy when they take over."

On investing: "There was a lot of hand-wringing last year among CEOs who cried 'uncertainty' when faced with capital allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash). At Berkshire, we didn't share their fears, instead spending a record $9.8 billion on plant and equipment in 2012, about 88% of it in the United States. That's 19% more than we spent in 2011, our previous high. Charlie and I love investing large sums in worthwhile projects, whatever the pundits are saying ... We will keep our foot to the floor and will almost certainly set still another record for capital expenditures in 2013. Opportunities abound in America."

On confidence: "A thought for my fellow CEOs: Of course, the immediate future is uncertain; America has faced the unknown since 1776. It's just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them (usually because the recent past has been uneventful). American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor. (The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions. And don't forget that shareholders received substantial dividends throughout the century as well.)"

On the recent Heinz deal: "We couldn't be in better company. Jorge Paulo is a longtime friend of mine and an extraordinary manager. His group and Berkshire will each contribute about $4 billion for common equity in the holding company. Berkshire will also invest $8 billion in preferred shares that pay a 9% dividend. The preferred has two other features that materially increase its value: at some point it will be redeemed at a significant premium price and the preferred also comes with warrants permitting us to buy 5% of the holding company's common stock for a nominal sum. Our total investment of about $12 billion soaks up much of what Berkshire earned last year. But we still have plenty of cash and are generating more at a good clip. So it's back to work; Charlie and I have again donned our safari outfits and resumed our search for elephants."

On market timing: "Since the basic game is so favorable, Charlie and I believe it's a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of 'experts,' or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it."

On the competition: "There are a lot of ways to lose money in insurance, and the industry never ceases searching for new ones."

On a coming reckoning: "Insurance earnings are now benefiting from 'legacy' bond portfolios that deliver much higher yields than will be available when funds are reinvested during the next few years -- and perhaps for many years beyond that. Today's bond portfolios are, in effect, wasting assets. Earnings of insurers will be hurt in a significant way as bonds mature and are rolled over."

On diversification: "If the insurance industry should experience a $250 billion loss from some megacatastrophe -- a loss about triple anything it has ever experienced -- Berkshire as a whole would likely record a significant profit for the year because it has so many streams of earnings. All other major insurers and reinsurers would meanwhile be far in the red, with some facing insolvency."

On valuation: "Of course, a business with terrific economics can be a bad investment if the price paid is excessive. We have paid substantial premiums to net tangible assets for most of our businesses, a cost that is reflected in the large figure we show for intangible assets. Overall, however, we are getting a decent return on the capital we have deployed in this sector. Furthermore, the intrinsic value of the businesses, in aggregate, exceeds their carrying value by a good margin. Even so, the difference between intrinsic value and carrying value in the insurance and regulated industry segments is far greater. It is there that the huge winners reside."

On risk: "Charlie and I believe in operating with many redundant layers of liquidity, and we avoid any sort of obligation that could drain our cash in a material way. That reduces our returns in 99 years out of 100. But we will survive in the 100th while many others fail. And we will sleep well in all 100."

On share repurchases: "Indeed, disciplined repurchases are the surest way to use funds intelligently: It's hard to go wrong when you're buying dollar bills for 80¢ or less. We explained our criteria for repurchases in last year's report and, if the opportunity presents itself, we will buy large quantities of our stock. We originally said we would not pay more than 110% of book value, but that proved unrealistic. Therefore, we increased the limit to 120% in December when a large block became available at about 116% of book value." 

More on Berkshire
Warren Buffett's long track record of success has made him one of the best investors of all time. With the Buffett at the helm, Berkshire Hathaway has grown book value per share at a compounded annual rate of 19.8% for nearly 50 years! Despite an incredible historical track record, investors have to understand the key issues to watch moving forward. To help investors, the Fool's resident Berkshire Hathaway expert, Joe Magyer, has created this premium research report on the company. Inside, you'll receive ongoing updates as key news hits, as well as reasons to both buy and sell the stock. Claim a copy by clicking here now.

Read/Post Comments (7) | Recommend This Article (74)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 01, 2013, at 6:52 PM, thedoge wrote:

    "There are a lot of ways to lose money in insurance, and the industry never ceases searching for new ones." And guess whose rates will go up when they do? Another reason why having the insurance cartel act as a gateway to health care is so crazy.

  • Report this Comment On March 01, 2013, at 7:07 PM, constructive wrote:

    Also on Todd and Ted:

    In Berkshire’s past annual reports, every

    stock itemized in this space has been bought by me, in the sense that I made the decision to buy it for Berkshire. But starting with this list, any investment made by Todd Combs or Ted Weschler – or a combined purchase by them – that meets the dollar threshold for the list ($1 billion this year) will be included. Above is the first such stock, DIRECTV, which both Todd and Ted hold in their portfolios and whose combined holdings at the end of 2012 were valued at the $1.15 billion shown.

