'Trigger finger is itchy,' Buffett says

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If you want to read Warren Buffett's letter to shareholders of Berkshire Hathaway, this link will take you to it.

Also, you can replay staff writer Steve Jordon's chat about the letter.

By Steve Jordon
WORLD-HERALD STAFF WRITER

Warren Buffett celebrated a successful railroad purchase, big insurance gains and an optimistic view of his country and his company in his 2010 letter to shareholders.

Buffett pronounced the purchase a year ago of Burlington Northern Santa Fe Railroad a success beyond his expectations and predicted above-average but not spectacular growth for Berkshire Hathaway Inc., the Omaha-based company he heads.

Despite the fact that the future is always uncertain, he said, “Don't let that reality spook you.”

In the letter he posted Saturday online and will mail to shareholders in March, Buffett expressed optimism about the future.

“Human potential is far from exhausted, and the American system for unleashing that potential . . . remains alive and effective,” Buffett wrote. “America's best days lie ahead.”

He also expressed optimism about Berkshire's future, indicating he was on the hunt for big investments to add to Berkshire's holdings, which include furniture, jewelry and clothing firms, insurance and utility businesses, and major investments in such companies as Coca-Cola and Wells Fargo.

Buying and owning good businesses is Berkshire's main objective, and the company has $38 billion in cash.

To make decent profits, Buffett wrote, “We will need both good performance from our current businesses and more major acquisitions. We're prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.”

Buffett uses his annual letter as Berkshire chairman to pass on wisdom to shareholders, explaining how Berkshire has done in the past, how he makes decisions and what the future may hold. Non-shareholders also read the letter for clues on subjects ranging from stock-buying to personal planning.

One of those observers is Alice Schroeder, a former insurance analyst and journalist from Connecticut who spent more than five years writing a biography of Buffett. She said this year's letter has something new: His description of how Berkshire would do in a “normal” year.

“He's saying the stock's undervalued, and he's giving people clues as to how to think about what the earnings of Berkshire would be under normal interest rates and normal conditions,” she said. “He hasn't done that before.”

Buffett's letter doesn't say what the price of Berkshire's stock should be. But Schroeder said that if Berkshire's Class A shares were trading at levels of five years ago in relation to its finances, they would be worth $30,000 more than the current $127,550 price.

“Berkshire is getting more valuable,” she said.

Schroeder said the letter also points out that Berkshire's companies generate $1 billion in cash each month, a “staggering” flow of money that has become a new pillar of its financial strength. “That's an astonishing statistic,” she said, a cash flow that few companies can match.

Berkshire's future value will depend in part on how that money is put to use, she said.

George Morgan, a former stockbroker who now teaches at the University of Nebraska at Omaha, said the report shows that Buffett has structured Berkshire so it avoids the worst problems when the economy turns down. “But at the same time it doesn't allow you to be the huge winner on the upside,” Morgan said.

Based on the scale that Buffett himself sets up for his company's performance, 2010 by itself was not an exceptional year.

Berkshire's book value gained 13 percent during 2010, below its annual average of 20.1 percent and below the 15.1 percent gain by the Standard & Poor's Index of 500 stocks, counting the dividends paid by those companies.
That made 2010 the eighth year out of the past 46 that the S&P did better, including five of the past 12.

Buffett said Berkshire's performance — once regularly far ahead of the overall stock market — is now “only satisfactory. The bountiful years, we want to emphasize, will never return.”

He, as in the past, pointed out that as Berkshire grows larger each year, it's increasingly difficult to boost its value by a large percentage.

“The huge sums of capital we currently manage eliminate any chance of exceptional performance,” he wrote, but above-average performance still is possible over an extended period and something he will strive for.

“We . . . feel it is fair for you to hold us to that standard.”

For the first time, the report included a chart that listed the average annual performances of Berkshire and the S&P index calculated for five-year periods — 1965-69, 1966-70, 1967-71, and so forth.

For each of those five-year periods, Berkshire outperformed the S&P, including a 7.7 percentage point advantage from 2006 to 2010.

“The pace of the earth's movement around the sun is not synchronized with the time required for either investment ideas or operating decisions to bear fruit,” Buffett said.

Berkshire's net income for 2010 was $12.97 billion, or $7,928 per share, on revenue of $136.2 billion. Net income was up 61 percent from 2009, and revenue was up 21 percent, in part because of Burlington Northern's $17 billion in revenue and $2.5 billion profit.

Buffett said, however, that net income is “almost always meaningless at Berkshire” because the company's investment portfolio contains billions of dollars that could be counted toward net income if he wanted to sell stock and pump up quarterly or annual numbers.

“Rest assured, though, that Charlie and I have never sold a security because of the effect a sale would have on the net income we were soon to report,” he wrote.

“Operating earnings, despite having some shortcomings, are in general a reasonable guide as to how our businesses are doing. Ignore our net income figure, however. Regulations require that we report it to you. But if you find reporters focusing on it, that will speak more to their performance than ours.”

Berkshire's net income minus after-tax gains from investments and derivatives totaled $11.1 billion in 2010, an increase of 47 percent from 2009.

