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Berkshire's Performance vs. the S&P 500
Note: 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 2017 was $65.3 billion, which increased the
The format of that opening paragraph has been standard for 30 years. But 2017 was far from standard: A large portion of our gain did not come from anything we accomplished at Berkshire.
The $65 billion gain is nonetheless real ' rest assured of that. But only $36 billion came from Berkshire's operations. The remaining $29 billion was delivered to us in December when Congress rewrote the U.S. Tax Code. (Details of Berkshire's
After stating those fiscal facts, I would prefer to turn immediately to discussing Berkshire's operations. But, in still another interruption, I must first tell you about a new accounting rule ' a generally accepted accounting principle (GAAP) ' that in future quarterly and annual reports will severely distort Berkshire's net income figures and very often mislead commentators and investors.
The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP
The new rule compounds the communication problems we have long had in dealing with the realized gains (or losses) that accounting rules compel us to include in our net income. In past quarterly and annual press releases, we have regularly warned you not to pay attention to these realized gains, because they ' just like our unrealized gains
' fluctuate randomly.
That's largely because we sell securities when that seems the intelligent thing to do, not because we are trying to influence earnings in any way. As a result, we sometimes have reported substantial realized gains for a period when our portfolio, overall, performed poorly (or the converse).
With the new rule about unrealized gains exacerbating the distortion caused by the existing rules applying to realized gains, we will take pains every quarter to explain the adjustments you need in order to make sense of our numbers. But televised commentary on earnings releases is often instantaneous with their receipt, and newspaper headlines almost always focus on the
We will attempt to alleviate this problem by continuing our practice of publishing financial reports late on Friday, well after the markets close, or early on Saturday morning. That will allow you maximum time for analysis and give investment professionals the opportunity to deliver informed commentary before markets open on Monday. Nevertheless, I expect considerable confusion among shareholders for whom accounting is a foreign language.
At Berkshire what counts most are increases in our normalized
There are four building blocks that add value to Berkshire: (1) sizable
In our search for new
That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an
Why the purchasing frenzy? In part, it's because the CEO job
Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don't ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large 'synergies' will be forecast. Spreadsheets never disappoint.
The ample availability of extraordinarily cheap debt in 2017 further fueled purchase activity. After all, even a
Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don't need. We held this view 50 years ago when we each ran an investment partnership, funded by a few friends and relatives who trusted us. We also hold it today after a million or so 'partners' have joined us at Berkshire.
Despite our recent drought of acquisitions, Charlie and I believe that from time to time Berkshire will have opportunities to make very large purchases. In the meantime, we will stick with our simple guideline: The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.
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We were able to make one sensible
PFJ has been run from the
When driving on the Interstate, drop in. PFJ sells gasoline as well as diesel fuel, and the food is good. If it's been a long day, remember, too, that our properties have 5,200 showers.
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Let's move now to
''Clayton Homes acquired two builders of conventional homes during 2017, a move that more than doubled our presence in a field we entered only three years ago. With these additions ' Oakwood Homes in Colorado and Harris Doyle in Birmingham ' I expect our 2018 site built volume will exceed $1 billion.
Clayton's emphasis, nonetheless, remains manufactured homes, both their construction and their financing. In 2017 Clayton sold 19,168 units through its own retail operation and wholesaled another 26,706 units to independent retailers. All told, Clayton accounted for 49% of the
'about three times what our nearest competitor did ' is a far cry from the 13% Clayton achieved in 2003, the year it joined Berkshire.
Both Clayton Homes and PFJ are based in Knoxville, where the Clayton and Haslam families have long been friends. Kevin Clayton's comments to the Haslams about the advantages of a Berkshire affiliation, and his admiring comments about the Haslam family to me, helped cement the PFJ deal.
''Near the end of 2016, Shaw Industries, our floor coverings business, acquired U.S. Floors ('USF'), a rapidly growing distributor of luxury vinyl tile. USF's managers, Piet Dossche and Philippe Erramuzpe, came out of the gate fast, delivering a 40% increase in sales in 2017, during which their operation was integrated with Shaw's. It's clear that we acquired both great human assets and business assets in making the USF purchase.
Vance Bell, Shaw's CEO, originated, negotiated and completed this acquisition, which increased Shaw's sales to $5.7 billion in 2017 and its employment to 22,000. With the purchase of USF, Shaw has substantially strengthened its position as an important and durable source of earnings for Berkshire.
''I have told you several times about HomeServices, our growing real estate brokerage operation. Berkshire backed into this business in 2000 when we acquired a majority interest in MidAmerican Energy (now named Berkshire Hathaway Energy). MidAmerican's activities were then largely in the electric utility field, and I originally paid little attention to HomeServices.
