Mr. Warren Buffet Sparkles In His Annual Share Holder Meeting At Omaha

For those who braved the inclement weather at Omaha, Nebraska, or those who spent a good part of their weekend witnessing the Annual Share Holder meeting live, thanks to Yahoo Finance, the effort was worth many times one could have imagined. The Sage of Omaha and his deputy, the supremely wise, Mr. Charlie Munger, staged an event that will be remembered for some time to come.

This time the telecast allowed people like me, thousands of miles away, to get a peek of the event, which otherwise would have cost a fortune. The telecast this time also had a bilingual appeal, with simultaneous translation into Mandarin, again a first of its kind.

Mr. Buffet moved from one subject to the next with a poise and equanimity that he so famous for and his topics ranged from analysis of past year performance to fundamental drivers of the business, from under-writing of risk in the re-insurance business to the impacts of low and negative interest rates on the ‘float’. But the better parts were his comments on principles of management or his beliefs around customers and competition or the role of trust.

Mr. Buffet started the show with his two slides, the first one on the performance numbers of Berkshire which is known and seen several times from his annual newsletter, but with a difference. He was plainly presenting the dip in insurance and railroad revenues and earnings, almost without emotion, although the insurance dip had to do with some storms in Texas. The Precision Cast Parts was at the center piece of discussions, which later he explained in details, while he was clear that there was nothing wrong with the GEICO under-writing of the risks in the car insurance business.

His second slide was more striking with two parts of his portfolio, one where the earnings after taxes were shown for outright holdings in businesses, that included much of manufacturing and the other where he showed the same for the marketable securities. The first segment showed an income after taxes of $17.36 Billion in 2015, while the second showed $6.73 Billion in 2015. The bigger observation would be to see that the second kind had a cumulative earnings of $32.29 Billion between 1999 to 2015, much smaller than what the first kind showed.

He made a remark early on that the retained earnings from operations of these businesses allowed him to develop the sustainable earnings power, which in turn could be used for acquiring others that were attractive value offerings.

One thing is striking that the net worth of Berkshire Hathaway is slowly and steadily moving away from the intrinsic worth or value of the company as Berkshire transitions from a company that bought and sold marketable securities to a company that is in the business of outright ownership of companies.

The first question he faced was related to the transition itself of Berkshire as it had been moving away from acquiring and managing capital-light businesses to the ones that require ‘tons’ of capital. Mr. Buffet termed this as eventual ‘problems of prosperity’ as that would be impeding on the ability to return on equity at the same pace, something that could come in the way of sustainable compounding of earnings growth. He was clear that businesses like the Buffalo Newspaper, which required almost no capital infusion, would be quite different than the ones like his entire renewable portfolio as in Berkshire Energy, which required $30 Billion of capital investments. But obviously it was clear that his range of businesses allowed such a wide spread of capital requirements for each.

He went on to explain about Precision Cast Parts in his portfolio that he was so proud of but did not hesitate to mention that the best part of that asset was Mark Donovan, who remained the CEO and independent driver of the business. He explained how Donovan was now completely free for attending to the needs of his business in terms of setting priorities in the area of investments or in customer fulfillment processes, now that he did not have to take care of the needs of Wall Street any more.

On the question on what constituted his pursuits of happiness, he was kind to mention that it entailed eating and drinking and living with people he liked and that was that. Charlie and he had no complaints whatsoever on anything, barring that they hoped they had ‘wised up faster’ than what they did.

The question on the future of salesmanship, when it was moving from ‘push’ to ‘pull’ mode with Amazon heading the pack with its customer centric model, Mr. Buffet was clear that it was an economic trend that wasn’t going to be reversed. But while he may have failed in retailing in some ways, he was clear that it was working well in the case of GEICO. He remarked that finally the purpose of business was to develop satisfied customers.

On the question of ‘negative health effects’ on drinking Coke, he explained in his characteristic style that he and Charlie remained to be the best living examples of drinking almost 700 calories of Coke every day. The statistics was no less onerous, when he said that the world takes in 1.9 billion 8 ounce servings, which is like 108 ounces per capita. The good effects of drinking that product far outpaced the detriments, if at all.

