Berkshire’s share price, though unpredictable from year to year, will itself outpace the S&P over time

from Warren Buffett – Letter To Shareholders 2012 on Rap Genius

Meaning

Buffett’s selection of the S&P 500 stock market index is one of the most fascinating aspects of how carefully he manages the public perception of Berkshire’s performance.

Outside analyses of Berkshire’s economic performance have calculated that Berkshire’s use of insurance float for its investing activities has the same effect on Berkshire’s equity investing performance as straight 1.6 to 1 leverage.

And like leverage, the insurance business brings with it risks that a normal investor investing unlevered cash in the stock market would not bear.

So to really evaluate Berkshire’s investing track record objectively, you would have to compare it to another investor investing with 1.6 to 1 leverage, or using similar levels of insurance float. Buffett never does this, and outside observers only rarely do.

As a result, Berkshire’s investment track record is not nearly as good as it looks, particularly as its insurance operations have expanded over the years. This is not to take away from Buffett’s long-term success, but rather to qualify it in an important way.

One open question is why more investors do not use the Berkshire structure. Your editor believes this may be the most interesting question about Berkshire overall.

See also:
http://www.econ.yale.edu/~af227/pdf/Buffett%27s%20Alpha%20-%20Frazzini,%20Kabiller%20and%20Pedersen.pdf

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