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Berkshire's Performance vs. the S&P 500
Notes: Data are for calendar years with these exceptions: 1965 and 1966, year ended 9/30; 1967, 15 months ended 12/31. Starting in 1979, accounting rules required insurance companies to value the equity securities they hold at market rather than at the lower of cost or market, which was previously the requirement. In this table, Berkshire's results through 1978 have been restated to conform to the changed rules. In all other respects, the results are calculated using the numbers originally reported. The S&P 500 numbers are
BERKSHIRE HATHAWAY INC.
To the Shareholders of Berkshire Hathaway Inc.:
Berkshire's gain in net worth during 2016 was $27.5 billion, which increased the
During the first half of those years, Berkshire's net worth was roughly equal to the number that really counts: the intrinsic value of the business. The similarity of the two figures existed then because most of our resources were deployed in marketable securities that were regularly revalued to their quoted prices (less the tax that would be incurred if they were to be sold). In Wall Street parlance, our balance sheet was then in very large part 'marked to market.'
By the early 1990s, however, our focus was changing to the outright ownership of businesses, a shift that materially diminished the relevance of balance sheet figures. That disconnect occurred because the accounting rules (commonly referred to as 'GAAP') that apply to companies we control differ in important ways from those used to value marketable securities. Specifically, the accounting for businesses we own requires that the carrying value of 'losers' be written down when their failures become apparent. 'Winners,' conversely, are never revalued upwards.
We've experienced both outcomes: As is the case in marriage, business acquisitions often deliver surprises after the 'I do's.' I've made some dumb purchases, paying far too much for the economic goodwill of companies we acquired. That later led to goodwill
We have no quarrel with the asymmetrical accounting that applies here. But, over time, it necessarily widens the gap between Berkshire's intrinsic value and its book value. Today, the large ' and growing ' unrecorded gains at our winners produce an intrinsic value for Berkshire's shares that far exceeds their book value. The overage is truly huge in our property/casualty insurance business and significant also in many other operations.
Over time, stock prices gravitate toward intrinsic value. That's what has happened at Berkshire, a fact explaining why the company's
What We Hope to Accomplish
Charlie Munger, Berkshire's Vice Chairman and my partner, and I expect Berkshire's normalized earning power per share to increase every year. Actual earnings, of course, will sometimes decline because of periodic weakness in the U.S. economy. In addition, insurance
It's our job, though, to over time deliver significant growth, bumpy or not. After all, as stewards of your capital, Berkshire directors have opted to retain all earnings. Indeed, in both 2015 and 2016 Berkshire ranked first among American businesses in the dollar volume of earnings retained, in each year reinvesting many billions of dollars more than did the
Some years, the gains in underlying earning power we achieve will be minor; very occasionally, the cash register will ring loud. Charlie and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it's imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.
I earlier described our gradual shift from a company obtaining most of its gains from investment activities to one that grows in value by owning businesses. Launching that transition, we took baby steps ' making small acquisitions whose impact on Berkshire's profits was dwarfed by our gains from marketable securities. Despite that cautious approach, I made one particularly egregious error, acquiring Dexter Shoe for $434 million in 1993. Dexter's value promptly went to zero. The story gets worse: I used stock for the purchase, giving the sellers 25,203 shares of Berkshire that at yearend 2016 were worth more than $6 billion.
That wreck was followed by three key happenings ' two positive, one negative ' that set us firmly on our present course. At the beginning of 1996, we acquired the half of GEICO we didn't already own, a cash transaction that changed our holding from a portfolio investment into a
Unfortunately, I followed the GEICO purchase by foolishly using Berkshire stock ' a boatload of stock ' to buy General Reinsurance in late 1998. After some early problems, General Re has become a fine insurance operation that we prize. It was, nevertheless, a terrible mistake on my part to issue 272,200 shares of Berkshire in buying General Re, an act that increased our outstanding shares by a whopping 21.8%. My error caused Berkshire shareholders to give far more than they received (a practice that ' despite the Biblical endorsement ' is far from blessed when you are buying businesses).
Early in 2000, I atoned for that folly by buying 76% (since grown to 90%) of MidAmerican Energy, a
Our portfolio of bonds and stocks,
Here's our financial record since 1999, when the redirection of our business began in earnest. During the
(in billions of dollars)
(1)Including interest and dividends from investments, but excluding capital gains or losses.
(2)In very large part, this tabulation includes only realized capital gains or losses. Unrealized gains and losses are also included, however, when GAAP requires that treatment.
Our expectation is that investment gains will continue to be substantial ' though totally random as to timing ' and that these will supply significant funds for business purchases. Concurrently, Berkshire's superb corps of operating CEOs will focus on increasing earnings at the individual businesses they manage, sometimes helping them to grow by making
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Our efforts to materially increase the normalized earnings of Berkshire will be aided ' as they have been throughout our managerial tenure ' by America's economic dynamism. One word sums up our country's achievements: miraculous. From a standing start 240 years ago ' a span of time less than triple my days on earth ' Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers.
You need not be an economist to understand how well our system has worked. Just look around you. See the 75 million
It's true, of course, that American owners of homes, autos and other assets have often borrowed heavily to finance their purchases. If an owner defaults, however, his or her asset does not disappear or lose its usefulness. Rather, ownership customarily passes to an American lending institution that then disposes of it to an American buyer. Our nation's wealth remains intact. As Gertrude Stein put it, 'Money is always there, but the pockets change.'
