Warren Buffett's latest Letter to Shareholders marks the legendary investor's 50th anniversary at the helm of Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), and both he and Charlie Munger penned special commentaries to accompany it.
With a look back over the past 50 years and a glimpse into the future, this may be the greatest shareholder letter ever. Offering a treasure trove for the Foolish investor, the message provides insights into Buffett's approach to succession and its effect on culture, as well as a clear-eyed look at the possibility of a Berkshire dividend.
A full transcript follows the video.
Kristine Harjes: Buffett's latest wisdom is out. This is Industry Focus.
[INTRO]
Hi everyone, Kristine Harjes here, along with our senior banking specialist, John Maxfield. John, how are you doing today?
John Maxfield: I'm doing great, thank you very much Kristine.
Harjes: Awesome. Did you have a good weekend?
Maxfield: I did. It was great. I'm out in Portland, Oregon. I don't know if it's still cold on the East Coast like it was for you guys, but it's just been beautiful out here, in the high 50s to low 60s. You can't get much better than that for late February/early March.
Harjes: I can say I'm definitely pretty jealous of that! It was certainly chilly here in Alexandria. But I bundled up, stayed in, and dove right in on the latest letter to shareholders for Berkshire Hathaway, read up on the Oracle of Omaha's wisdom; I'm sure you did as well.
Maxfield: I did! I spent many an hour this weekend -- I have twin toddlers -- fending them off so I could delve into Buffett's latest letter. One of our colleagues wrote something saying that it was the best ever. I couldn't agree more.
Harjes: Yes, definitely worth a read, if not several reads. Let's dig into it a little bit more. First off, what is the big deal with this letter?
Maxfield: The big deal with this letter is that it commemorates the 50th anniversary since Buffett acquired control of Berkshire Hathaway. When you think back to the very beginning, Berkshire Hathaway was just a very small collection of textile mills based on the East Coast, and now it's turned into this massive conglomerate.
What's so interesting about this letter is that, first and foremost, it caps that natural milestone. But secondarily, because it caps that natural milestone, both Buffett and his Vice Chairman at Berkshire Hathaway, Charlie Munger, sat down and wrote special addendums to the letter, covering the next 50 years in Buffett's case, and in Munger's case, how Berkshire got to where it is today.
Harjes: They were absolutely fascinating reads, I have to say.
Maxfield: Yes, I couldn't agree with you more. First of all, let me just put this out there. I'm not a fanboy, per se, of Warren Buffett, but I am an enormous intellectual admirer of him.
One of the things that is great about his letter, and if you've ever read any of Munger's letters in the past, is that you can tell these guys are both exquisitely good writers, and voracious readers. Those two things come together in a shareholder letter like this, to really be able to successfully teach a variety of different lessons to the people who read them.
Harjes: Absolutely, and they are so readable. For being so intellectually rich, they're broken down, they're organized, and they're packed with these analogies that make it something that every person could read and gain some really solid truthful, but understandable, wisdom.
Maxfield: Yes. In my opinion, this is one of the most important ... the shareholder letters of Berkshire Hathaway, as they continue on -- particularly while Buffett is still there -- is probably if not the single most important living document that is still being collated, is certainly among a handful of them that are out there right now.
Harjes: Absolutely. One thing that was interesting for me to note in these was the fact that they included both a past-looking perspective, as well as the forward-looking perspective. What's your opinion? Which one of those two do you think was more interesting for you to read?
Maxfield: That's a really good question. I would say that they're both really interesting, for different reasons. If you look at Buffett's addendum to the letter, he talks about the next 50 years at Berkshire Hathaway.
What I found that was so interesting bout that is how he started the letter just talking about what a safe and secure investment Berkshire is.
We can go through the specific reasons that he gave later, but just that thought process that this is like the Rock of Gibralter in terms of companies, I thought is a very good point to start out with, to lay into the Berkshire shareholders' heads as the potential that Buffett will at some point step down from his role at Berkshire Hathaway.
