Warren E. Buffett, Berkshire's Chairman, issued what he calls "An Owner's Manual" to the shareholders of Berkshire Hathaway in 1996. This booklet contains 13 economic principles to assist new shareholders to clearly understand the way Berkshire is run. Many corporations lay out corporate governance guidelines for their owners, but none has been down in a very simplified and conversational way, as Warren Buffett is typically known for. This would be a great way for new investors to learn what one should look for in great management and also understand the way Buffett thinks as well.
The owner's manual series will be divided into 3 parts. We will first concentrate on the first 3 principles of the manual in this posting and highlight key points that should be noted.
Owner-Related Business Principles
1. Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as owner-partners, and of ourselves as managing partners. (Because of the size of our shareholdings we are also, for better or worse, controlling partners.) We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets.
i. Mr. Buffett and Mr. Munger both view shareholders as owner-partners. Warren Buffett truly emphasizes the importance management plays in his decisions to buy into businesses. He is no different and truly sets that example. They fully grasp and respect that shareholders are owners of public corporations and that their decisions should be based on what is ultimately best for the shareholders and disregard personal interests.
ii. They both are highly invested in the company. They both have the majority of their net worth in Berkshire stock and is therefore, as Mr. Buffett would say, "eating their own cooking." This is an important point to consider when looking at investments. What percentage of the stock does management own? Are their interests aligned with that of the shareholders? Well, a great way to tell is if they own their own company's stock.
iii. The corporate entity does not own the business. Legally, the creation of a corporation frees management from liability. However, what Mr. Buffett is indicating in this first principle is that they view the company merely as a vehicle through which shareholders own the assets of the business. This first point alone says a lot of the management of Berkshire Hathaway and as soon as you are able to find management in other companies that exhibit the same qualities in a great business, you know that this is a company that you should look into further and buy and hold on forever. Such companies are hard to find; such management are even more rare. What he expects of shareholders as well is that they view themselves as owners that are in it for the long haul. He invests with a long term horizon and would like his shareholders to have that time horizon as well; therefore they should be willing to own the stock for the rest of their lives.
2. In line with Berkshire’s owner-orientation, most of our directors have a major portion of their net worth invested in the company. We eat our own cooking.
Charlie Munger's family has 90% or more of its net worth in Berkshire shares.
Warren Buffett has about 99%. His relatives also keep a large portion of their net worth
in Berkshire stock as well.
He continues to explain under this second principle that Berkshire Hathaway is a diversified group of quality business, and even though they are unable to guarantee results, they will make money when their shareholders make money and also lose money when their shareholders lose money.
3. Our long-term economic goal (subject to some qualifications mentioned later) is to maximize Berkshire’s average annual rate of gain in intrinsic business value on a per-share basis. We do not measure the economic significance or performance of Berkshire by its size; we measure by per-share progress. We are certain that the rate of per-share progress will diminish in the future — a greatly enlarged capital base will see to that. But we will be disappointed if our rate does not exceed that of the average large American corporation.
The important point to understand from this third principle is that the management of Berkshire is focused on per-share intrinsic business value gains.
Also, Mr. Buffett has been telling his shareholders for a long time that this rate of gain will decrease as the amount of capital they have to work with increases. They will have to find larger investment opportunities that will have a significant impact on the intrinsic business value.
4. Our preference would be to reach our goal by directly owning a diversified group of businesses that generate cash and consistently earn above-average returns on capital. Our second choice is to own parts of similar businesses, attained primarily through purchases of marketable common stocks by our insurance subsidiaries. The price and availability of businesses and the need for insurance capital determine any given year’s capital allocation.
Warren Buffett not only owns great businesses, but also owns percentages of great businesses as well. He mentions in the commentary following the fourth principle that the difficulty arises when they have too much cash on hand and not many great investment opportunities. However, he reassures us that a depressed market, [like today], provides great opportunities to buy entire businesses, or add to the ownership of the great businesses as well. These companies also repurchase their own stock in depressed markets as well, so the shareholders benefit even more.
For the detailed reading of The Owner's Manual, please refer to Berkshire's Hathaway's website.Related Links:
Berkshire Hathaway | Owner’s Manual Part 4
Berkshire Hathaway | Owner’s Manual Part 3
Berkshire Hathaway | Owner’s Manual Part 2
Berkshire Hathaway | Owner’s Manual Part 1