You can read Warren Buffett’s latest letter to shareholders of Berkshire Hathaway here [PDF], but in the meantime, I’ve provided my key takeaways below. Leave your key takeaways in the comments below!

On Succession

This is the big one everyone is talking about. Buffett has announced that his ultimate replacement as CEO has been chosen and approved of by the Board. Though this is newsworthy, I think the more important point here for most investors is the following:

The primary job of a Board of Directors is to see that the right people are running the business and to be sure that the next generation of leaders is identified and ready to take over tomorrow.

Takeaway: It is hard to underestimate the importance of the Board of Directors in holding management accountable and particularly in devising an adequate succession plan. For larger companies, this is usually not an issue (though, Hewlett-Packard (NYSE: HPQ) does come to mind), but many value investors focus on relatively unfollowed small caps which are often family-led endeavours. Most family-run companies do a poor job of succession management, and the knee jerk reaction is to keep family members, however unqualified, in leadership positions. When making your investment decisions it is important to focus on whether the Board of Directors is adequately fulfilling its primary obligation of ensuring both that the right people are running the business (rather than say, nepotism) and whether this will continue to be the case when the current leaders retire or die.

It is worth noting that succession can also be a source of opportunity. If you recall, Conrad Industries’ (PINK: CNRD) 95 year old founder is still the co-Chairman of the Board. His children have successfully started their own businesses. The odds are low that the children, even if they wanted the company to be sold (similar companies have been sold in the last two years at significantly higher multiples than CNRD has traded at), would sell while their father is alive. It could be that his ultimate passing could be a catalyst for change at CNRD.

On Insurance

Buffett again outlines the key reasons why insurance can be such a great business for investors:

Our insurance operations continued their delivery of costless capital that funds a myriad of other opportunities. This business produces “float” – money that doesn’t belong to us, but that we get to invest for Berkshire’s benefit. And if we pay out less in losses and expenses than we receive in premiums, we additionally earn an underwriting profit, meaning the float costs us less than nothing. Though we are sure to have underwriting losses from time to time, we’ve now had nine consecutive years of underwriting profits, totaling about $17 billion. Over the same nine years our float increased from $41 billion to its current record of $70 billion. Insurance has been good to us.

Property-casualty (“P/C”) insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers’ compensation accidents, payments can stretch over decades. This collect-now, pay-later model leaves us holding large sums – money we call “float” – that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit. Though individual policies and claims come and go, the amount of float we hold remains remarkably stable in relation to premium volume.

If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit occurs, 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 in most years that it causes the P/C industry as a whole to operate at a significant underwriting loss.

If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit occurs, 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 in most years that it causes the P/C industry as a whole to operate at a significant underwriting loss.

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 evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that will deliver a profit, on average, 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 their competitors are eagerly writing. 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.

Takeaway: Insurance can be a fantastic, if difficult, business in which to operate and especially if the right value-focused manager is at the helm. The unique nature of its float is like catnip for long-term investors. For greater discussion of insurance, I suggest reading the annual letters of Prem Watsa of Fairfax Financial (found here).

On Investing and Risk

He reiterates his definition of investing and investment risk.

Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.

Takeaway:  Value investors should have these concepts internalized.

On Share Repurchases

Buffett discusses the conditions under which share repurchases should take place, and the frequent abuse that he has witnessed in the market:

Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.

We have

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