  • Report this Comment On March 02, 2013, at 3:56 AM, clbjblk wrote:

    Why does no one bring up his Warren/Obama Oil Train that is going to get an extra 22$ Billion because it cost $10.00 a barrel of oil than a pipeline. There is your Keystone White House SLEEP OVER insider deal. See you at the gas pump China loves this and we make a fool of our best neighbor. The tree huggers think that if the US does not get it that it is dead, well China will get it and the same climate control problem will be worse because now China gets the Money.

  • Report this Comment On March 02, 2013, at 2:28 PM, NewAlchemist wrote:

    Here to play devils advocate.

    - Buffet trailed the market 3 out of the last 4 years, and the year he didn't he outperformed by a mere 2%.

    - Buffet expects to only perform the market "slightly" going forward. His words not mine.

    - Buffet used to scoff at Investing in Tech, then he bought IBM.

    - Buffet used to scoff at others companies doing buybacks, now he buys back his own shares.

    - Buffet loves dividends but doesn't pay one.

    - Buffet once called derivatives weapons of mass destruction, then he bought them.

    - Buffet bashes CEO's for not investing their huge cash piles but admits he didn't invest his huge cash pile in 2012.

    The biggie. Buffet says he doesn't pay enough taxes but sued the IRS in 2011 to avoid paying taxes. When pushed by Joe Kernen on CNBC he said that people who make $250,000 are not under taxed. He still pushes forward so that their taxes are increased so that his aren't. This after admitting he doesn't pay enough but they do.

  • Report this Comment On March 02, 2013, at 10:15 PM, FoolishJayhawk wrote:

    @NewAlchemist - I applaud you playing devils advocate. But, first, if you're going to criticize the world's greatest investor, then let's spell his name correctly: Buffett. Two 't's not one. This isn't Golden Corral.

    Next, your criticism of outperformance is silly. He has handily beat the market. I don't know where you're getting your numbers. Here's the hard truth: page 2 of the 2012 annual letter states BRK return from 1964-2012 = 586,817% (Post-Tax!) vs. 7,433% for the S&P (with dividends, PRE-tax).

    On only "slightly" outperform the market - that's a lot more than most can claim. Can you do so consistently? Have you?

    On IBM: He never scoffed at investing in tech, he simply said it was not in his circle of competence in 1999. As one learns and grows, one is allowed to change their mind.

    On buy backs: he scoffs at companies that buy their shares when they're overvalued; he buys shares of his company when they are undervalued. Not the same thing.

    On dividends: I suggest you read his letter. He addresses it there. Bottom line: he can reinvest the cash a lot better than almost anyone else can.

    On derivatives: again, did you read his letter? See page 15. Also, have you ever tried to run a commodity-based business? Derivatives are not inherently bad. However, his reference to their use as WMDs was qualified and in the context of financial shenanigans that brought the house down, i.e. that whole housing bubble and crash thing in 2007-2009.

    On investing. One more time - read the newsletter. He talks about the big elephants he tried to acquire but couldn't.

    Bottom line: Please don't take these comments personally. The Motley Fool community loves a good discussion. However, it has to be well reasoned and informed. Reading BRK's annual statements/letter may be a good start. Else, it's just banter.



  • Report this Comment On March 03, 2013, at 7:20 AM, Tom10Saga wrote:

    Mr. Buffet is optimistic on 2013.

    It is in a good agreement with

    Perhaps the most amazing fact is that the S&P 500 in gold stood at 1.1 ounces on October 1928, giving us a price higher than the ratio today. There has been a long stream of dividends since then, but the real price of the equity market is lower today than the level of 84 years ago!

  • Report this Comment On March 04, 2013, at 3:56 PM, NewAlchemist wrote:


    I've read all of Buffett's letters to shareholders including this one.

    Performance. If you will click the link and read page 2 (as you suggested I do) you will see that Buffet trailed the market 3 out of the last 4 years. Of course he's outperformed long term but it's a lot easier when you are smaller. His investment universe is considerably smaller now compared to when he started out. He can't go for small game when he's that big and dent performance, he has to "hunt elephants". This makes his job harder and over the last 4 years he's trailed the market. Will he going forward? Who knows but even Buffett himself doesn't sound that optimistic. In one of his previous letters he said that if he managed less money he'd manage it very differently. Maybe his portfolio would consist of highly undervalued small cap stocks instead of big US large caps?

    My performance. I don't know what my performance record has to do with Buffett. Does it anger you I pointed out some criticisms with him? Yes I have consistently outperformed the market but I don't know how that adds to the discussion on Buffett.

    Tech, Dividends, Buy backs etc. In my experience some people view Buffett as a god. He can do no wrong. His followers view his methods as the best way or the only way. Buffett disciples avoided Tech because Buffet did. Buffett's views on these topics are widely quoted. When somebody had a different view the Buffett disciples would mock them.

    I also notice you addressed my comments line by line but avoided the tax hypocrisy of Buffett.

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