After twelve successful years, with the stock market vastly overpriced in his opinion, Warren Buffett outlined the windup of Buffett Partnership, Ltd., in October 1969. Partners would get a payout consisting of at least 56 percent cash, possibly some scraps of stock in assorted companies, and an estimated 30 to 35 percent, for those who chose not to have them sold for cash, in two companies—Diversified Retailing and a New England textile company called Berkshire Hathaway. He added the discouraging, “For the first time in my investment lifetime, I now believe there is little choice for the average investor between professionally managed money in stocks and passive investment in bonds.”
As I reread Buffett’s letter today I see no clue now, nor did I then, that Berkshire Hathaway would become the successor to Warren’s partnership. Ralph Gerard, a longtime investor with Buffett and the man who introduced us, never did, either. Of the $100 million distributed to partners, about $25 million was Buffett’s. He eventually ended up with nearly half of Berkshire’s stock.
Berkshire was what Buffett and his mentor Benjamin Graham called a cigar butt—you can pick it up cheaply and get one last puff. As Forbes said in 1990, in its characteristic shorthand, “[Buffett] bought Berkshire Hathaway textile mills 1965 ($12/share), dissolved partnership 1969 after thirty-fold growth, decided to use Berkshire Hathaway as prime investment vehicle. Textile business floundered (ceased operations in 1985) but investment business boomed.”
Focused on Princeton Newport, I lost track of Warren after 1969. Then in 1983, I heard about the remarkable growth of a company called Berkshire Hathaway. Not knowing it was to become Warren’s investment vehicle, I had stopped paying attention to it back in 1969. The stock price then was $42 a share, if you could find anyone to trade with. It was now publicly trading at over $900. I knew at once what this meant. The “cigar butt” had become a humidor of Havanas. Despite its having increased by a multiple of more than 23 in fourteen years, I made my first purchase at $982.50 a share and continued to accumulate stock. By contrast, in 2004 I was talking to a bank president in San Francisco when he mentioned that his mother had been a limited partner in Buffett Partnership, Ltd., and received some Berkshire stock as part of her distribution when the partnership closed. “That’s wonderful,” I said. “At today’s prices [then $80,000 a share or so] she must be very rich.” “Sadly,” he said, “she sold at $79 for a several hundred percent profit.”
If asked for advice, I recommended the stock to family, friends, and associates with the understanding that it was a long-term holding with a possibly volatile future. I didn’t suggest it to those who couldn’t understand the reasoning behind the purchase and who would be scared by a big drop in price. The response was sometimes frustrating.
In 1985 our divorced house cleaner, Carolyn, got $6,000 as a settlement from an automobile accident. She wanted to invest it to send her children, aged five and six, through college. Week after week she pleaded with me to advise her, but as she knew absolutely nothing about securities or investing, I declined. Urged on by her fortune-teller, who told her that I would double or even triple her money, she persisted. In a weak moment I relented, provided that if she bought the stock I recommended, she would never sell before checking with me. I arranged low commissions for her, as a favor to me by a broker friend, and she bought two shares of Berkshire Hathaway (BRK) for $2,500 each. She later left housecleaning for office work and we lost touch with her. Meanwhile BRK rose to about $5,000 a share just before the October 1987 crash. I learned later from the broker that Carolyn had sold near the post-crash bottom at $2,600 a share. Sixteen years later, in the first quarter of 2003 at the time her children might have been finishing college, the stock ranged between about $60,000 and $74,000 a share.
My wife and I, our oldest daughter, Raun, and her husband, Brian, their daughter Ava, and my son, Jeff, decided, at Jeff’s suggestion, to go to the May 2003 annual meeting held, as always, in Warren’s hometown of Omaha, Nebraska. I wrote Warren ahead of time, mentioning that we were coming and that seven-year-old Ava, also a shareholder, had questions for him. Although we hadn’t been in contact since 1969, he remembered our meetings fondly and said to tell Ava that he would “bone up” so he’d be ready for her questions.
The shareholders’ meeting was on a Saturday morning and we flew in the previous Thursday, expecting to leave, variously, on Sunday and Monday. The small annual shareholder meetings of thirty years earlier had grown into a huge multiday celebration featuring “Berkshire millionaires” and informally known as “Woodstock for capitalists.”