But then you had Munger's part, that looked back on why Berkshire Hathaway was able to become so extraordinarily successful.
For somebody with his insight, given that he was the Vice Chairman and, if not Buffett's best friend, certainly among his best friends, his vantage point on that and the way that he so comprehensively goes through what he believes led to Berkshire's success, I found -- and I suspect you did too -- to be incredibly insightful.
Harjes: I wholeheartedly agree. You know what also stands out to me there is that he was able to consolidate it into four distinct factors.
Maxfield: Yes. Four, and then kind of a fifth one, because then he talks about that next 50 years too, and that was in that fifth one.
What I liked about it is that it's really clear that the man that wrote that letter, i.e. Charlie Munger, is a lawyer, because he goes through things in such a systematic, well-organized and thorough way.
It's almost more like an outline, as opposed to a narrative, where every word in Charlie Munger's letter means something; as opposed to, you look at letters from other CEOs, there's a lot of fluff, a lot of unnecessary words that are in there just to create that narrative.
Harjes: Yes. His is short, sweet, to the point. That's a really good observation. Something that you mentioned in there that I think we'd be remiss not to discuss a little bit; you mentioned CEOs, and earlier you talked a little bit about the succession.
We even had an Industry Focus episode on this a couple of weeks ago, about how important the succession of CEOs is at banks, was our initial discussion, but we did talk a little bit about how this is something that's really important for companies across all sectors, is getting that leadership transition right.
Of course, that has been a huge theme of media coverage of this particular letter, and even just a lot of buzz in general for a while now because Buffett, he's getting up there. We need to start thinking about these things, and people have been certainly thinking about them, if not over-thinking about them. What's your take on that?
Maxfield: To your point, this is an incredibly important thing. Being focused on banks in particular, one of the commonalities that I have seen at the best-run banks in the United States, over multiple decades, through multiple credit cycles, is a continuity of leadership.
That doesn't necessarily mean the same exact person over the whole time, but where you have the transition from one leader to another it's both a pleasant transition, and it's one that is done in a way that the underlying culture of the corporation can stay consistent, irrespective of who is at the top.
When you look at Berkshire Hathaway, this is as important as it is at a bank, if not more so, for this reason. When you think about how Berkshire is organized, its corporation, you have a tiny central office based in Omaha, Nebraska, that has all of 25 employees.
Meanwhile, it has this mass of subsidiaries in a variety of different businesses. They own multiple insurance companies in multiple areas of insurance -- reinsurance, casualty insurance, etc., etc. They own a huge railroad, BNSF. They own energy companies.
They own all of these different things, and the CEO at the top of Berkshire, i.e. Buffett, is responsible for keeping all of this together, but also for not interfering with how each of those underlying subsidiaries is run, because a big part of Berkshire's model is extreme decentralization, to where the CEOs of the subsidiaries can make the decisions on their own.
That next CEO at Berkshire is not only going to have to be able to step in and do the amazing job at allocating capital that Buffett has done, which is incredible, but they're also going to have to be able to step back and allow that extreme delegation model to play a role -- and when you look at a lot of imperial CEOs throughout large companies in the United States, that just isn't their style.
For Buffett and Munger, it was incredibly important that that next CEO come from within, so it's somebody who really grasps that aspect of Berkshire Hathaway.
Harjes: Absolutely. One statement along these lines that I found really interesting in this letter was Buffett's claim. I'm just going to read the sentence straight from the letter. "In certain important respects, this person," meaning the CEO that will succeed him, "will do a better job than I am doing." What do you think he meant by that?
Maxfield: I only wish I knew exactly what he meant! It is my guess that what he is referring to is the fact that Buffett himself is not so much of an operating manager. That's why this extreme delegation is such an important part of Berkshire Hathaway. It's basically a huge investment fund that its assets consist of, in addition to a large securities portfolio, a mass of subsidiaries.
