If you've ever glanced at one of Warren Buffett's annual letters to shareholders, then you probably have at least a rough idea of how incredibly successful Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) has been with the 84-year-old billionaire at the helm.
In the five decades that he has led the company, its book value per share has increased by an incredible 751,113% compared with the S&P 500's 11,196%. And that dramatically understates the actual return to shareholders, who have seen the per-share market value of Berkshire's stock soar by 1.8 million percent since 1965.
How did the once ailing textile company accomplish this? According to its vice chairman, Charlie Munger, who wrote an addendum to this year's letter, there are four reasons:
- The constructive peculiarities of Buffett,
- The constructive peculiarities of the Berkshire system,
- Good luck, and
- The unusually intense, contagious devotion of some shareholders and other admirers, including some in the press.
Berkshire's constructive peculiarities
While most people think of Berkshire as a massive and widely diversified financial and industrial conglomerate, it's important not to lose sight of its consciously designed corporate structure. The $360 billion behemoth is run from a mere 25-person headquarters based in Omaha, Neb. It's there where Buffett sits in state, reads, thinks, and strategizes about his next acquisition target.
The advantages this bestows can't be overstated. By necessity, the Berkshire system requires that the CEOs of its growing stable of subsidiaries operate with "extreme autonomy." This not only allows Buffett to focus on his core competency of allocating capital, but also makes Berkshire a magnet for owners of acquisition targets who want to monetize their investments without sacrificing operational control.
In this way, Berkshire is one of a kind. The closest analogy is to a private-equity company. But private-equity companies aren't interested in permanent value. They aren't interested in bolstering the strength of their acquisition targets. They're focused instead on extracting value quickly, efficiently, and without sentiment. They meddle in operations. They slash and burn expenses. And, in the process of extracting value from their unwitting targets, they saddle their portfolio companies with an unconscionable amount of debt that all but guarantees eventual demise.
The point is that Berkshire fills a void in the capital markets, where the owners of whole businesses, and in many cases large businesses, can conscientiously hand over their life's work without fear that it will be ravaged and cast aside by financial raiders -- or, in Buffett's estimation, porn shop operators.
"You can sell [your business] to Berkshire, and we'll put it in the Metropolitan Museum; it'll have a wing all by itself; it'll be there forever,'' Buffett said at Berkshire's 2008 annual meeting. "Or you can sell it to some porn shop operator, and he'll take the painting and he'll make the boobs a little bigger and he'll stick it up in the window, and some other guy will come along in a raincoat, and he'll buy it.''
This goes a long way toward explaining why Buffett has been able to acquire phenomenally profitable and well-run companies such as Nebraska Furniture Mart and Borsheims Fine Jewelry, among countless others. But, to Munger's point, this explains only half the story. The other half concerns the "constructive peculiarities" of Buffett himself -- to say nothing, of course, of the subordinate role played by luck and the devotion of shareholders and "other admirers."
Buffett's constructive peculiarities
Buffett is one of a small handful of individuals in this world who have the temperament, intelligence, confidence, drive, and interest in investing that have made Berkshire's extraordinary success possible.
For much of his career, moreover, Buffett's now-proven strategy of exploiting the market's irrationality was all but dismissed by the financial mainstream, who were slavishly enamored of the idea that markets behaved rationally and efficiently everywhere and at all times. One can't help but conclude that this now-discredited theory kept potential competitors at bay for decades as academics chalked Buffett's performance up to luck, not skill.
This isn't to say that Berkshire's success stems from the naivete of others. Indeed, Buffett's rare combination of talents most certainly played the leading role in his company's ascent.
He learned early on from his mentor Benjamin Graham that most investors invert the concept of risk. Most investors see stocks as safe when the economy is roaring and equity prices are soaring. The idea that others are getting rich fuels our greed and incites us to buy into the mania, only to then stampede toward the exits when the market invariably crashes, making stocks, in the average investor's estimation, risky.
Buffett turned this on its head. The key to investing, he said, is "being fearful when others are greedy and greedy when others are fearful." Perhaps no single phrase or string of words better encapsulates Buffett's, and therefore Berkshire's, success over the past five decades.
The examples of Buffett eating his own cooking, so to speak, are legion. He invested in American Express in the mid-1960s when the payments company was engulfed in the now-long-forgotten salad oil scandal. He bought Wells Fargo when Wall Street analysts were predicting the bank's demise due to an acute downturn in California real estate. And he served as a "first responder" during the financial crisis of 2008-2009. All told, Berkshire dispensed $15.6 billion in cash to the likes of General Electric, Goldman Sachs, and Bank of America at the nadir of their respective crises.
At the end of the day, the honest observer can do little but stand in awe of Buffett's accomplishments. He secured his place in the pantheon of American business years ago, alongside the likes of Cornelius Vanderbilt, Andrew Carnegie, John D. Rockefeller, J.P. Morgan, and Henry Ford. He did it not by inventing a product, but by happening upon a void in our capitalist system that was invisible to others. And despite his penchant for Coca-Cola and fried food, he purports to have many more years left in him. I, for one, hope he's right.