With those purchases we added 12,300 agents, raising our total to 40,950. HomeServices is now close to leading the country in home sales, having participated (including our three acquisitions
Despite its recent acquisitions, HomeServices is on track to do only about 3% of the country's home- brokerage business in 2018. That leaves 97% to go. Given sensible prices, we will keep adding brokers in this most fundamental of businesses.
''Finally, Precision Castparts, a company built through acquisitions, bought Wilhelm Schulz GmbH, a German maker of corrosion resistant fittings, piping systems and components. Please allow me to skip a further explanation. I don't understand manufacturing operations as well as I do the activities of real estate brokers, home builders or truck stops.
Fortunately, I don't need in this instance to bring knowledge to the table: Mark Donegan, CEO of Precision, is an extraordinary manufacturing executive, and any business in his domain is slated to do well. Betting on people can sometimes be more certain than betting on physical assets.
Let's now move on to operations, beginning with
Before I discuss our 2017 insurance results, let me remind you of how and why we entered the field. We began by purchasing National Indemnity and a smaller sister company for $8.6 million in early 1967. With our purchase we received $6.7 million of tangible net worth that, by the nature of the insurance business, we were able to deploy in marketable securities. It was easy to rearrange the portfolio into securities we would otherwise have owned at Berkshire itself. In effect, we were 'trading dollars' for the net worth portion of the cost.
The $1.9 million premium over net worth that Berkshire paid brought us an insurance business that usually delivered an underwriting profit. Even more important, the insurance operation carried with it $19.4 million of 'float'
' money that belonged to others but was held by our two insurers.
Ever since, float has been of great importance to Berkshire. When we invest these funds, all dividends, interest and gains from their deployment belong to Berkshire. (If we experience investment losses, those, of course, are on our tab as well.)
Float materializes at p/c insurers in several ways: (1) Premiums are generally paid to the company upfront whereas losses occur over the life of the policy, usually a
Float generally grows as premium volume increases. Additionally, certain p/c insurers specialize in lines of business such as medical malpractice or product liability ' business labeled
Berkshire has been a leader in
Our 2017 volume was boosted by a huge deal in which we reinsured up to $20 billion of
Float will probably increase slowly for at least a few years. When we eventually experience a decline, it will be modest ' at most 3% or so in any single year. Unlike bank deposits or life insurance policies containing surrender options, p/c float can't be withdrawn. This means that p/c companies can't experience massive 'runs' in times of widespread financial stress, a characteristic of prime importance to Berkshire that we factor into our investment decisions.
Charlie and I never will operate Berkshire in a manner that depends on the kindness of strangers ' or even that of friends who may be facing liquidity problems of their own. During the
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The downside of float is that it comes with risk, sometimes oceans of risk. What looks predictable in insurance can be anything but. Take the famous Lloyds insurance market, which produced decent results for three centuries. In the 1980's, though, huge latent problems from a few
Berkshire's insurance managers are conservative and careful underwriters, who operate in a culture that has long prioritized those qualities. That disciplined behavior has produced underwriting profits in most years, and in such instances, our cost of float was less than zero. In effect, we got paid then for holding the huge sums tallied in the earlier table.
I have warned you, however, that we have been fortunate in recent years and that the
My guess at this time is that the insured losses arising from the hurricanes are $100 billion or so. That figure, however, could be far off the mark. The pattern with most
We currently estimate Berkshire's losses from the three hurricanes to be $3 billion (or about $2 billion after tax). If both that estimate and my industry estimate of $100 billion are close to accurate, our share of the industry loss was about 3%. I believe that percentage is also what we may reasonably expect to be our share of losses in future American
It's worth noting that the $2 billion net cost from the three hurricanes reduced Berkshire's GAAP net worth by less than 1%. Elsewhere in the reinsurance industry there were many companies that suffered losses in net worth ranging from 7% to more than 15%. The damage to them could have been far worse: Had Hurricane Irma followed a path through Florida only a bit to the east, insured losses might well have been an additional $100 billion.
We believe that the annual probability of a U.S.
No company comes close to Berkshire in being financially prepared for a $400 billion
Prior to 2017, Berkshire had recorded 14 consecutive years of underwriting profits, which totaled $28.3 billion
A large amount of additional information about our various insurance operations is included in the
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For many years, this letter has described the activities of Berkshire's many other businesses. That discussion has become both repetitious and partially duplicative of information regularly included in the
Viewed as a group ' and excluding investment income ' our operations other than insurance delivered pre- tax income of $20 billion in 2017, an increase of $950 million over 2016. About 44% of the 2017 profit came from two subsidiaries. BNSF, our railroad, and Berkshire Hathaway Energy (of which we own 90.2%). You can read more about these businesses on pages
Proceeding down Berkshire's long list of subsidiaries, our next five
The next five, similarly ranked and listed (Forest River, Johns Manville, MiTek, Shaw and TTI) earned $2.1 billion last year, up from $1.7 billion in 2016.