It's my guess that when you look at the two people that he's pointed out as potential successors, they both run businesses within the Berkshire family. Again, I would hazard a guess what he is referring to -- and Munger makes the same insinuation in his addendum -- is that these guys have a lot of experience actually running business lines, as opposed to essentially dealing with capital allocation and handing off the authority to run everything to subsidiary CEOs.
Harjes: Right. I think another thing to add onto that is both of these letters reference the fact that there are so many systems in place at Berkshire to caution against any sort of disruptive potential for having a CEO that didn't live up to expectations, that even given all this hype, and certainly the true fact that there is importance about who the next CEO is, this business is not in danger.
For example, one of the mechanisms that was brought up in the letter was Buffett's plan for his son to end up being a non-executive chairman, after Buffett. The son is not going to be the CEO, but he's going to be the Chairman. This is a very interesting setup. Would you agree?
Maxfield: It certainly is. Basically, the role that Howard Buffett will play, according to Warren Buffett, is that he will be the keeper of the culture. I found this interesting because, to relate it back to banks, that is basically the same thing that John Stumpf, who is the CEO of Wells Fargo (WFC +0.63%), said about his role at Wells Fargo.
One of the things that we know about banking and, in large part, insurance -- and of course investing in a securities portfolio -- is that you've got to maintain an incredible level of discipline through various cycles; credit cycles, insurance cycles, and all those various things.
That ability is a cultural ability, so in order for a company like Berkshire to do well, you've got to have somebody who's kind of responsible for that. Until now, it's been Warren Buffett himself, but later on down the road he's trying to layer in some additional protections for the culture specifically, by putting his son, Howard Buffett, in the non-executive chairmanship.
Harjes: I think that's a pretty smart idea, in my own opinion.
Maxfield: I agree with that, wholeheartedly. Let me say one other thing. This strikes me every year as I read Buffett's letters, and I've gone back in history and read all of them.
It is the fact that, when you look at a company like Berkshire Hathaway and how it's run, and you compare it to all of these other major corporations, what you see is that it is indeed possible to run an extremely shareholder-friendly company, that is also extraordinarily successful.
One of the things that we run into nowadays is that these CEOs and these board members with these companies just get paid so much money to do what they're doing, that it's almost like that notion of a fiduciary duty, to where they have to put their shareholders' interests above their own, has completely gone by the wayside.
But at Berkshire Hathaway, it most certainly hasn't. On top of that, Berkshire Hathaway's wealth has been built on investing in companies that act in the same way. It's just a reminder that shareholders, despite all the noise out there, really should try to focus on not settling for a second-rate or third-rate company when they're making investment decisions.
Harjes: Absolutely. That's something that Buffett touches on a little bit toward the very end of his letter, talking about Berkshire shareholders and how unique they are. Do you want to talk a little bit about the issue that he brought up from last year's annual meeting, the proxy resolution?
Maxfield: Sure. Last year, some shareholder who evidently didn't attend the meeting submitted for proxy vote that he would like Berkshire to pay a dividend because not all the shareholders at Berkshire are billionaires, like Warren Buffett was.
I can't remember off the top of my head the exact percentages -- and Berkshire's corporate board did nothing to lobby on behalf of not issuing a dividend or anything like that -- but the shareholders voted something like 98% or 94% against forcing the Berkshire board to pay a dividend.
What that shows is a considerable amount of trust and respect in, and for, the decisions that Buffett makes on behalf of shareholders, with those retained earnings that he then uses and allocates.
Basically, shareholders are telling Buffett, "Look, we would rather you keep our money than we keep it." That's a big compliment to a CEO. But of course, Warren Buffett is probably the best investor ... perhaps the best investor of all time, anywhere.
Harjes: Right. That is just an incredible vote of confidence in him. The number that you threw out there, 98%, that's spot on. With the A shares, the vote was decided no on the dividend; a margin of 89-1 I've got. Then the B shareholders were 47-1, so simply overwhelming majority there.
I think that's a really incredible thing, that shows how much confidence people have in the philosophy of Berkshire, and in Buffett himself, and in all the systems that he has set up there.