Above all, it's our market system ' an economic traffic cop ably directing capital, brains and labor ' that has created America's abundance. This system has also been the primary factor in allocating rewards. Governmental redirection, through federal, state and local taxation, has in addition determined the distribution of a significant portion of the bounty.
America has, for example, decided that those citizens in their productive years should help both the old and the young. Such forms of aid ' sometimes enshrined as 'entitlements' ' are generally thought of as applying to the aged. But don't forget that four million American babies are born each year with an entitlement to a public education. That societal commitment, largely financed at the local level, costs about $150,000 per baby. The annual cost totals more than $600 billion, which is about 31'2% of GDP.
However our wealth may be divided, the
Early Americans, we should emphasize, were neither smarter nor more hard working than those people who toiled century after century before them. But those venturesome pioneers crafted a system that unleashed human potential, and their successors built upon it.
This economic creation will deliver increasing wealth to our progeny far into the future. Yes, the
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America's economic achievements have led to staggering profits for stockholders. During the 20th century the
American business ' and consequently a basket of stocks ' is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that.
Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines ' even panics ' that will affect virtually all stocks. No one can tell you when these traumas will occur ' not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: 'We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.'
During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large,
As for Berkshire, our size precludes a brilliant result: Prospective returns fall as assets increase. Nonetheless, Berkshire's collection of good businesses, along with the company's impregnable financial strength and
In the investment world, discussions about share repurchases often become heated. But I'd suggest that participants in this debate take a deep breath: Assessing the desirability of repurchases isn't that complicated.
From the standpoint of exiting shareholders, repurchases are always a plus. Though the
For continuing shareholders, however, repurchases only make sense if the shares are bought at a price below intrinsic value. When that rule is followed, the remaining shares experience an immediate gain in intrinsic value. Consider a simple analogy: If there are three equal partners in a business worth $3,000 and one is bought out by the partnership for $900, each of the remaining partners realizes an immediate gain of $50. If the exiting partner is paid $1,100, however, the continuing partners each suffer a loss of $50. The same math applies with corporations and their shareholders. Ergo, the question of whether a repurchase action is
It is puzzling, therefore, that corporate repurchase announcements almost never refer to a price above which repurchases will be eschewed. That certainly wouldn't be the case if a management was buying an outside business. There, price would always factor into a
When CEOs or boards are buying a small part of their own company, though, they all too often seem oblivious to price. Would they behave similarly if they were managing a private company with just a few owners and were evaluating the wisdom of buying out one of them? Of course not.
It is important to remember that there are two occasions in which repurchases should not take place, even if the company's shares are underpriced. One is when a business both needs all its available money to protect or expand its own operations and is also uncomfortable adding further debt. Here, the internal need for funds should take priority. This exception assumes, of course, that the business has a decent future awaiting it after the needed expenditures are made.
The second exception, less common, materializes when a business acquisition (or some other investment opportunity) offers far greater value than do the undervalued shares of the potential repurchaser. Long ago, Berkshire itself often had to choose between these alternatives. At our present size, the issue is far less likely to arise.
My suggestion: Before even discussing repurchases, a CEO and his or her Board should stand, join hands and in unison declare, 'What is smart at one price is stupid at another.'
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To recap Berkshire's own repurchase policy: I am authorized to buy large amounts of Berkshire shares at 120% or less of book value because our Board has concluded that purchases at that level clearly bring an instant and material benefit to continuing shareholders. By our estimate, a
The authorization given me does not mean that we will 'prop' our stock's price at the 120% ratio. If that level is reached, we will instead attempt to blend a desire to make meaningful purchases at a
To date, repurchasing our shares has proved hard to do. That may well be because we have been clear in describing our repurchase policy and thereby have signaled our view that Berkshire's intrinsic value is significantly higher than 120% of book value. If so, that's fine. Charlie and I prefer to see Berkshire shares sell in a fairly narrow range around intrinsic value, neither wishing them to sell at an unwarranted high price ' it's no fun having owners who are disappointed with their purchases ' nor one too low. Furthermore, our buying out 'partners' at a discount is not a particularly gratifying way of making money. Still, market circumstances could create a situation in which repurchases would benefit both continuing and exiting shareholders. If so, we will be ready to act.
One final observation for this section: As the subject of repurchases has come to a boil, some people have come close to calling them
Let's now look at Berkshire's various businesses, starting with our most important sector, insurance. The property/casualty ('P/C') branch of that industry has been the engine that has propelled our growth since 1967, the year we acquired National Indemnity and its sister company, National Fire & Marine, for $8.6 million. Today, National Indemnity is the largest property/casualty company in the world as measured by net worth.
One reason we were attracted to the P/C business was its financial characteristics: P/C insurers receive premiums upfront and pay claims later. In extreme cases, such as claims arising from exposure to asbestos, payments can stretch over many decades. This
We recently wrote a huge policy that increased float to more than $100 billion. Beyond that
We may in time experience a decline in float. If so, the decline will be very gradual ' at the outside no more than 3% in any year. The nature of our insurance contracts is such that we can never be subject to immediate or
If our premiums exceed the total of our expenses and eventual losses, our insurance operation registers an underwriting profit that adds to the investment income the float produces. When such a profit is earned, we enjoy the use of free money ' and, better yet, get paid for holding it.
Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous indeed that it sometimes causes the P/C industry as a whole to operate at a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. Competitive dynamics almost guarantee that the insurance industry, despite the float income all its companies enjoy, will continue its dismal record of earning subnormal returns on tangible net worth as compared to other American businesses.
This outcome is made more certain by the dramatically lower interest rates that now exist throughout the world. The investment portfolios of almost all P/C companies ' though not those of Berkshire ' are heavily concentrated in bonds. As these
Nevertheless, I very much like our own prospects. Berkshire's unrivaled financial strength allows us far more flexibility in investing than that generally available to P/C companies. The many alternatives available to us are always an advantage; occasionally, they offer us major opportunities. When others are constrained, our choices expand.
Moreover, our P/C companies have an excellent underwriting record. Berkshire has now operated at an underwriting profit for 14 consecutive years, our
So how does our float affect intrinsic value? When Berkshire's book value is calculated, the full amount of our float is deducted as a liability, just as if we had to pay it out tomorrow and could not replenish it. But to think of float as a typical liability is a major mistake. It should instead be viewed as a revolving fund. Daily, we pay old claims and related expenses ' a huge $27 billion to more than six million claimants in 2016 ' and that reduces float. Just as surely, we each day write new business that will soon generate its own claims, adding to float.
If our revolving float is both costless and
A partial offset to this overstated liability is a $15.5 billion 'goodwill' asset that we incurred in buying our insurance companies and that is included in our
Fortunately, that does not describe Berkshire. Charlie and I believe the true economic value of our insurance goodwill ' what we would happily pay for float of similar quality were we to purchase an insurance operation possessing it ' to be far in excess of its historic carrying value. Indeed, almost the entire $15.5 billion we carry for goodwill in our insurance business was already on our books in 2000 when float was $28 billion. Yet we have subsequently increased our float by $64 billion, a gain that in no way is reflected in our book value. This unrecorded asset is one reason ' a huge reason ' why we believe Berkshire's intrinsic business value far exceeds its book value.
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Berkshire's attractive insurance economics exist only because we have some terrific managers running disciplined operations that in most cases possess
First by float size is the Berkshire Hathaway Reinsurance Group, managed by Ajit Jain. Ajit insures risks that no one else has the desire or the capital to take on. His operation combines capacity, speed, decisiveness and, most important, brains in a manner unique in the insurance business. Yet he never exposes Berkshire to risks that are inappropriate in relation to our resources.
Indeed, Berkshire is far more conservative in avoiding risk than most large insurers. For example, if the insurance industry should experience a $250 billion loss from some
When Ajit entered Berkshire's office on a Saturday in 1986, he did not have a day's experience in the insurance business. Nevertheless, Mike Goldberg, then our manager of insurance, handed him the keys to our small and struggling reinsurance business. With that move, Mike achieved sainthood: Since then, Ajit has created tens of billions of value for Berkshire shareholders. If there were ever to be another Ajit and you could swap me for him, don't hesitate. Make the trade!
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We have another reinsurance powerhouse in General Re, managed until recently by Tad Montross. After 39 years at General Re, Tad retired in 2016. Tad was a class act in every way and we owe him a ton of thanks. Kara Raiguel, who has worked with Ajit for 16 years, is now CEO of General Re.
At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively assess the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can't be obtained.
Many insurers pass the first three tests and flunk the fourth. They simply can't turn their back on business that is being eagerly written by their competitors. That old line, 'The other guy is doing it, so we must as well,' spells trouble in any business, but in none more so than insurance. Tad never listened to that nonsensical excuse for sloppy underwriting, and neither will Kara.
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Finally, there is GEICO, the company that set my heart afire 66 years ago (and for which the flame still burns). GEICO is managed by Tony Nicely, who joined the company at 18 and completed 55 years of service in 2016.
Tony became CEO of GEICO in 1993, and since then the company has been flying. There is no better manager than Tony, who brings his combination of brilliance, dedication and soundness to the job. (The latter quality is essential to sustained success. As Charlie says, it's great to have a manager with a 160 IQ ' unless he thinks it's 180.) Like Ajit, Tony has created tens of billions of value for Berkshire.
On my initial visit to GEICO in 1951, I was blown away by the huge cost advantage the company enjoyed over the giants of the industry. It was clear to me that GEICO would succeed because it deserved to succeed. The company's annual sales were then $8 million; In 2016, GEICO did that much business every three hours of the year.
Auto insurance is a major expenditure for most families. Savings matter to them ' and only a
GEICO's low costs create a moat ' an enduring one ' that competitors are unable to cross. As a result, the company gobbles up market share year after year, ending 2016 with about 12% of industry volume. That's up from 2.5% in 1995, the year Berkshire acquired control of GEICO. Employment, meanwhile, grew from 8,575 to 36,085.
GEICO's growth accelerated dramatically during the second half of 2016. Loss costs throughout the
GEICO continues on a roll as I send you this letter. When insurance prices increase, people shop more. And when they shop, GEICO wins.
