Warren Buffett, America’s most famous investor, holds himself to a high standard. That’s why he described 2012, a year in which his conglomerate Berkshire Hathaway achieved a total gain for its shareholders of $24.1 billion, as “subpar.” As Buffett pointed out, for the ninth time in 48 years, Berkshire’s book value gain (14.4%) was less than the S&P’s gain (16%). This mea culpa of sorts kicks off Buffett’s annual letter, which was released on Friday. As usual, the document is required reading for anyone interested in investing, and features the Oracle of Omaha’s wry, homespun style.
Aside from Berkshire’s “subpar” performance, Buffett’s other main regret was his “inability” to make a major acquisition in 2012. “I pursued a couple of elephants, but came up empty-handed,” he wrote. Buffett found his mojo earlier this year, however, with the blockbuster $23.3 billion acquisition of ketchup titan H.J. Heinz Co. Berkshire is spending $12 billion to buy half of the company, with a small group of investors led by Brazilian businessman Jorge Paulo Lemann buying the other half.
With that deal done, Buffett wrote, it’s back to big-game hunting. “Charlie and I have again donned our safari outfits and resumed our search for elephants.” (Charlie Munger is Buffett’s longtime partner and the sour to his sweet.)
As usual, Buffett’s letter is an education in his value-investing philosophy, which he learned from his revered mentor Benjamin Graham, author of the business classic, The Intelligent Investor. Buffett’s modus operandi is deceptively simple: invest for the long term in easy-to-undertand, undervalued businesses, cultivate principled managers who love what they do and disregard flavor-of-the-month trends. (Ahem.)
Buffett loves big, reliable American businesses, which explains why Berkshire’s “Big Four” investments are American Express, Coca-Cola, IBM and Wells Fargo. Berkshire’s ownership stake in each company increased last year. The Omaha-based conglomerate now owns 8.7% of Wells Fargo, 6% of IBM, 8.9% of Coca-Cola and 13.7% of American Express. “Berkshire’s ownership interest in all four companies is likely to increase in the future,” Buffett wrote. “Mae West had it right: ‘Too much of a good thing can be wonderful.'”
Here are some highlights from Buffett’s letter.
It’s one of the most frequently asked questions in American capitalism: Who will ultimately replace the 82-year-old Oracle? Buffett has made clear that his duties will be divided between an investment manager, responsible for allocating Berkshire’s money, and a CEO, responsible for running the $170 billion Berkshire empire. Last year, Buffett confirmed that Todd Combs and Ted Weschler, two little-known hedge-fund managers, are in line to replace him on the investment side. Buffett was pleased with their 2012 performance.
Combs and Weschler “have proved to be smart, models of integrity, helpful to Berkshire in many ways beyond portfolio management and a perfect cultural fit,” Buffett wrote. “We hit the jackpot with these two. In 2012 each outperformed the S&P 500 by double-digit margins.” The mischievous Buffett then added, in super tiny type font: “They left me in the dust as well.” As a result, Berkshire is increasing the funds managed by each man to about $5 billion. “Todd and Ted are young and will be around to manage Berkshire’s massive portfolio long after Charlie and I have left the scene,” Buffett wrote. “You can rest easy when they take over.”
On the management side, Buffett didn’t offer many clues, but he did shower praise upon Ajit Jain, a longtime Buffett favorite who manages the multibillion-dollar Berkshire Hathaway Reinsurance Group. Jain is widely considered a top candidate for the CEO position. “From a standing start in 1985, Ajit has created an insurance business with float of $35 billion and a significant cumulative underwriting profit, a feat that no other insurance CEO has come close to matching,” Buffett wrote. “He has thus added a great many billions of dollars to the value of Berkshire. If you meet Ajit at the annual meeting, bow deeply.”
Buffett loves newspapers, “and if their economics make sense, [Berkshire] will buy them even when they fall far short of the size threshold we would require for the purchase of, say, a widget company.” During the past 15 months, Berkshire acquired 28 daily newspapers at a cost of $344 million, he wrote, despite his long-standing prediction that “the circulation, advertising and profits of the newspaper industry overall are certain to decline.”