The remaining businesses that Berkshire owns ' and there are many ' recorded little change in
Depreciation charges for all of these
Amortization charges were an additional $1.3 billion. I believe that in large part this item is not a true economic cost. Partially offsetting this good news is the fact that BNSF (like all other railroads) records depreciation charges that fall well short of the sums regularly needed to keep the railroad in
Berkshire's goal is to substantially increase the earnings of its
Below we list our fifteen common stock investments that at yearend had the largest market value. We exclude our Kraft Heinz holding ' 325,442,152 shares ' because Berkshire is part of a control group and therefore must account for this investment on the 'equity' method. On its balance sheet, Berkshire carries its Kraft Heinz holding at a GAAP figure of $17.6 billion. The shares had a yearend market value of $25.3 billion, and a cost basis of $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 of me, manages more than $12 billion; I usually learn about decisions they have made by looking at monthly portfolio summaries. Included in the $25 billion that the two manage is more than $8 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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Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their 'chart' patterns, the 'target' prices of analysts or the opinions of media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well. Sometimes the payoffs to us will be modest; occasionally the cash register will ring loudly. And sometimes I will make expensive mistakes. Overall ' and over time ' we should get decent results. In America, equity investors have the wind at their back.
From our stock portfolio ' call our holdings 'minority interests' in a diversified group of
That dividend figure, however, far understates the 'true' earnings emanating from our stock holdings. For decades, we have stated in Principle 6 of our
Our recognition of capital gains (and losses) will be lumpy, particularly as we conform with the new GAAP rule requiring us to constantly record unrealized gains or losses in our earnings. I feel confident, however, that the earnings retained by our investees will over time, and with our investees viewed as a group, translate into commensurate capital gains for Berkshire.
The connection of
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Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure long- term growth in value. For the last 53 years, the company has built value by reinvesting its earnings and letting compound interest work its magic. Year by year, we have moved forward. Yet Berkshire shares have suffered four truly major dips. Here are the gory details:
This table offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren't immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.
In the next 53 years our shares (and others) will experience declines resembling those in the table. No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow.
When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt. That's the time to heed these lines from Kipling's If:
'If you can keep your head when all about you are losing theirs . . .
If you can wait and not be tired by waiting . . .
If you can think ' and not make thoughts your aim . . .
If you can trust yourself when all men doubt you . . .
Yours is the Earth and everything that's in it.'
'The Bet' is Over and Has Delivered an Unforeseen Investment Lesson
Last year, at the 90% mark, I gave you a detailed report on a
I made the bet for two reasons: (1) to leverage my outlay of $318,250 into a disproportionately larger sum that ' if things turned out as I expected ' would be distributed in early 2018 to Girls Inc. of Omaha; and (2) to publicize my conviction that my pick ' a virtually
Addressing this question is of enormous importance. American investors pay staggering sums annually to advisors, often incurring several layers of consequential costs. In the aggregate, do these investors get their money's worth? Indeed, again in the aggregate, do investors get anything for their outlays?
Prot''g'' Partners, my counterparty to the bet, picked five
Essentially, Prot''g'', an advisory firm that knew its way around Wall Street, selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund. This assemblage was an elite crew, loaded with brains, adrenaline and confidence.
The managers of the five
Every actor on Prot''g'''s side was highly incentivized: Both the
Those performance incentives, it should be emphasized, were frosting on a huge and tasty cake: Even if the funds lost money for their investors during the decade, their managers could grow very rich. That would occur because fixed fees averaging a staggering 21'2% of assets or so were paid every year by the
Here's the final scorecard for the bet:
Footnote: Under my agreement with Prot''g'' Partners, the names of these
Let me emphasize that there was nothing aberrational about
Performance comes, performance goes. Fees never falter.
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The bet illuminated another important investment lesson: Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period ' or even to look foolish ' is also essential.
Originally, Prot''g'' and I each funded our portion of the ultimate $1 million prize by purchasing $500,000 face amount of
As the name implies, the bonds we acquired paid no interest, but (because of the discount at which they were purchased) delivered a 4.56% annual return if held to maturity. Prot''g'' and I originally intended to do no more than tally the annual returns and distribute $1 million to the winning charity when the bonds matured late in 2017.
After our purchase, however, some very strange things took place in the bond market. By November 2012, our bonds ' now with about five years to go before they matured ' were selling for 95.7% of their face value. At that price, their annual yield to maturity was less than 1%. Or, to be precise, .88%.