Have you called yet?
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In addition to our three major insurance operations, we own a collection of smaller companies that primarily write commercial coverages. In aggregate, these companies are a large, growing and valuable operation that consistently delivers an underwriting profit, usually one much superior to that reported by their competitors. Over the past 14 years, this group has earned $4.7 billion from underwriting ' about 13% of its premium volume ' while increasing its float from $943 million to $11.6 billion.
Less than three years ago, we formed Berkshire Hathaway Specialty Insurance ('BHSI'), which is included in this grouping. Our first decision was to put Peter Eastwood in charge, a move that proved to be a home run: We expected significant losses in the early years while Peter built the personnel and infrastructure needed for a
Here's a recap of
Berkshire's great managers, premier financial strength and a range of business models protected by wide moats amount to something unique in the insurance world. This assemblage of strengths is a huge asset for Berkshire shareholders that time will only make more valuable.
Our BNSF railroad and Berkshire Hathaway Energy ('BHE'), our
A key characteristic of both companies is their huge investment in very
At BHE, meanwhile, two factors ensure the company's ability to service its debt under all circumstances. The first is common to all utilities:
All told, BHE and BNSF invested $8.9 billion in plant and equipment last year, a massive commitment to their segments of America's infrastructure. We relish making such investments as long as they promise reasonable returns ' and, on that front, we put a large amount of trust in future regulation.
Our confidence is justified both by our past experience and by the knowledge that society will forever need huge investments in both transportation and energy. It is in the
Low prices are a powerful way to keep these constituencies happy. In Iowa, BHE's average retail rate is 7.1'' per KWH. Alliant, the other major electric utility in the state, averages 9.9''. Here are the comparable industry figures for adjacent states: Nebraska 9.0'', Missouri 9.5'', Illinois 9.2'', Minnesota 10.0''. The national average is 10.3''. We have promised Iowans that our base rates will not increase until 2029 at the earliest. Our
At BNSF, price comparisons between major railroads are far more difficult to make because of significant differences in both their mix of cargo and the average distance the load is carried. To supply a very crude measure, however, our revenue per
Both BHE and BNSF have been leaders in pursuing
BNSF, like other Class I railroads, uses only a single gallon of diesel fuel to move a ton of freight almost 500 miles. Those economics make railroads four times as
All told, BHE and BNSF own assets that are of major importance to our country as well as to shareholders of Berkshire. Here are the key financial figures for both:
HomeServices may appear out of place in the above table. But it came with our purchase of MidAmerican (now BHE) in 1999 ' and we are lucky that it did.
HomeServices owns 38 realty companies with more than 29,000 agents who operate in 28 states. Last year it purchased four realtors, including Houlihan Lawrence, the leader in New York's Westchester County (in a transaction that closed shortly after yearend).
In real estate parlance, representing either a buyer or a seller is called a 'side,' with the representation of both counting as two sides. Last year, our owned realtors participated in 244,000 sides, totaling $86 billion in volume.
HomeServices also franchises many operations throughout the country that use our name. We like both aspects of the real estate business and expect to acquire many realtors and franchisees during the next decade.
Manufacturing, Service and Retailing Operations
Our manufacturing, service and retailing operations sell products ranging from lollipops to jet airplanes. Let's look, though, at a summary balance sheet and earnings statement for the entire group.
Included in this financial summary are 44 businesses that report directly to headquarters. But some of these companies, in turn, have many individual operations under their umbrella. For example, Marmon has 175 separate business units, serving widely disparate markets, and Berkshire Hathaway Automotive owns 83 dealerships, operating in nine states.
This collection of businesses is truly a motley crew. Some operations, measured by earnings on unleveraged net tangible assets, enjoy terrific returns that, in a couple of instances, exceed 100%. Most are solid businesses generating good returns in the area of 12% to 20%.
A few, however ' these are serious blunders I made in my job of capital allocation ' produce very poor returns. In most cases, I was wrong when I originally sized up the economic characteristics of these companies or the industries in which they operate, and we are now paying the price for my misjudgments. In a couple of instances, I stumbled in assessing either the fidelity or ability of incumbent managers or ones I later put in place. I will commit more errors; you can count on that. Fortunately, Charlie ' never bashful ' is around to say 'no' to my worst ideas.
Viewed as a single entity, the companies in the manufacturing, service and retailing group are an excellent business. They employed an average of $24 billion of net tangible assets during 2016 and, despite their holding large quantities of excess cash and carrying very little debt, earned 24%
Of course, a business with terrific economics can be a bad investment if it is bought at too high a price. We have paid substantial premiums to net tangible assets for most of our businesses, a cost that is reflected in the large figure we show on our balance sheet for goodwill and other intangibles. Overall, however, we are getting a decent return on the capital we have deployed in this sector. Absent a recession, earnings from the group will likely grow in 2017, in part because Duracell and Precision Castparts (both bought in 2016) will for the first time contribute a full year's earnings to this group. Additionally, Duracell incurred significant transitional costs in 2016 that will not recur.