We began by sampling from the array of Berkshire companies including Dairy Queen (a chain of ice cream confection stores), Borsheims jewelry (the largest independent jewelry store) and its special “annual meeting weekend” rates for shareholders, Nebraska Furniture Mart (the largest independent furniture store), and of course See’s Candies, a California favorite. Every Berkshire company employee whom we encountered—and they were many and diverse—seemed competent, courteous, and well trained, a remarkable fact, the learning of which in itself (considering the size of our stake) made the trip worthwhile. Friday night we went to Gorat’s Steak House, Buffett’s favorite, and had a large and delicious T-bone with trimmings for…$18.95. Buffett and his business partner, Charlie Munger, were scheduled to eat there Saturday night at a special shareholders’ dinner, so we booked that, too.
Saturday’s meeting began at 7:30 A.M. with a video for the early arrivals. We slept in and ambled over to the Omaha Civic Auditorium just before 9:30, when Warren and Charlie would take the stage. On the way we passed several incoherently screaming protesters—a first?—wearing signs accusing Warren and the company of supporting infanticide. They displayed bloody photos of aborted fetuses and incorrectly accused the company of being pro-abortion. The ironic consequences are reported below.
Finding the Omaha Civic Auditorium full with a crowd of fourteen thousand, we joined two thousand more in an overflow room. Warren and Charlie presented a concise account of Berkshire’s previous year, seen by us on a big-screen TV, and then answered questions. There were ten microphone stations with long sign-up lists at each. Ava was ninth on the shortest list we could find. After an hour, the slow pace of the questions and answers made it evident that her turn would never come. On the way out we visited the extensive product exhibits by various Berkshire companies. You could buy See’s Candies, sets of encyclopedias, and for $8 have your picture taken with a cardboard cutout of Warren. As Vivian said, “They’re not giving anything away.”
Berkshire has evolved from the simple stock-picking days of the 1960s into a conglomerate with three major parts. First there are common stockholdings in companies like Coca-Cola, Gillette, and The Washington Post. Second, there are wholly owned or controlled companies such as Wesco Financial, World Book Encyclopedia, and Clayton Homes. The 2003 annual report lists some sixty-six of these, with 172,000 employees, orchestrated by Warren and Charlie from a corporate office that has “swollen” to sixteen employees. Third and perhaps most important is the insurance segment consisting mostly of GEICO and the reinsurance company General Re.
We headed for lunch and the NetJets exhibit at the local airport. Saturday night we were back at Gorat’s. The price of the T-bone dinner we had Friday was, as a “special for shareholders,” now $3 more. Charlie Munger reluctantly worked the room we were in and I mentioned to him a tale I’d heard about his youth. Charlie had gone to Harvard Law School and, when my friend Paul Marx got his degree there a few years later, he found that Charlie was a legend—with many saying he was the smartest person ever to have attended. As a first-year student Charlie was reported to have regularly intimidated professors. In a famous interchange, the professor called upon Charlie, who had not read the case at hand, to answer questions about it. Charlie’s immediate response was, “Sir, you tell me the facts and I’ll tell you the law.” While autographing my menu, Charlie said sadly, “That was a long time ago…a long time ago.”
Omaha turned out to be a surprising treat. A Midwest town that had peaked early in the last century, much of the city had migrated to the suburbs, leaving a quiet and spacious downtown. Sunday we visited Omaha’s fine art museum, featuring a spectacular photographic exhibit by Warren’s son Howard. Also interesting was the zoo, which had two large and distinct domed walk-through habitats. Sunday afternoon, tornado warning sirens sounded and everyone in the hotel was directed to the gym in the basement. As we waited out the storm, I exercised on the machines while my son-in-law Brian Tichenor went to the fourth floor and looked outside to see the horizontal counterweighted arms of multistory construction cranes spinning freely on their vertical supports. This protected them from being demolished by the tornado. Alternating waves of lower and higher pressure caused the soda in his hand to repeatedly fizz excessively, then not at all. The tornado wandered randomly through town, doing minor sporadic damage. The tornado belt, a region of mid-America from Omaha to Dallas, terrorizes residents with an average of eighty tornadoes a year, more than anywhere else in the world.