Given that pathetic return, our bonds had become a dumb ' a really dumb ' investment compared to American equities. Over time, the S&P 500 ' which mirrors a huge
In November 2012, as we were considering all this, the cash return from dividends on the S&P 500 was 21'2% annually, about triple the yield on our U.S. Treasury bond. These dividend payments were almost certain to grow. Beyond that, huge sums were being retained by the companies comprising the 500. These businesses would use their retained earnings to expand their operations and, frequently, to repurchase their shares as well. Either course would, over time, substantially increase
Presented late in 2012 with the extraordinary valuation mismatch between bonds and equities, Prot''g'' and I agreed to sell the bonds we had bought five years earlier and use the proceeds to buy 11,200 Berkshire 'B' shares. The result: Girls Inc. of Omaha found itself receiving $2,222,279 last month rather than the $1 million it had originally hoped for.
Berkshire, it should be emphasized, has not performed brilliantly since the 2012 substitution. But brilliance wasn't needed: After all, Berkshire's gain only had to beat that annual .88% bond bogey ' hardly a Herculean achievement.
The only risk in the
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Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date. 'Risk' is the possibility that this objective won't be attained.
By that standard, purportedly
I want to quickly acknowledge that in any upcoming day, week or even year, stocks will be riskier ' far riskier ' than
It is a terrible mistake for investors with
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A final lesson from our bet: Stick with big, 'easy' decisions and eschew activity. During the
Prot''g'' and I, meanwhile, leaning neither on research, insights nor brilliance, made only one investment decision during the ten years. We simply decided to sell our bond investment at a price of more than 100 times earnings (95.7 sale price/.88 yield), those being 'earnings' that could not increase during the ensuing five years.
We made the sale in order to move our money into a single security ' Berkshire ' that, in turn, owned a diversified group of solid businesses. Fueled by retained earnings, Berkshire's growth in value was unlikely to be less than 8% annually, even if we were to experience a
The Annual Meeting
The annual meeting falls on May 5th and will again be webcast by Yahoo!, whose web address is https://finance.yahoo.com/brklivestream. The webcast will go live at 8:45 a.m. Central Daylight Time. Yahoo! will interview directors, managers, stockholders and celebrities before the meeting and during the lunch break. Both the interviews and meeting will be translated simultaneously into Mandarin.
Our partnership with Yahoo! began in 2016 and shareholders have responded enthusiastically. Last year,
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 Friday, May 4th, our Berkshire exhibitors at CenturyLink will be open from noon until 5 p.m. We added that extra shopping time in 2015, and serious shoppers love it. Last year about 12,000 people came through the doors in the five hours we were open on Friday.
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 43% from 2016.
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
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 most airlines substantially increase prices for the Berkshire weekend. 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
The period's special pricing will even apply to the products of several prestigious manufacturers that normally have ironclad rules against discounting but which, in the spirit of our shareholder weekend, have made an exception for you. We appreciate their cooperation. During 'Berkshire Weekend,' NFM will be open from 10 a.m. to 9 p.m. Monday through Saturday and 11 a.m. to 8 p.m. on Sunday. From 5:30 p.m. to 8 p.m. on Saturday, NFM is hosting a picnic to which you are all invited.
NFM will again extend its shareholder's discount offerings to our Kansas City and Dallas stores. From May 1st through May 7th, shareholders who present meeting credentials or other evidence of their Berkshire ownership (such as brokerage statements) to those NFM stores 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, April 30th through Saturday, May 12th. 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 afternoon, on the upper level above Borsheims, we will have Bob Hamman and Sharon Osberg, two of the world's top bridge experts, available to play with our shareholders. If they suggest wagering on the game, change the subject. Ajit, Charlie, Bill Gates and I will likely drop by as well.
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. 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.) I will participate on an advisory basis only.
Gorat's will be open exclusively for Berkshire shareholders on Sunday, May 6th, serving from 12 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 Gary Ransom of Dowling & Partners. 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. After the 54th, all questions come from the audience. Charlie and I have often tackled more than 60 by 3:30.
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 that information 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
If managers (or directors) own Berkshire shares ' and many do ' it's from
We continue to have a wonderful group at headquarters. 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 at the annual meeting in whatever way they are needed. They are proud to work for Berkshire, and I am proud of them.
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I've saved the best for last. Early in 2018, Berkshire's board elected Ajit Jain and Greg Abel as directors of Berkshire and also designated each as Vice Chairman. Ajit is now responsible for insurance operations, and Greg oversees the rest of our businesses. Charlie and I will focus on investments and capital allocation.
You and I are lucky to have Ajit and Greg working for us. Each has been with Berkshire for decades, and Berkshire's blood flows through their veins. The character of each man matches his talents. And that says it all.
Come to Omaha ' the cradle of capitalism ' on May 5th and meet the Berkshire Bunch. All of us look forward to your visit.