The question on dis-investing Munich Re and Swiss Re needed some explaining to be done, especially when the holding on Munich Re was about 10%. Mr. Buffet did not mince words when he said that the insurance business now is quite different from what it was ten years back with more competition and with other issues now cropping up like the low interest rates, which make it less attractive. The low interest rate environment, especially in Europe, makes it even more difficult to do justice to the huge ‘float’ available as fixed income returns have stayed extremely low. The matter is entirely different in the case of the Reinsurance business of Berkshire as it allowed a much higher earnings power variety due to many areas unrelated to the insurance business. No matter how much more competitive this business may have become (‘supply was always far more than demand’), Berkshire remained strong in this business.

Mr. Buffet surprised many with his statistics of road accidents in the U.S. which has moved to the lows of 1 per million-miles, from 15 per million miles some years back. Had the same statistics continued there would have been half a million deaths on road against the current 40,000 per annum.

I was reminded of his annual shareholder letter, where he was proud of the increase in float to $88 Billion in his re-insurance business, which remains to be his star performer. This float, is not Berkshire’s money though, but could be invested and that is the reason for his stupendous cash in hand of $71.7 Billion. In current times when interest rates are so low, it reduced the value of holding money, but Berkshire can use the float in ways that others could not.

In his letter he was so much eager to talk about GEICO, the auto insurance business that covers 40% of American auto industry. How things have changed is evident in his comparison, “Their fledgling did $238,000 of auto insurance business in 1937, its first full year. Last year GEICO did $22.6 billion, more than double the volume of USAA. (Though the early bird gets the worm, the second mouse gets the cheese.) GEICO’s underwriting expenses in 2015 were 14.7% of premiums, with USAA being the only large company to achieve a lower percentage. GEICO employs about 34,000 people to serve its 14 million policyholders.”

There was this question on derivatives and he showed his characteristic apathy for it, as it makes the treatment on discontinuity that much more difficult. He was glad that he just had one derivatives position to be taken care off and that BOA or Wells Fargo remained largely unscathed from these potential ‘time bombs’.

On his railroad company BNSF, there were many questions, but he was very clear that BNSF was doing well in spending more than what depreciation would allow. He explained that railroad was such a business where depreciation could be an inadequate measure to keep the assets in steady state, something that could be very important for the long term sustenance. He was clear that BNSF would have to bear the brunt of the secular decline in coal, which contributed to 20% of its revenues, but there were other areas where it had potential to grow. His annual letter had some proud moments around BNSF, when he wrote, “In 1996, the merged company’s first full year of operation, 411 million ton-miles of freight got transported by 45,000 employees, whereas last year the comparable number was 702 million ton-miles (plus 71%) and 47,000 employees (plus only 4%). That dramatic gain in productivity benefits both owners and shippers.”

His slide three came much later, when he explained why going to hedge funds was not a sure prescription for success. His figures showed that from 2008 to 2015, the S&P 500 returned 65.7% after taxes while the hedge funds (five of the best ones) returned 21.9%. He explained in some questions the culture of investing should be about believing in the businesses which you are investing in, which is quite different from what an activist investor could be thinking of doing. By breaking up his businesses he was clear in his mind that the sum of the parts will be much lower than the whole, the very reason why Berkshire excels.

On the question on business integrity, Mr. Buffet was clear that it was through pattern recognition that very early on it was possible to separate out people who weren’t of the same order. It was only in one case where this got missed out.

He also did talk about his move towards renewable energy, currently holding America’s 6% in solar and 7% in wind and the good effects of subsidizing these businesses for the society as a whole. He however made it clear that when the costs would reflect the true value of these investments, these subsidies would go away.

On the question of stock buy-backs he gave the associated metric that he always used to decide whether it was the right move in the best interests of the shareholder. If the current value exceeded the intrinsic value by 1.2 times, he thought that it was the right point to initiate stock buy-backs. But he also mentioned that stock buy-backs have become a current obsession with many of the firms (‘more used for propping the stocks in the short term’), which could be actually destroying shareholder value. But more importantly he found it rather odd (stock-buy backs) that to increase value of the company one had to sever ties with the partners in this case, something as a philosophy he did not find very appealing.

The entire event, spread across five hours, passed like a flash. Many like me were left dumbfounded. The wisdom of Mr. Buffet showed no signs of abating.