Among highlights of Buffett's letter this year:

• He expects the national housing market to begin turning around in a year or so. The housing-related businesses within Berkshire, such as brick and lumber makers, have lost 9,400 employees since 2006. Still, a housing recovery is certain and, in anticipation, Berkshire's housing-related companies are making further investments — Johns Manville, for example, is building a $55 million roofing membrane plant in Ohio, and Shaw Industries will spend $200 million on its U.S. carpet factories during 2011.

• Berkshire invested $11 million in Goldman Sachs, General Electric and Swiss Reinsurance during the 2008-2009 financial crisis, receiving preferred stock that paid a high dividend. Swiss Re has repaid the money, and the two others also will pay it back, along with a $1.4 billion premium for early payment. The repayments will reduce Berkshire's future earnings, but Buffett expects that dividends paid on other stock that Berkshire owns “almost certainly” will increase.

• Owning the Burlington Northern Santa Fe railroad increases Berkshire's earning power by more than 30 percent in a normal year, and Berkshire already has replenished the $22 billion in cash it spent to buy the railroad.

• Berkshire has no institutional restraints and can invest in virtually anything that it chooses — “We are able to compare any one opportunity against a host of others” — an advantage over other businesses that has become a key component of its culture, overseen by Buffett and Berkshire Vice Chairman Charlie Munger. “This culture,” Buffett said, “grows stronger every year, and it will remain intact long after Charlie and I have left the scene.”

• Berkshire's succession plan is on track, but Buffett did not disclose the name of his successor as CEO.

The letter also includes its share of Buffett quips.

He quoted one investor as saying during the 2009 drop in stock market prices, “This is worse than divorce. I've lost half my net worth — and I still have my wife.”

Buffett said he hopes to land a big purchase someday soon and is getting impatient. “To update Aesop, a girl in a convertible is worth five in the phone book.”

Discussing corporate imperiousness, he quoted a humorist as saying, “You know you're no longer CEO when you get in the back seat of your car and it doesn't move.”

Buffett said his 1965 purchase of Berkshire Hathaway, then a New England-based textile business,was a mistake.

“The dumbest thing I could have done was to pursue ‘opportunities' to improve and expand the existing textile operation — so for years that's exactly what I did,” he said. “And then, in a final burst of brilliance, I went out and bought another textile company. Aaaaaaargh!

“Eventually I came to my senses, heading first into insurance and then into other industries.”

Getting into the railroad business, he said, was a good move, and he's enthusiastic about the future.

“Over time the movement of goods in the United States will increase, and BNSF should get its full share of the gain,” Buffett wrote.

He acknowledged that the railroad will need to “invest massively” to bring about this growth. Owning a railroad, he said, is “a huge responsibility,” with an obligation to constantly maintain and improve 23,000 miles of track along with its ancillary bridges, tunnels, engines and cars.

But he said no one is better situated than Berkshire to provide the funds.
“Last year — in the face of widespread pessimism about our economy — we demonstrated our enthusiasm for capital investment at Berkshire by spending $6 billion on property and equipment,” Buffett wrote. “Of this amount, $5.4 billion — or 90 percent of the total — was spent in the United States.

“Certainly our businesses will expand abroad in the future, but an overwhelming part of their future investments will be at home. In 2011, we will set a new record for capital spending — $8 billion — and spend all of the $2 billion increase in the United States.”

Buffett warned against too much debt. Most businesses assume that they can refinance debt when it comes due, he said.

“Occasionally, though, either because of company-specific problems or a worldwide shortage of credit, maturities must actually be met by payment. For that, only cash will do the job.

“Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that's all that is noticed.

“Even a short absence of credit can bring a company to its knees. In September 2008, in fact, its overnight disappearance in many sectors of the economy came dangerously close to bringing our entire country to its knees.”

Buffett said Berkshire, meanwhile, keeps ready cash on hand not only to buy other businesses but also in case of unexpected problems.

Berkshire has 68 non-insurance businesses, offering a wide range of products and services from candy to aircraft. Each company can stand on its own, headed by a top manager, which Buffett said lets him consider any sort of business investment. Most companies concentrate on one industry because their management must run the business.

A company that is limited to investments in a single industry runs into too much competition for good deals, he said.

“The seller has the upper hand, as a girl might if she were the only female at a party attended by many boys,” he said. “That lopsided situation would be great for the girl, but terrible for the boys.”

Buffett gave an update on Berkshire's investment in derivatives, which are mostly contracts signed with other parties who want insurance-like protection. His derivatives have drawn some criticism because of the role that other derivatives played in the collapse of the housing market and other financial problems in 2008-09.

But Buffett said Berkshire's derivatives still are doing well and stand to earn the company a profit over time, a position he has maintained consistently. The contracts also gave Berkshire billions of dollars upfront in premiums that it can use for other investments while the contracts are in effect.

Buffett said he personally manages Berkshire's 203 derivative contracts. One group of contracts insures against bond defaults and is “almost certain” to earn a profit, he said. The other, which insures against a drop in stock market prices, also looks like it will be profitable, he said, but is “far from a sure thing.”

Berkshire gained about 3,000 employees during 2010 and now has about 260,500 employees in its companies. Burlington Northern gained about 3,000 workers for a total of 38,000 and Fruit of the Loom gained 3,000 to put it at 30,000. Clayton Homes, which manufactures and finances houses, dropped 2,000 to 10,400.

Berkshire's corporate staff stayed steady at 21 people.

Contact the writer:
402-444-1080, steve.jordon@owh.com
twitter.com/buffettOWH

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