We have far too many companies in this group to comment on them individually. Moreover, their competitors ' both current and potential ' read this report. In a few of our businesses, we might be disadvantaged if outsiders knew our numbers. Therefore, in certain of our operations that are not of a size material to an evaluation of Berkshire, we only disclose what is required. You can nevertheless find a good bit of detail about many of our operations on pages 90 - 94. Be aware, though, that it's the growth of the Berkshire forest that counts. It would be foolish to focus
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For several years I have told you that the income and expense data shown in this section does not conform to GAAP. I have explained that this divergence occurs primarily because of
On page 54 we itemize $15.4 billion of intangibles that are yet to be amortized by annual charges to earnings. (More intangibles to be amortized will be created as we make new acquisitions.) On that page, we show that the 2016 amortization charge to GAAP earnings was $1.5 billion, up $384 million from 2015. My judgment is that about 20% of the 2016 charge is a 'real' cost.
Eventually amortization charges fully write off the related asset. When that happens ' most often at the
Now that I've described a GAAP expense that I believe to be overstated, let me move on to a less pleasant distortion produced by accounting rules. The subject this time is
At BNSF, to get down to particulars, our GAAP depreciation charge last year was $2.1 billion. But were we to spend that sum and no more annually, our railroad would soon deteriorate and become less competitive. The reality is that ' simply to hold our own ' we need to spend far more than the cost we show for depreciation. Moreover, a wide disparity will prevail for decades.
All that said, Charlie and I love our railroad, which was one of our better purchases.
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Too many managements ' and the number seems to grow every year ' are looking for any means to report, and indeed feature, 'adjusted earnings' that are higher than their company's GAAP earnings. There are many ways for practitioners to perform this legerdemain. Two of their favorites are the omission of 'restructuring costs' and
Charlie and I want managements, in their commentary, to describe unusual items ' good or bad ' that affect the GAAP numbers. After all, the reason we look at these numbers of the past is to make estimates of the future. But a management that regularly attempts to wave away very real costs by highlighting 'adjusted
Charlie and I cringe when we hear analysts talk admiringly about managements who always 'make the numbers.' In truth, business is too unpredictable for the numbers always to be met. Inevitably, surprises occur. When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers.
Let's get back to the two favorites of
We have never, however, singled out restructuring charges and told you to ignore them in estimating our normal earning power. If there were to be some truly major expenses in a single year, I would, of course, mention it in my commentary. Indeed, when there is a total rebasing of a business, such as occurred when Kraft and Heinz merged, it is imperative that for several years the huge
To explore this maneuver further, join me for a moment in a visit to a
Listen carefully while I tell these enablers that
My accounting minions suppress a giggle and immediately point out that 20% of what is paid these Berkshire managers is tantamount to 'cash paid in lieu of
Back to reality: If CEOs want to leave out
During the accounting nonsense that flourished during the 1960s, the story was told of a CEO who, as his company revved up to go public, asked prospective auditors, 'What is two plus two?' The answer that won the assignment, of course, was, 'What number do you have in mind?'
Finance and Financial Products
Our three leasing and rental operations are conducted by CORT (furniture), XTRA
We also include Clayton Homes in this section. This company receives most of its revenue from the sale of manufactured homes, but derives the bulk of its earnings from its large mortgage portfolio. Last year, Clayton became America's largest home builder, delivering 42,075 units that accounted for 5% of all new American homes. (In fairness, other large builders do far more dollar volume than Clayton because they sell
In 2015, Clayton branched out, purchasing its first
Even so, Clayton's focus will always be manufactured homes, which account for about 70% of new American homes costing less than $150,000. Clayton manufactures close to
Clayton's earnings in recent years have materially benefited from extraordinarily low interest rates. The company's mortgage loans to
Last year Clayton had to foreclose on 8,304
Clayton also has long had programs that help borrowers through difficulties. The two most popular are loan extensions and payment forgiveness. Last year about 11,000 borrowers received extensions, and 3,800 had $3.4 million of scheduled payments permanently canceled by Clayton. The company does not earn interest or fees when these
Clayton and Berkshire have been a wonderful partnership. Kevin Clayton came to us with a
Marmon's railcar business experienced a major slowdown in demand last year, which will cause earnings to decline in 2017. Fleet utilization was 91% in December, down from 97% a year earlier, with the drop particularly severe at the large fleet we purchased from General Electric in 2015. Marmon's crane and container rentals have weakened as well.
Big swings in railcar demand have occurred in the past and they will continue. Nevertheless, we very much like this business and expect decent returns on equity capital over the years. Tank cars are Marmon's specialty. People often associate tank cars with the transportation of crude oil; in fact, they are essential to a great variety of shippers.
Over time, we expect to expand our railcar operation. Meanwhile, Marmon is making a number of
* Excludes capital gains or losses
Below we list our fifteen common stock investments that at yearend had the largest market value. We exclude our Kraft Heinz holding because Berkshire is part of a control group and therefore must account for this investment on the 'equity' method. The 325,442,152 shares Berkshire owns of Kraft Heinz are carried on our balance sheet at a GAAP figure of $15.3 billion and had a yearend market value of $28.4 billion. Our cost basis for the shares is $9.8 billion.
*Excludes shares held by pension funds of Berkshire subsidiaries.