Flights out of Omaha were canceled. With thirty thousand people who had come for the Berkshire weekend missing flights and wanting to leave as soon as possible, it looked as if we would be delayed at least two days. We held a family conference and within an hour Jeff had chartered a private jet for us. The next morning we took a ten-minute ride to the local airport and boarded in minutes—no wait, no lines, no luggage hassle, no TSA body scans and searches. We had two engines, two pilots, a flight attendant, and a good lunch. Seven-year-old Ava spoke for everyone when she declared she never wanted to fly any other way again. Whereas it took ten hours to reach Omaha from Newport Beach, California, including hours of delay in Dallas due to thunderstorms, we got home in two hours.
For many years Berkshire had a shareholder-directed charitable contribution program. Each year the company allowed each A shareholder to donate $X, where $X was $1 a share at the start and gradually increased to something like $18 a share. Shareholders allocated their amounts to charities chosen by them, not management, and Berkshire sent the money. As a result of the antiabortion protests at this annual meeting and the related boycott of a Berkshire company, the program was discontinued. The antiabortion protesters succeeded in eliminating not only shareholder contributions supporting family planning, but those to other charities as well, including organizations the demonstrators themselves favored.
To decide whether to buy Berkshire one can do a little analysis. Berkshire, as remarked earlier, has three major parts. First are the positions in publicly traded companies like Coca-Cola, The Washington Post, and Gillette. The securities markets price these every day. Is this Buffett portfolio worth more than, less than, or the same as its market price? Should one add a premium for Buffett’s market timing and stock-picking prowess?
Second are numerous wholly owned companies such as See’s Candies, Clayton Homes, and NetJets. We can value these by applying the principles of security analysis to the balance sheets, and by considering the growth rates of the companies, their “franchise value,” and the quality of management.
The third component is the insurance group, with GEICO the most important. To value these non-public companies we use, in addition to security analysis as above, the value of the “float.” This is money paid as premiums that is currently being held to pay off future claims. Buffett invests this and has made a profit well in excess of the projected cost of claims. To the extent Warren makes superior returns on the float, as well as follows his practice of selling insurance when prices are high and stepping aside when competition drives prices down, the value of Berkshire is greater. For a few years prior to 2008 Berkshire had an uninvested cash surplus of as much as $40 billion, as Buffett found stocks generally overpriced. This “cash drag” slowed the price increase of Berkshire during that period. When the market collapsed in 2008, he put this money to work.
As Berkshire has grown, Buffett’s gain over the S&P 500 has diminished, as he predicted. Table 2, which covers my experience, shows this. The edge dropped in each new period. Beating the index in the future will be ever more difficult. There is also price risk arising from the uncertainty when Buffett ceases to manage Berkshire. Despite the likelihood that his replacements will be unusually talented, the stock price may fall sharply, perhaps for an extended time.
Not long after buying Berkshire, I began putting some of my PNP profits into other hedge funds. Networking with some of the smartest and richest people on Wall Street, sharing information and investment opportunities, I also gained the benefits of diversifying my personal portfolio.
Date |
Price $ BRKA |
Elapsed Time |
Annualized Return |
Price $ S&P 500 |
Annualized Return |
BRKA Edge Per Year |
|
08/10/83 |
980.50 |
——— |
——— |
161.54 |
——— |
——— |
|
01/31/90 |
7,455 |
6.48 years |
36.8 % |
329.08 |
11.6 % |
+25.2 % |
|
04/30/99 |
76,400 |
9.25 years |
28.6 % |
1335.18 |
16.3 % |
+12.3 % |
|
01/23/09 |
86,250 |
9.73 years |
1.3 % |
831.95 |
−4.7 % |
+6.0 % |
|
04/12/16 |
215,360 |
7.22 years |
13.5 % |
2061.72 |
13.4 % |
+0.1% |
* I chose the dates for the first three periods because the price graphs suggested that they were natural divisions. The fourth and last period covers the aftermath of the Great Recession.