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Berkshire Hathaway Inc.’s “rock-solid foundation” will keep the company going strong over the next 50 years, Warren Buffett said Saturday, adding that its major businesses will be vital to the American economy “a century hence.”
But he projected only above-average financial results, saying the big percentage gains in his investment company’s earlier years are no longer possible. “The numbers have become too big.”
Buffett’s longtime business partner, Charlie Munger, said in a rare written report that Berkshire Hathaway Inc., the company that the two men oversee, has momentum and opportunity to last “a very long time,” even if Buffett left tomorrow. He said “the Berkshire system” could be a model for other businesses if their managers would follow Buffett’s example.
Their viewpoints came in the 50th letter to Berkshire shareholders by Buffett, chairman and CEO, posted early Saturday on the Omaha-based conglomerate’s website as part of the company’s annual report.
The 43-page letter, expanded from last year’s 24 pages, included the essays on Berkshire’s past, present and future, 7½ pages by Buffett and 4½ pages by Munger, part of Berkshire’s 142-page annual report on 2014.
For shareholders or would-be shareholders wondering about Berkshire’s future and the two aging overseers — Buffett is 84 and Munger is 91 — this year’s letter lays out a reassuring argument that they have constructed a financial juggernaut that won’t be halted by mere human mortality.
Munger wrote that Berkshire’s “abnormally good results would continue if Buffett were soon to depart” because its subsidiaries have “much business momentum grounded in much durable competitive advantage.” That’s true even if Buffett’s successors have “only moderate ability,” he wrote.
But Berkshire’s next CEO will be more than that, Munger said, citing Berkshire insurance chief Ajit Jain and Berkshire Energy CEO Greg Abel as two executives who “are proven performers who would probably be underdescribed as ‘world-class.’ ”
Munger’s listing the two by name raised speculation that Jain and Abel are the most likely people to be named CEO if necessary today. The fact that Matt Rose, executive chairman of BNSF Railway, is not mentioned in the report and that Buffett pointed out the railroad’s problems also brought some attention.
“Buffett’s explicit criticism of BNSF raises the question about its CEO, Matt Rose,” said David Kass, a business professor at the University of Maryland. “It cannot be considered a positive note for Rose’s chances.”
Buffett continued his policy of not naming the person whom Berkshire’s directors have in mind as his successor, saying only that the next CEO is “ready to assume the job the day after I die or step down. In certain important respects, this person will do a better job than I am doing.”
Barclays PLC analyst Jay Gelb said Jain and Abel might be candidates for CEO, but Buffett’s emphasis on having a young CEO succeed him might rule them out, soon if not now. Jain is 63 and Abel is 52.
Whomever the next CEO will be, Saturday’s letter gives investors details about why Buffett and Munger are confident of Berkshire’s continued success. Now the fourth-largest corporation in the United States, Berkshire’s stock price has increased an average of 19.4 percent a year over those 50 years, more than twice as fast as the rest of the stock market.
Laura Rittenhouse, a management consultant who has written books about Berkshire, said the letter
“really speaks to a lot of the skepticism that investors inside and outside of Berkshire might have about what the future would look like without Buffett. I think they hit those questions head-on.”
Berkshire’s advantages include the ability to move money among businesses according to their capital needs and relying on managers to run the Berkshire-owned businesses, and that won’t change when CEOs change, she said.
“They make the most compelling case and tell the story of a business model that is unique and, surprisingly, is not emulated by other companies, and yet has had the longest and most successful financial results of any large corporation,” Rittenhouse said. “Buffett and Munger together have been steadfast throughout the years in making sure that they earn the trust of their investors.
“Why more businesses don’t adopt this system — that’s a terrific question.”
Munger said other corporations would benefit from Berkshire’s avoidance of bureaucracy and reliance on “one thoughtful leader for a long, long time as he kept improving and brought in more people like himself.”
“I believe that versions of the Berkshire system should be tried more often elsewhere and that the worst attributes of bureaucracy should much more often be treated like the cancers they so much resemble,” Munger wrote.
Buffett wrote that in 10 or 20 years, Berkshire might pay its first dividend if its managers aren’t able to find companies to purchase or other ways to use money that continues to accumulate. Berkshire companies generate about $2.7 billion in cash per month, and the company has about $60 billion in cash.
Buffett and Munger said Berkshire’s conglomerate model — a large corporation with widely diverse holdings rather than being focused on a single industry — will work well in the future because Berkshire gives business managers the freedom to run their businesses as if they were independent.
Moving money as needed among businesses also gives Berkshire a cost advantage, Buffett said. Profits from insurance can be used to expand railroad operations, for example.
“If the conglomerate form is used judiciously, it is an ideal structure for maximizing long-term capital growth,” Buffett wrote. Berkshire is “perfectly positioned to allocate capital rationally and at minimal cost. Of course, form itself is no guarantee of success: We have made plenty of mistakes, and we will make more. Our structural advantages, however, are formidable.”
Berkshire had an 8.3 percent gain in book value during 2014, less than the 13.7 percent gain in the Standard & Poor’s 500 with dividends included. That’s the fifth time in the past six years that Buffett’s long-standing measurement of growth has lagged the S&P, a broad measure of the overall stock market’s progress.
For 2014, Buffett added a new calculation of Berkshire’s year-by-year performance: the percentage gain in market value of Berkshire shares. By that measurement, Berkshire gained 27 percent in 2014, the best performance relative to the S&P since 2007. Berkshire has done better than the stock market in five of the past seven years as measured by market value of its shares.
Buffett said in the letter that he added the market value figures because an increasing amount of Berkshire’s value is within the companies that it owns, which isn’t reflected in book value, an accounting calculation of the company’s worth. That means Berkshire’s true value — which Buffett calls “intrinsic value” — is becoming much greater than its book value and closer to the market value determined by its share price.
Berkshire’s market value, the report said, has gained 1,826,163 percent since 1965, while the S&P 500 has gained 11,196 percent and Berkshire’s book value gained 751,113 percent during that 50-year period.
Robert Miles, who has written books about Buffett and teaches a class at the University of Nebraska at Omaha on Buffett, said he was surprised at Buffett’s use of Berkshire’s stock market value to compare its performance with the overall stock market.
“He’s stayed away from it because everyone else measures (success) by market price,” Miles said. Citing the stock price seemed “too much like Wall Street, worrying about the last quarter. It’s so un-Berkshirelike.”
In the letter, Buffett warned investors that buying Berkshire stock at a high price, with borrowed money or with the intention of selling it quickly, can turn out badly.
Berkshire’s stock price has fallen about 50 percent three times since 1965, Buffett said. “Someday, something close to this kind of drop will happen again, and no one knows when. Berkshire will almost certainly be a satisfactory holding for investors. But it could well be a disastrous choice for speculators employing leverage.”
Buffett said 2014 was “a good year for Berkshire on all major fronts” except BNSF Railway, which has been unable to meet all shipper demands this year, especially for hauling crude oil and grains.
Buffett said Berkshire’s insurance division has made money on its underwriting for 12 years in a row, increasing the money that it holds for insurance claims, known as “float,” from $41 billion to $84 billion during that time.
Berkshire’s underwriting profit totaled $2.7 billion in 2014 and $24 billion over the past 12 years.
Buffett said Berkshire will continue looking for companies to acquire.
“Though we will always invest abroad as well, the mother lode of opportunities runs through America,” he wrote. “The treasures that have been uncovered up to now are dwarfed by those still untapped.”
The Omaha World-Herald Co. is owned by Berkshire Hathaway Inc.
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The World-Herald's Steve Jordon hosted a Warren Watch chat earlier Saturday. Check it out below.