**This is our actual purchase price and also our tax basis; GAAP 'cost' differs in a few cases because of
Some of the stocks in the table are the responsibility of either Todd Combs or Ted Weschler, who work with me in managing Berkshire's investments. Each, independently, manages more than $10 billion; I usually learn about decisions they have made by looking at monthly trade sheets. Included in the $21 billion that the two manage is about $7.6 billion of pension trust assets of certain Berkshire subsidiaries. As noted, pension investments are not included in the preceding tabulation of Berkshire holdings.
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Excluded from the table ' but important ' is our ownership of $5 billion of preferred stock issued by Bank of America. This stock, which pays us $300 million per year, also carries with it a valuable warrant allowing Berkshire to purchase 700 million common shares of Bank of America for $5 billion at any time before September 2, 2021. At yearend, that privilege would have delivered us a profit of $10.5 billion. If it wishes, Berkshire can use its preferred shares to satisfy the $5 billion cost of exercising the warrant.
If the dividend rate on Bank of America common stock ' now 30 cents annually ' should rise above 44 cents before 2021, we would anticipate making a cashless exchange of our preferred into common. If the common dividend remains below 44 cents, it is highly probable that we will exercise the warrant immediately before it expires.
Many of our investees, including Bank of America, have been repurchasing shares, some quite aggressively. We very much like this behavior because we believe the repurchased shares have in most cases been underpriced. (Undervaluation, after all, is why we own these positions.) When a company grows and outstanding shares shrink, good things happen for shareholders.
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It's important for you to understand that 95% of the $86 billion of 'cash and equivalents' (which in my mind includes U.S. Treasury Bills) shown on our balance sheet are held by entities in the United States and, consequently, is not subject to any repatriation tax. Moreover, repatriation of the remaining funds would trigger only minor taxes because much of that money has been earned in countries that themselves impose meaningful corporate taxes. Those payments become an offset to U.S. tax when money is brought home.
These explanations are important because many
Berkshire has a partial offset to the favorable geographical location of its cash, which is that much of it is held in our insurance subsidiaries. Though we have many alternatives for investing this cash, we do not have the unlimited choices that we would enjoy if the cash were held by the parent company, Berkshire. We do have an ability annually to distribute large amounts of cash from our insurers to the parent ' though here, too, there are limits. Overall, cash held at our insurers is a very valuable asset, but one slightly less valuable to us than is cash held at the parent level.
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Sometimes the comments of shareholders or media imply that we will own certain stocks 'forever.' It is true that we own some stocks that I have no intention of selling for as far as the eye can see (and we're talking 20/20 vision). But we have made no commitment that Berkshire will hold any of its marketable securities forever.
Confusion about this point may have resulted from a
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Before we leave this investment section, a few educational words about dividends and taxes: Berkshire, like most corporations, nets considerably more from a dollar of dividends than it reaps from a dollar of capital gains. That will probably surprise those of our shareholders who are accustomed to thinking of capital gains as the route to
But here's the corporate math. Every $1 of capital gains that a corporation realizes carries with it 35 cents of federal income tax (and often state income tax as well). The tax on dividends received from domestic corporations, however, is consistently lower, though rates vary depending on the status of the recipient.
Berkshire's insurance subsidiaries pay a tax rate on dividends that is somewhat higher than that applying to
And that's our tax lesson for today.
'The Bet' (or how your money finds its way to Wall Street)
In this section, you will encounter, early on, the story of an investment bet I made nine years ago and, next, some strong opinions I have about investing. As a starter, though, I want to briefly describe Long Bets, a unique establishment that played a role in the bet.
Long Bets was seeded by Amazon's Jeff Bezos and operates as a
Here are examples of what you will find on Long Bets' very interesting site:
In 2002, entrepreneur Mitch Kapor asserted that 'By 2029 no computer ' or 'machine intelligence' ' will have passed the Turing Test,' which deals with whether a computer can successfully impersonate a human being. Inventor Ray Kurzweil took the opposing view. Each backed up his opinion with $10,000. I don't know who will win this bet, but I will confidently wager that no computer will ever replicate Charlie.
That same year, Craig Mundie of Microsoft asserted that pilotless planes would routinely fly passengers by 2030, while Eric Schmidt of Google argued otherwise. The stakes were $1,000 each. To ease any heartburn Eric might be experiencing from his outsized exposure, I recently offered to take a piece of his action. He promptly laid off $500 with me. (I like his assumption that I'll be around in 2030 to contribute my payment, should we lose.)
Now, to my bet and its history. In Berkshire's 2005 annual report, I argued that active investment management by professionals ' in aggregate ' would over a period of years underperform the returns achieved by rank amateurs who simply sat still. I explained that the massive fees levied by a variety of 'helpers' would leave their clients ' again in aggregate ' worse off than if the amateurs simply invested in an unmanaged
Subsequently, I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds '
What followed was the sound of silence. Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their
I hadn't known Ted before our wager, but I like him and admire his willingness to put his money where his mouth was. He has been both
For Prot''g'' Partners' side of our
Here are the results for the first nine years of the bet ' figures leaving no doubt that Girls Inc. of Omaha, the charitable beneficiary I designated to get any bet winnings I earned, will be the organization eagerly opening the mail next January.
Footnote: Under my agreement with Prot''g'' Partners, the names of these
The compounded annual increase to date for the index fund is 7.1%, which is a return that could easily prove typical for the stock market over time. That's an important fact: A particularly weak nine years for the market over the lifetime of this bet would have probably helped the relative performance of the hedge funds, because many hold large 'short' positions. Conversely, nine years of exceptionally high returns from stocks would have provided a tailwind for index funds.
