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Berkshire Hathaway
Trash Heap of Corporate America

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By hartmanbirge
September 20, 2002

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Let's take a quick look at the battlefield, which is littered with the corpses of corporate America. Imagine yourself standing in the middle of the NYSE on a hot trading day three years ago and being told that the following would either implode, be riddled with rot and corruption, or even the unthinkable - cease to exist: Enron; JP Morgan; Tyco; AOL; McDonalds; Williams; Cisco; Bristol Myers; Disney; Dynegy; and Lucent. This does not include many, many others or even entire sectors such as the Internet - but most of us here saw the Internet implosion coming.

What most of us here did NOT see was the magnitude of the collapse in some of the major names in corporate America. In fact, the list above could easily have been a "blue chip portfolio" diversified and designed to weather a storm. We have a drug stock, financial, conglomerate, fast food, networking, oil and gas...beautiful. This is proof positive that one cannot rely on management alone, or numbers alone, or broker recommendations alone, or reputation, or a brand name, or anything in isolation.

If we take a step back today and view the carnage around us I think it's pretty startling...some might call it catastrophic. The entire brokerage industry missed the boat. Middle America missed the boat. I think that it's a useful exercise to take a step back, take a deep breath, and look where so many people went so wrong. Buffett saw it coming (I believe) and those of us who own Berkshire have largely escaped the storm - even gained. Here are some lessons I have taken away from the carnage:

1. There is no substitute for in-depth UNDERSTANDING of the companies you own - each and every one of them. Understanding includes the balance sheet, competition, management philosophy, resource constraints, etc.

2. Capital allocation strategy. I didn't realize how vital this was until I looked back and took samples of what companies were doing with shareholder money. Stock options are the most glaring but the abuses also include imbecilic outlays to stupidity - McDonalds's expensive cooking system, JP Morgan's lending strategy into over-capacity, Enron's debacle into shadow contracts, AOL's purchase (with stock) of Time Warner...on and on...and the blatant stupidity continues to pop up in the headlines nearly every day. Do they ever learn?

3. A thorough understanding of the external environment. Huh? You say. Doesn't Buffett turn off the noise of the economy? I would argue that Buffett understood the external environment indeed and this more than anything is what has kept him away from equities. In Buffett's case I believe it was a realization of the mathematical impossibility that companies could grow at 15% annual clips in an economy growing at 3%. That fact had to be taken into consideration when one was anticipating the viability of long-term growth rates going forward. Note how the rates of steady growers such as Gillette, Coke, McDonalds, Disney, Amex, etc. keep getting ratcheted ever downward.

4. I placed a very high premium on management integrity three years ago...Despite the premium I still underestimated just how critical it can be. Without it nothing else matters. So I look for clues - like how they reward themselves...stock option accounting etc. seem to me to be very viable tools for us to use.

5. Mergers? It's getting to the point where a merger becomes a death sentence. The moment management utters their usual buzzwords - synergy, efficiency, cost savings, etc. look out. I wonder aloud how well GE for example has REALLY integrated all of its acquisitions. The Berkshire model is an exception...Buffett doesn't buy the damn thing unless it's cheap and self sufficient and then he doesn't touch it and provides endless capital possibilities.

Those are my top 5...I could go on with quite the list but for brevity's sake I'll stop here...who would have thought that the above "blue chips" would be falling all around us in their death spirals?

HB


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