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many of their businesses having enjoyed record levels of both earnings and cash Warren Buffett – Letter To Shareholders 2012

10,851

11 years

One of the oddities of the depressed economic environment of the last five years – in the wake of the financial crisis of 2007-2008 and the European meltdown – is that many American companies have reported extraordinarily high levels of earnings and cash. As a result, cash levels on corporate balance sheets are at all time highs. This is in sharp contrast to the moods of both management and shareholders.

One hypothesis is that we are seeing a long-delayed payoff of productivity improvements from the new generation of information technology, specifically PCs and the Internet. Fearful companies under revenue pressure are using technology to improve efficiency and reduce headcount, thereby expanding margins. This is simultaneously good for consumers and bad for employment levels.

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dilution Warren Buffett – Letter To Shareholders 2012

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11 years

Unlike most investment funds, Berkshire is of course a company with its own stock. Many of Buffett’s acquisitions are done with cash, but this particular acquisition used newly issued Berkshire stock. This diluted the value of all of the existing Berkshire stock – including Buffett’s own substantial holdings.

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warrants permitting us to buy 5% of the holding company’s common stock for a nominal sum Warren Buffett – Letter To Shareholders 2012

10,851

11 years

This structure is used as a “sweetener” – it provides Berkshire with upside in the case where the underlying stock rises, with no risk of loss if the underlying stock falls. It’s a good term when you can get it.

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preferred shares Warren Buffett – Letter To Shareholders 2012

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11 years

In recent years, Buffett has been able to leverage the value of his reputation and credibility to demand preferred stock in several high-profile investment situations. This played out particularly dramatically in the 2008 financial crisis – for example, when he invested in Goldman Sachs preferred stock.

Preferred stock can be a safer way to invest as it can have debt-like characteristics while still providing stock-like upside.

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Berkshire’s share price, though unpredictable from year to year, will itself outpace the S&P over time Warren Buffett – Letter To Shareholders 2012

10,851

11 years

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.

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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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270

11 years

The leverage coming from the leverage-like effects of having a large amount of float is helpful but Buffett is still awesome.

First Buffett’s ability to generate low-cost, free or even profitable float is very impressive and a feat in itself. Most other insurance operations can’t match this.

Second, Buffett is still probably the greatest investor of all time. From the report you link to: “Among all stocks with at least a 30-year history from 1926 to 2011, Berkshire has realized the highest Sharpe ratio and Information ratio. If you could travel back in time and pick one stock in 1976, Berkshire
would be your pick.”

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419

11 years

Andreessen isn’t arguing that Buffet isn’t an incredible investor. He’s making the correct point that the benchmark Buffet uses to evaluate himself isn’t the correct one. This is important because it means that it’s not correct to just compare his raw results to some other non-leveraged investor’s raw results–which is what you’re ignoring by looking at just how he performs compared to other stocks. The question is how much better does he do, and who are the correct people to compare him to.

This isn’t only relevant to Buffet. Incorrect benchmark selection is a key issue in many asset classes. In fact, you could argue that venture capital is an example of this as returns are generally benchmarked against nothing (not that it wouldn’t be difficult/impossible to find an ideal benchmark).

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Ruben GLover

11 years

This is incredibly off-base. First off, isn’t this supposed to make things clearer? Marc uses a study from a finance academic (who use pseudo-science to explain markets) to explain something already very simple. Buffett is comparing to the S&P500 the growth of the book-value of the COMPANY, not his stock-picking. His company is currently worth $250B and does business in many different industries – what other benchmark is better than an index of the 500 largest companies in the US? The fact that he uses leverage – and he explains how it is very different from normal leverage because of Berkshire’s frequent underwriting profitability – does not mean Buffett should use a S&P500 * 1.6 benchmark or some other nonsense. By that logic, EVERY company should compare their performance to a benchmark multiplied by their own leverage ratio.

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Max Olson

11 years

Although Marc is correct that the investment results should be viewed in the context of using near-costless float as leverage, this has nothing to do with using the S&P 500 as a benchmark.

Comparing Berkshire book value growth to 1.6 * S&P500 results would be completely incorrect, for many reasons. For one, the S&P itself already has non-recourse leverage in all the companies that comprise it. Even not considering this, the float “leverage” is much safer and more non-recourse than margin or any other form of debt, and therefore can’t be compared.

As the commentor Ruben Glover mentioned, by this logic every company should compare their per-share book value growth (the ultimate determinant of value over time) to a leveraged benchmark. Again, this would be incorrect, no matter the company.

Now, you could argue that risk-adjusted returns are more comparable (i.e., investing in Berkshire carries more risk than investing in the S&P), but even then, you wouldn’t simply multiply the S&P’s returns by 1.6 (which would imply Berkshire was much more risky than the S&P).

Although Marc is correct that the *investment* results should be viewed in the context of using near-costless float as leverage, this has nothing to do with using the S&P 500 as a benchmark.

Comparing Berkshire book value growth to 1.6 * S&P500 results would be completely incorrect, for many reasons. For one, the S&P itself already has non-recourse leverage in all the companies that comprise it. Even not considering this, the float "leverage" is much safer and more non-recourse than margin or any other form of debt, and therefore can't be compared.

Now, you could argue that *risk-adjusted* returns are more comparable (i.e., investing in Berkshire carries more risk than investing in the S&P), but even then, you wouldn't simply multiply the S&P's returns by 1.6 (which would imply Berkshire was *much* more risky than the S&P).

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23 men and women who work with me at our corporate office Warren Buffett – Letter To Shareholders 2012

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11 years

Having only 23 people overseeing a company of Berkshire’s size and scope has to be some kind of record in business.

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101

11 years

Indeed. Only comparable company would be East India Company[1], which was managed by 24 directors.
[1] http://en.wikipedia.org/wiki/East_India_Company

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10,851

11 years

24 directors and the entire British military :-).

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116

10 years

Not to mention the lovely Indians that “Volunteered”, until Ghandi introduced a Union

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They are truly AllStars, who run their businesses as if they were the only asset owned by their families. Warren Buffett – Letter To Shareholders 2012

10,851

11 years

Buffett is well known in the business world for heaping gushing praise on his managers right up to the point when he fires them and drops them down the memory hole. Case in point, David Sokol.

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11 years

Dale Carnegie efficacy

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Ruben Glover

11 years

This is a proper example of your wild accusation? Sokol was accused of insider trading. How about the founder of NetJets, Richard Santulli, who was not performing well? http://www.cnbc.com/id/32289235/Warren_Buffett_039Reluctantly039_Accepts_Decision_By_NetJets_Creator_To_Step_Down

Again, wildly off-base. You’re making things less clear.

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a result far superior to that experienced by big-city dailies Warren Buffett – Letter To Shareholders 2012

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11 years

To use George W. Bush’s favorite phrase, this may be the soft bigotry of low expectations playing out in business.

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endorsed a presidential candidate Warren Buffett – Letter To Shareholders 2012

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11 years

Buffett refers here to the antiquated practice of newspapers endorsing political candidates, which in today’s world is about as meaningful as supermarkets or nail salons endorsing political candidates.

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Whatever works best – and the answer is not yet clear – will be copied widely. Warren Buffett – Letter To Shareholders 2012

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11 years

This assumes, of course, that there will be an answer. Buffett is not infallable – witness his prior misadventures in textiles and airlines.

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