Instead we operated in what I would call a 'neutral' environment. In it, the five
Bear in mind that every one of the
I'm certain that in almost all cases the managers at both levels were honest and intelligent people. But the results for their investors were dismal ' really dismal. And, alas, the huge fixed fees charged by all of the funds and
Still, we're not through with fees. Remember, there were the
In my opinion, the disappointing results for
A lot of very smart people set out to do better than average in securities markets. Call them active investors.
Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore, the balance of the
Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor's equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.
A number of smart people are involved in running hedge funds. But to a great extent their efforts are
So that was my argument ' and now let me put it into a simple equation. If Group A (active investors) and Group B
There are, of course, some skilled individuals who are highly likely to
There are no doubt many hundreds of people ' perhaps thousands ' whom I have never met and whose abilities would equal those of the people I've identified. The job, after all, is not impossible. The problem simply is that the great majority of managers who attempt to
Further complicating the search for the rare
Finally, there are three connected realities that cause investing success to breed failure. First, a good record quickly attracts a torrent of money. Second, huge sums invariably act as an anchor on investment performance: What is easy with millions, struggles with billions (sob!). Third, most managers will nevertheless seek new money because of their personal equation ' namely, the more funds they have under management, the more their fees.
These three points are hardly new ground for me: In January 1966, when I was managing $44 million, I wrote my limited partners: 'I feel substantially greater size is more likely to harm future results than to help them. This might not be true for my own personal results, but it is likely to be true for your results. Therefore, . . .
I intend to admit no additional partners to BPL. I have notified Susie that if we have any more children, it is up to her to find some other partnership for them.'
The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with
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If a statue is ever erected to honor the person who has done the most for American investors, the hands- down choice should be Jack Bogle. For decades, Jack has urged investors to invest in
In his early years, Jack was frequently mocked by the
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Over the years, I've often been asked for investment advice, and in the process of answering I've learned a good deal about human behavior. My regular recommendation has been a
I believe, however, that none of the
That professional, however, faces a problem. Can you imagine an investment consultant telling clients, year after year, to keep adding to an index fund replicating the S&P 500? That would be career suicide. Large fees flow to these
The wealthy are accustomed to feeling that it is their lot in life to get the best food, schooling, entertainment, housing, plastic surgery, sports ticket, you name it. Their money, they feel, should buy them something superior compared to what the masses receive.
In many aspects of life, indeed, wealth does command
Much of the financial damage befell pension funds for public employees. Many of these funds are woefully underfunded, in part because they have suffered a double whammy: poor investment performance accompanied by huge fees. The resulting shortfalls in their assets will for decades have to be made up by local taxpayers.
Human behavior won't change. Wealthy individuals, pension funds, endowments and the like will continue to feel they deserve something 'extra' in investment advice. Those advisors who cleverly play to this expectation will get very rich. This year the magic potion may be hedge funds, next year something else. The likely result from this parade of promises is predicted in an adage: 'When a person with money meets a person with experience, the one with experience ends up with the money and the one with money leaves with experience.'
Long ago, a
Homer gave me a pitying look and said: 'Warren, it's not how you sell 'em, it's how you tell 'em.' What worked in the stockyards continues to work in Wall Street.
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And, finally, let me offer an olive branch to Wall Streeters, many of them good friends of mine. Berkshire loves to pay fees ' even outrageous fees ' to investment bankers who bring us acquisitions. Moreover, we have paid substantial sums for
To get biblical (Ephesians 3:18), I know the height and the depth and the length and the breadth of the energy flowing from that simple
The Annual Meeting
Last year we partnered with Yahoo to air the
The webcast cut attendance at last year's meeting to about 37,000 people (we can't get a precise count), which was down about 10%. Nevertheless, both Berkshire's subsidiaries and Omaha hotels and restaurants racked up huge sales. Nebraska Furniture Mart's sales broke their 2015 record volume by 3%, with the Omaha store recording
Our Berkshire exhibitors at CenturyLink were open from noon until 5 p.m. on Friday and drew a crowd of 12,000
The annual meeting falls on May 6th and will again be webcast by Yahoo, whose web address is https://finance.yahoo.com/brklivestream. The webcast will go live at 9 a.m. Central Daylight Time. Yahoo will interview directors, managers, stockholders and celebrities before the meeting and during the lunch break. Both those interviews and meeting will be translated simultaneously into Mandarin.
For those attending the meeting in person, the doors at the CenturyLink will open at 7:00 a.m. on Saturday to facilitate shopping prior to our shareholder movie, which begins at 8:30. The
On Saturday morning, we will have our sixth International Newspaper Tossing Challenge. Our target will again be the porch of a Clayton Home, located precisely 35 feet from the throwing line. When I was a teenager ' in my one brief flirtation with honest labor ' I delivered about 500,000 papers. So I think I'm pretty good at this game. Challenge me! Humiliate me! Knock me down a peg! The papers will run 36 to 42 pages, and you must fold them yourself (no rubber bands allowed). The competition will begin about 7:45, and I'll take on ten or so competitors selected a few minutes earlier by my assistant, Deb Bosanek.
