Few investors have the reputation that Berkshire Hathaway (BRK.A 1.86%) (BRK.B 1.47%) CEO Warren Buffett has. Even though Berkshire has grown to be one of the largest conglomerates in the world, Buffett still prides himself on the simple rules he follows in dealing with his company and its investors.
In order to let shareholders know what to expect when they invest in Berkshire, Buffett laid out his 13 owner-related business principles once again, in Berkshire Hathaway's latest annual report. Although they're now 35 years old, Buffett still values them as much as ever. Below, we'll go through them, with some brief explanations of why they're important.
1. "Although our form is corporate, our attitude is partnership."
Buffett doesn't see Berkshire shareholders as uninterested investors of a financial security. Instead, he sees each Berkshire share as a part-interest in every single one of the wholly owned businesses under the company's corporate umbrella. The same holds true for the publicly traded companies in which Berkshire invests, with Buffett seeing himself as a partner in many leading players in their respective industries.
2. "We eat our own cooking."
Aligning interests of corporate leaders with outside shareholders is important, and Berkshire does a great job of this. Buffett has 98% of his net worth in Berkshire shares, while Charlie Munger has the majority of his family's wealth invested in Berkshire. That way, no one can say that Buffett and Munger don't have enough skin in the game to make shareholders feel comfortable about their commitment to the company as a whole.
3. "We measure by per-share progress."
Unlike some companies, Berkshire Hathaway doesn't have the goal of being a behemoth in the global economy. Sheer size is worthless if it comes at the expense of per-share performance. Buffett believes that by keeping this focus, Berkshire should be able to earn favorable returns, even with the handicap of having seen its capital base grow substantially over the years.
4. Direct investment is best
Buffett notes that his preference is to own a diversified group of cash-generating businesses directly and wholly in order to maximize return. As a next-best option, owning partial stakes in such businesses through purchases of common stock is acceptable, and in practice, Berkshire has resorted to a mix of these strategies in order to allocate capital.
5. "Consolidated reported earnings may reveal relatively little about our true economic performance."
Buffett owns too many businesses for a single sum total to represent overall performance. In any given year, one major holding could have an outsized impact on Berkshire as a whole, even though the remainder of its holdings might be doing quite well. There's no shortcut to going through the information provided on each business to put together your own sense of the whole.
6. "Accounting consequences don't influence our operating or capital-allocation decisions."
A lot of investors focus more on cash flow than underlying earnings, but Buffett has almost the opposite view. He values undistributed earnings from his subsidiaries at least as much as what gets paid out to Berkshire, because he knows that those businesses can make good use of their own capital. Buffett's approach has been rewarding shareholders, and should continue to do so.
7. "We use debt sparingly."
With so much insurance float available, Berkshire Hathaway has little need for conventional debt. Leverage can enhance returns, but it can also lead to huge capital losses from which it can be impossible to recover. Paraphrasing another quote, you can't win a race if you don't finish, and outstanding debt can take you out of the game at the worst possible time.
8. "A managerial 'wish list' will not be filled at shareholder expense."
Buffett doesn't have delusions of grandeur about Berkshire's size. He won't do a deal just to make Berkshire bigger. Instead, any deal has to make Berkshire better, not just overall but on a per-share basis. Diluting existing shareholders' interest in pursuit of growth for growth's sake isn't Buffett's style.
9. "Noble intentions should be checked periodically against results."
Buffett likes to check his performance by comparing book-value gains against the returns of the S&P 500 on a five-year rolling basis. If the rise in book value has outperformed the S&P 500, then Buffett's decision to retain Berkshire's earnings was smart. If not, then paying a dividend would arguably be the superior move, but that's not something Buffett has yet had to contemplate.
10. "We'll issue common stock only when we receive as much in business value as we give."
Berkshire has so much cash that the idea of secondary offerings of stock is silly. Yet even in doing deals, Buffett prefers using cash rather than issuing stock. Using stock gives up not only the current value of shares but also any future value the business will generate, and that's not something Buffett takes lightly.
11. "We have no interest at all in selling any good businesses that Berkshire owns."
Buffett notes that his buy-and-hold philosophy is sometimes bad for Berkshire's financial performance, but he insists that selling good businesses isn't worth it at any price. Buffett even holds onto poorer businesses longer than he should in some cases, as long as they produce at least some cash returns. Yet Buffett doesn't throw good money after bad, preferring to let poor-performing businesses languish of their own accord, rather than investing huge amounts of capital in turnaround efforts.
12. "We will be candid with you."
Buffett is known for his candor, and that shows up both in his comments and in his company's financial statements. Accounting gimmicks aren't worthy of his time, and through his annual letters, regular disclosures, and well-attended shareholder meeting, Buffett makes himself accessible to his investors.
13. "We normally will not talk about our investment ideas."
Despite that candor, Buffett knows that being too open about proprietary knowledge can hurt his shareholders. That doesn't stop the Oracle of Omaha from sharing general wisdom about investing, but when it comes to specific investments or companies in which he's interested, Buffett doesn't hesitate to draw the line.
These 13 principles have served Warren Buffett well over the years, and even after he's gone, Berkshire shareholders can count on them lasting for years to come. The day that Buffett or his successors lose sight of these principles is the day that many of the company's longest and most loyal shareholders will exit their positions in the stock.