Maxfield: Along the same lines as the dividend ... with the dividend, you're talking about a capital allocation decision. One of our CEOs, Tom Gardner's, favorite books is called The Outsiders, and it talks about these eight different CEOs who are, among other things, extremely good at profitably allocating capital.
You can do that in a number of different ways, but the two primary ways, once that capital has come in ... I guess there are three ways. You can retain it and then reinvest it in the business. You can distribute it via dividends, or you can buy back stock.
One of the things that we've seen with Berkshire, and this is one of the reasons it's been able to compound at such an incredible rate over the years or over the decades, is that it has not, number one, distributed the money to its shareholders. Number two, in those few instances in which it has bought back its shares, it has only done so at a measure that Buffett perceives it to be below the intrinsic book value.
You look around at corporations today, and companies just as a matter of their regular course of operations buy back billions of dollars of their own shares of common stock, irrespective of price. If you pay too much for your common stock, you are destroying value.
I think it's something like if you pay more than 1 plus your return on equity, you are by definition destroying value -- and that is the standard operating procedure at, I don't know, maybe 9 out of 10 companies in the S&P 500 today. Berkshire Hathaway is not one of those.
Harjes: Right, and Buffett does talk about that strategy going forward, and whether that will continue to be the case. It seems like he does hint that it's possible that a dividend could be in the future, if it makes sense, but he's not trying to say "Yes, this is definitely coming our way. The tides have changed."
He basically just lays out that the management's decisions will be the right ones. He's so confident in that, whether that is buying back shares at well below intrinsic business value, or if it might be the time to distribute these excess earnings as a dividend.
One interesting point there is that this change could happen simply because of the implications of Berkshire's size. That's, going forward, what's going to make the next 50 years so different from the previous 50.
Maxfield: Yes, that's exactly right. At this point, I don't know what Berkshire's market cap is, but it's many hundreds of billions of dollars. Even if it increased in size by $5 billion a year, or what would otherwise be an enormous amount, on a percentage basis just because Berkshire has gotten so big, to your point, it's going to be much smaller.
The larger a company gets, just by definition, the fewer great uses of those retained earnings you're going to be able to find.
What Buffett is saying is, "Look. There will come a point where we have too much cash, that we can profitably employ at a rate of return, that we think justifies keeping the money as opposed to returning it to shareholders in some way, shape, or form."
Now I would say that it seemed to me he placed that timeframe probably outside of the point at which he will be managing the company anymore. You can correct me if I'm wrong, but I think he said it's 10 or 20 years out in the future, which would put him in the mid to late 90s -- which, I hope he's still running Berkshire, but certainly I would think that the odds are against that.
Harjes: Of course! Before we wrap up, I'm just going to ask you if there are any other points that we can take out of these letters and really highlight? What's another big thing in here that we'd be remiss not to talk about?
Maxfield: There's a menu of incredible insights.
Harjes: Yes, I'm sure we could talk for 20 minutes about any of these sentences in here, alone!
Maxfield: Yes. The one thing that, to any serious investor or anybody who's interested in Warren Buffett that's listening to this, the one thing that I would say is, reading what Buffett writes in his shareholder letters, which are all available on Berkshire's website, is probably the single best education -- and it's free -- that you can give yourself when it comes to investing.
By the time these letters are broken down and talked about and written about and analyzed by analysts and commentators, it's kind of like the game of Telephone, where the actual message that Buffett is trying to get across, and the context in which he's talking about it, are diluted.
Any investor that is interested in both protecting the money that he or she has made, and growing it over the long term, probably the most valuable way to spend that time is just to sit down and maybe once a week, once a month, whatever it is, just slowly churn through Buffett's letters.
It will just teach you the importance of discipline and the importance of, when you are investing your hard-earned money, the importance of not settling with people you wouldn't trust to, let's say house-sit over the weekend while you're on vacation.
Harjes: That's awesome advice. I love the Telephone analogy in there. That was very Buffett-like! Thank you so much for all of the great insights today. We will see you next week. For now, this is Kristine Harjes. Have a great week, everyone!
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