Your venue for shopping will be the
A GEICO booth in the shopping area will be staffed by a number of the company's top counselors from around the country. At last year's meeting, we set a record for policy sales, up 21% from 2015. I predict we will be up again this year.
So stop by for a quote. In most cases, GEICO will be able to give you a shareholder discount (usually
8%). This special offer is permitted by 44 of the 51 jurisdictions in which we operate. (One supplemental point: The discount is not additive if you qualify for another discount, such as that available to certain groups.) Bring the details of your existing insurance and check out our price. We can save many of you real money. Spend the savings on other Berkshire products.
Be sure to visit the Bookworm. This
The Bookworm will once again offer our history of the highlights (and lowlights) of Berkshire's first 50 years.
An attachment to the proxy material that is enclosed with this report explains how you can obtain the credential you will need for admission to both the meeting and other events. Keep in mind that airlines have sometimes jacked up prices for the Berkshire weekend ' though I must admit I have developed some tolerance, bordering on enthusiasm, for that practice now that Berkshire has made large investments in America's four major carriers. Nevertheless, if you are coming from far away, compare the cost of flying to Kansas City vs. Omaha. The drive between the two cities is about 21/2 hours, and it may be that Kansas City can save you significant money. The savings for a couple could run to $1,000 or more. Spend that money with us.
At Nebraska Furniture Mart, located on a
This year we have good news for shareholders in the Kansas City and Dallas metro markets who can't attend the meeting or perhaps prefer the webcast. From May 2nd through May 8th, shareholders who present meeting credentials or other evidence of their Berkshire ownership (such as brokerage statements) to their local NFM store will receive the same discounts enjoyed by those visiting the Omaha store.
At Borsheims, we will again have two
We will have huge crowds at Borsheims throughout the weekend. For your convenience, therefore, shareholder prices will be available from Monday, May 1st through Saturday, May 13th. During that period, please identify yourself as a shareholder either by presenting your meeting credential or a brokerage statement showing you own our stock.
On Sunday, in the mall outside of Borsheims, Norman Beck, a remarkable magician and motivational speaker from Dallas, will bewilder onlookers. On the upper level, we will have Bob Hamman and Sharon Osberg, two of the world's top bridge experts, available to play with our shareholders on Sunday afternoon. If they suggest wagering on the game, change the subject. I will join them at some point and hope Ajit, Charlie and Bill Gates will do so also.
My friend, Ariel Hsing, will be in the mall as well on Sunday, taking on challengers at table tennis. I met Ariel when she was nine, and even then I was unable to score a point against her. Ariel represented the United States in the 2012 Olympics. Now, she's a senior at Princeton (after interning last summer at JPMorgan Chase). If you don't mind embarrassing yourself, test your skills against her, beginning at 1 p.m. Bill Gates did pretty well playing Ariel last year, so he may be ready to again challenge her. (My advice: Bet on Ariel.)
Gorat's will be open exclusively for Berkshire shareholders on Sunday, May 7th, serving from 1 p.m. until 10 p.m. To make a reservation at Gorat's, call
We will have the same three financial journalists lead the
From the questions submitted, each journalist will choose the six he or she decides are the most interesting and important to shareholders. The journalists have told me your question has the best chance of being selected if you keep it concise, avoid sending it in at the last moment, make it
An accompanying set of questions will be asked by three analysts who follow Berkshire. This year the insurance specialist will be Jay Gelb of Barclays. Questions that deal with our
Neither Charlie nor I will get so much as a clue about the questions headed our way. Some will be tough, for sure, and that's the way we like it.
All told, we expect at least 54 questions, which will allow for six from each analyst and journalist and for 18 from the audience. The questioners from the audience will be chosen by means of 11 drawings that will take place at 8:15 a.m. on the morning of the annual meeting. Each of the 11 microphones installed in the arena and main overflow room will host, so to speak, a drawing.
While I'm on the subject of our owners' gaining knowledge, let me remind you that Charlie and I believe all shareholders should simultaneously have access to new information that Berkshire releases and, if possible, should also have adequate time to digest and analyze it before any trading takes place. That's why we try to issue financial data late on Fridays or early on Saturdays and why our annual meeting is always held on a Saturday (a day that also eases traffic and parking problems).
We do not follow the common practice of talking
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For good reason, I regularly extol the accomplishments of our operating managers. They are truly
Equally important, however, are the men and women who work with me at our corporate office. This team efficiently deals with a multitude of SEC and other regulatory requirements, files a
They handle all of these business tasks cheerfully and with unbelievable efficiency, making my life easy and pleasant. Their efforts go beyond activities strictly related to Berkshire: Last year, for example, they dealt with the 40 universities (selected from 200 applicants) who sent students to Omaha for a Q&A day with me. They also handle all kinds of requests that I receive, arrange my travel, and even get me hamburgers and French fries (smothered in Heinz ketchup, of course) for lunch. In addition, they cheerfully pitch in to help Carrie Sova ' our talented ringmaster at the annual meeting ' deliver an interesting and entertaining weekend for our shareholders. They are proud to work for Berkshire, and I am proud of them.
I'm a lucky guy, very fortunate in being surrounded by this excellent staff, a team of