Berkshire Hathaway | Owner’s Manual part 4

Owner-related business principles cont’d

14. To the extent possible, we would like each Berkshire shareholder to record a gain or loss in market value during his period of ownership that is proportional to the gain or loss in per-share intrinsic value recorded by the company during that holding period. For this to come about, the relationship between the intrinsic value and the market price of a Berkshire share would need to remain constant, and by our preferences at 1-to-1. As that implies, we would rather see Berkshire’s stock price at a fair level than a high level. Obviously, Charlie and I can’t control Berkshire’s price. But by our policies and communications, we can encourage informed, rational behavior by owners that, in turn, will tend to produce a stock price that is also rational. Our it’s-as-bad-to-be-overvalued-as-to-be-undervalued approach may disappoint some shareholders. We believe, however, that it affords Berkshire the best prospect of attracting long-term investors who seek to profit from the progress of the company rather than from the investment mistakes of their partners.

I really believe that Berkshire is for long-term investors, and as Warren Buffett says, his communication and policies do indicate that philosophy. A philosophy of not splitting the stock, or making investments that are beneficial over the long-run all dictate this underlying philosophy. Even today, investors are doubting the decisions made by Warren Buffett, but they fail to realize one thing, he is a man of integrity that will take this company even further. Just wait and see.

15. We regularly compare the gain in Berkshire’s per-share book value to the performance of the S&P 500. Over time, we hope to outpace this yardstick. Otherwise, why do our investors need us? The measurement, however, has certain shortcomings that are described in the next section. Moreover, it now is less meaningful on a year-to-year basis than was formerly the case. That is because our equity holdings, whose value tends to move with the S&P 500, are a far smaller portion of our net worth than they were in earlier years. Additionally, gains in the S&P stocks are counted in full in calculating that index, whereas gains in Berkshire’s equity holdings are counted at 65% because of the federal tax we incur. We, therefore, expect to outperform the S&P in lackluster years for the stock market and underperform when the market has a strong year.

Bruce Berkowitz took Warren Buffett’s advice and sold off shares of Berkshire because he believes he can find bargains in today’s environment where he could earn a better return. I think however, because of Berkshire’s sheer size, it would be difficult to earn a high return as well, however, this environment offered so many opportunities, I believe he can earn a significant return for his long-term investors as well. I feel honored to have bought shares during his tenure. It is my intention to hold forever.

This is the end of the principles within the Owner’s Manual. The next section would be a discussion of his definition of INTRINSIC VALUE. Stay tuned.!!

Related Links:
Berkshire Hathaway | Owner’s Manual Part 3
Berkshire Hathaway | Owner’s Manual Part 2
Berkshire Hathaway | Owner’s Manual Part 1

Berkshire Hathaway | Owner's manual Pt. 2

Owner-related business principles cont'd.

5. Because of our two-pronged approach to business ownership and because of the 
limitations of conventional accounting, consolidated reported earnings may reveal relatively little about our true economic performance. Charlie and I, both as owners and managers, virtually ignore such consolidated numbers. However, we will also report to you the earnings of each major business we control, numbers we consider of great importance. These figures, along with other information we will supply about the individual businesses, should generally aid you in making judgments about them.

Warren Buffett and Charlie Munger are very knowledgeable about accounting and its limitations in presenting the best performance of companies consolidated on Berkshire's financial statements. They analyze each business and the environment that they operate in and relay their conclusions to their shareholders. They basically assist shareholders in making well-informed decisions about the operating businesses of Berkshire Hathaway. They are very honest with their evaluations as can be seen in the Chairman's letters; when businesses do well, they acknowledge that and when businesses perform below expectations, they are not shy about stating those facts either. You cannot put enough value on honest management, especially today.

 

6. Accounting consequences do not influence our operating or capital-allocation decisions. When acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under standard accounting principles than to purchase $1 of earnings that is reportable. This is precisely the choice that often faces us since entire businesses (whose earnings will be fully reportable) frequently sell for double the pro-rata price of small portions (whose earnings will be largely unreportable). In aggregate and over time, we expect the unreported earnings to be fully reflected in our intrinsic business value through capital gains.

It is obvious that Warren Buffett takes does not focus totally on reportable numbers that appear of financial statements (using GAAP standards), but puts more emphasis on the true earnings of a company because he knows that eventually, it will be reflected in the intrinsic value of the business. It is important to buy businesses that are of greater overall value based on actual earnings and not reportable earnings; the rest will take care of itself. He also understands that there are many ways undistributed earnings can be allocated within the company that will add value to the underlying business such as repurchasing shares or reinvesting in the business. He believes these to be alternatives that should be considered as effective use of capital at certain times.

 

7. We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long-term fixed-rate basis. We will reject interesting opportunities rather than over-leverage our balance sheet. This conservatism has penalized our results but it is the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders, lenders and the many equity holders who have committed unusually large portions of their net worth to our care. (As one of the Indianapolis “500” winners said: “To finish first, you must first finish.”)

Berkshire's management does not believe in having a lot of leverage and because of the nature of the businesses they own, they generate a lot of cash (from insurance businesses) that can be used for investments and financing purchases. This cash is referred to as float and it is free once Berkshire's insurance operations break even. A no debt structure, even though, may prevent them from making huge investments that will increase returns, allows Buffett and Munger to sleep well at night because they have nothing to worry about when it comes to debt maturity dates and such. In this current turbulent times, the $40 billion in cash he has available is serving us shareholders very well. In several years, I assure you the economic value of the business will be greatly improved.

 

8. A managerial “wish list” will not be filled at shareholder expense. We will not diversify by purchasing entire businesses at control prices that ignore long-term economic consequences to our shareholders. We will only do with your money what we would do with our own, weighing fully the values you can obtain by diversifying your own portfolios through direct purchases in the stock market.

Buffett and Munger are the most shareholder-friendly managers you can find in business today. All the purchases they make are done with the intentions of improve Berkshire's per-share intrinsic value. Once you read this document, you will see that this should serve as a model of corporate governance for all companies.

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