Here’s Buffett’s logic: “News, to put it simply, is what people don’t know that they want to know,” he wrote. “And people will seek their news — what’s important to them — from whatever sources provide the best combination of immediacy, ease of access, reliability, comprehensiveness and low cost.” Buffett readily admits that the Internet has disrupted the traditional newspaper business model, causing readership and revenue to decline dramatically. But there’s one area of the industry where Buffett sees an opportunity:
Newspapers continue to reign supreme, however, in the delivery of local news. If you want to know what’s going on in your town — whether the news is about the mayor or taxes or high school football — there is no substitute for a local newspaper that is doing its job. A reader’s eyes may glaze over after they take in a couple of paragraphs about Canadian tariffs or political developments in Pakistan; a story about the reader himself or his neighbors will be read to the end. Wherever there is a pervasive sense of community, a paper that serves the special informational needs of that community will remain indispensable to a significant portion of its residents …
Charlie and I believe that papers delivering comprehensive and reliable information to tightly bound communities and having a sensible Internet strategy will remain viable for a long time. We do not believe that success will come from cutting either the news content or frequency of publication. Indeed, skimpy news coverage will almost certainly lead to skimpy readership. And the less-than-daily publication that is now being tried in some large towns or cities — while it may improve profits in the short term — seems certain to diminish the papers’ relevance over time. Our goal is to keep our papers loaded with content of interest to our readers and to be paid appropriately by those who find us useful, whether the product they view is in their hands or on the Internet.
In one of the more eyebrow-raising parts of his letter, Buffett called out some of his fellow U.S. CEOs who have “cried ‘uncertainty’ when faced with capital-allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash).” Buffett, an unreconstructed American optimist, wrote that he doesn’t share their concerns. “If you are a CEO who has some large, profitable project you are shelving because of short-term worries, call Berkshire,” Buffett wrote. “Let us unburden you.”
American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor. (The Dow Jones Industrials advanced from 66 to 11,497 in the 20th century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions. And don’t forget that shareholders received substantial dividends throughout the century as well.)
Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it. My own history provides a dramatic example: I made my first stock purchase in the spring of 1942 when the U.S. was suffering major losses throughout the Pacific war zone. Each day’s headlines told of more setbacks. Even so, there was no talk about uncertainty; every American I knew believed we would prevail.
The country’s success since that perilous time boggles the mind: on an inflation-adjusted basis, GDP per capita more than quadrupled between 1941 and 2012. Throughout that period, every tomorrow has been uncertain. America’s destiny, however, has always been clear: ever increasing abundance.
Next Stop, Omaha
It’s called the Woodstock of Capitalism — for good reason. Every year, tens of thousands of Berkshire faithful make the pilgrimage to the company’s annual meeting, which takes place in Omaha this year on May 4. It’s quite a spectacle: just imagine a Grateful Dead concert populated by hardcore, and in some cases, extremely wealthy, capitalist true believers. Everyone is in a good mood. Among the highlights of this year’s meeting:
- The second annual Berkshire Hathaway International Newspaper Tossing Challenge. “Last year I successfully fought off all challengers,” Buffett wrote. “But now Berkshire has acquired a large number of newspapers and with them came much tossing talent [or so the throwers claim]. Come see whether their talent matches their talk.”
- The “Berkshire 5K” road race starting at the CenturyLink Center, the 19,000-seat arena where the meeting will be held. “We will have plenty of categories for competition, including one for the media,” Buffett wrote. “[It will be fun to report on their performance.] Regretfully, I will forgo running; someone has to man the starting gun.”
- The Borsheims Fine Jewelry gala on Sunday, May 5. (Berkshire has owned Omaha-based Borsheims since 1989.) “Around 1 p.m. on Sunday, I will begin clerking at Borsheims,” Buffett wrote. “Last year my sales totaled $1.5 million. This year I won’t quit until I hit $2 million. Because I need to leave well before sundown, I will be desperate to do business. Come take advantage of me. Ask for my ‘Crazy Warren’ price.”
The Berkshire Hathaway annual meeting is a memorable experience. At times, Buffett can seem ageless, but alas, that’s not the case. And if you’re a Berkshire shareholder in the Omaha area on the first weekend of May, you never know whom you might run into at Gorat’s or Piccolo’s. “These restaurants are my favorites, and I will eat at both of them on Sunday evening,” Buffett wrote. Oh, and if you go to Piccolo’s, “order a giant root-beer float for dessert,” Buffett advised. “Only sissies get the small one. [I once saw Bill Gates polish off two of the giant variety after a full-course dinner; that’s when I knew he would make a great director.]”