Value Investing

Berkshire Hathaway 2015 Annual Meeting Notes

Berkshire Hathaway 2015 Annual Meeting Notes By Ingrid R. Hendershot, CFA – Hendershot Investments

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We attended the Golden Anniversary Berkshire Hathaway annual meeting held on May 2, 2015, in Omaha, along with a record crowd of more than 40,000 other folks from around the globe who gathered once again for the Woodstock for Capitalists. Warren Buffett, Chairman of Berkshire Hathaway, and Charlie Munger, Vice-Chairman, answered questions from shareholders, analysts and the media. The meeting opened once again with an entertaining movie produced by John Landis of Trading Places that included humorous clips with Buffett and Munger acting with celebrities in skits featuring their brands, and ended with Warren Buffett, as the Berkshire Bomber, in the ring with Floyd Mayweather, welterweight boxing champion, in a parody of Mayweather’s fight which was scheduled later that evening with Manny Pacquiao.

Here are my notes from the annual meeting.

First Quarter Results

Warren Buffett began the meeting with a brief recap of Berkshire Hathaway's first quarter financial results (see our detailed first quarter analysis for Berkshire Hathaway on our website). Book value increased .5% from year end to $146,963 per A share. Insurance float as of 3/31/15 was approximately $83.5 billion. Operating earnings increased 20% to $4.2 billion during the first quarter. Burlington Northern Santa Fe (BNSF) did dramatically better in many measures as Berkshire Hathaway spent more money on the railroad. BNSF gained market share during the quarter. The trains are running again the way they should with huge improvement over last year.

Business Practices Of Clayton Homes And 3G Capital

Warren Buffett responded to the long-term shareholder with heartburn over “predatory lending practices” described in The Seattle Times article on Clayton Homes and the moral practices of 3G Capital, which gutted jobs at Tim Horton and Heinz when they took over the companies in partnership with Berkshire. The shareholder wondered what happened to capitalism with compassion historically practiced by Berkshire Hathaway.

Buffett noted there were important mistakes in the Clayton Homes article. Clayton follows an exemplary pattern and is extraordinary in home building and the mortgage business. The greatest cause of the housing bubble of 2008 occurred when the mortgage holder became totally divorced from the mortgage originator. The mortgage originator sold mortgages around the world and suffered no loss if loans went bad. At Clayton, unlike other builders, mortgages are offered to all buyers of their homes. Berkshire retains roughly $12 billion of mortgages on 300,000 homes. When a mortgage goes bad, the person who bought it loses and the person that owns the mortgage loses. Since Berkshire Hathaway retains 100% of the mortgages, they have the same interest as the buyer. Berkshire has no interest in selling anyone a house where the mortgage will default. There has been much talk in terms of possible changes in mortgage rules - not making mortgage loans to people who will get in trouble on the loans. Most Clayton home buyers are lower income buyers who would not be able to have a home without Clayton financing. At Clayton, they lend intelligently to people who can make payments and keep the house. Clayton is exemplary in doing that. However, about 3% default, which may be due to death, divorce or the loss of a job. In those cases, Clayton loses money, and the person who bought the home loses money. However, 97% of Clayton homebuyers don’t default. Buffett advised folks to take a look at the 1200 square foot Clayton house on display at the meeting. For $69,500, the house, complete with appliances, will be transported and ready to go. The home buyer only needs land, which may cost another $25,000. This represents a decent value with Clayton putting their own money at risk to help the homeowner finance the home.

Buffett read The Seattle Times article, which said Berkshire Hathaway was making a 20% profit on the homes which he knew was “nonsense.” The statement in the affidavit mentioned in the article discussed a gross profit of 20%. The report confused the difference between gross profit and net profit. Net profit includes operating expenses and taxes. Clayton’s gross margin is 20%, however, the pre-tax margin is 3% and the net profit margin is just 2%. Clayton always provides buyers the lending terms available from a variety of lenders. Buffett displayed a copy of the one-page document with no small print on it with a list of four or five lenders. Buffett exclaimed that he makes no apologies about Clayton’s lending terms, noting that he has not received one call from any party in connection with a Clayton home complaint in the last three years.

Buffett noted that Clayton Homes is regulated in almost every state. During the last three years, they have had 91 examinations by various states to make sure they conform to state laws. The largest fine from all the exams has been $5,500 with $110,000 issued in refunds. Most borrowers have FICO scores below 620, with the average principal and interest payment approximating $600 a month. Buffett concluded that he is proud that Clayton Homes’ management has put 30,000 people into homes at a low cost. A high percentage of those folks will have their homes paid off probably in 20 years or less. Clayton Homes have been a real bargain.

Charlie added that he did not know much about the lending practices of Clayton Homes. He did acknowledge that they sold an enormous amount of homes and had 50% market share among manufactured homes, which is a very efficient way to create houses. He also noted that Clayton is a very productive part of the economy. He stated, “You can't make lending to poor people buying houses 100% successful.”

Buffett agreed as death, divorce, and loss of a job impacts the financial ability to make mortgage payments –noting it happens with high-priced houses, too. It happens to people living on the edge. During the 2008/2009 recession, the default rate on regular homes in all kinds of securitized deals was many times more than what happened at Clayton Homes.

Turning to 3G management practices, Buffett said 3G people are successful in building marvelous businesses. They entered into purchases where there were more people running the business than needed. After a reduction of people needed, the companies did well. Burger King outgrew its competitors by a significant margin. Buffett stated, “I don't know any company that has a policy that says we will have a lot more people than we need. I hope our Berkshire Hathaway companies are not being run with more people than we need.”

Charlie agreed that businesses need to be right-sized. He explained what happened in Russia. Some workers said, “They pretend to pay us, and we pretend to work.” With that approach, an economy does not work. Charlie concluded, “Of course, we want the right number of people in the right number of jobs.”

Buffett recounted that in the past, 1.6 million people worked in the railroad business which was a lousy business. Today, less than 200,000 folks work in the railroad business, which is now carrying more freight, covering more distance and doing it in dramatically safer conditions. Buffett concluded, “Efficiency is required over time in capitalism. I tip my hat to the 3G people.”

In another question on whether 3G management methods were congruent with Berkshire’s methods, and whether 3G management would cut jobs at Berkshire Hathaway if they managed Berkshire’s business, Buffett commented that GEICO, with 33,000 employees, is run just as efficiently as 3G. They don’t believe in having extra people around. Buffett noted that Berkshire newspapers had to cut back employees, and that Berkshire Hathaway cut back employees in the textile business in the early days of the company. Buffett acknowledged that some Berkshire businesses may have more people than needed, but they do not believe in running fat operations. Berkshire’s owner manual never endorses running a business at a loss to have excess people around. Buffett boasted, “Our corporate office has 25 people!”

Charlie grumbled, “We've almost exhausted this topic. Waves of layoffs frighten people. What would our country do if we kept everyone on the farm?” Businesses need to be right-sized.

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Van Tuyl Acquisition

Buffett was asked whether Van Tuyl will need to adapt to a new mode of selling cars versus the traditional dealership model of selling cars.

Buffett responded, “If change is required, it will be made.” The one-price selling method has been experimented with before with no negotiating and no haggling. When you implement that system for some reason it breaks down. Negotiation is going on in a lot of businesses. Van Tuyl will adapt to what the customer wants. There is no problem at all if the world goes in that direction. However, Buffett noted he wouldn’t be surprised if the system remains the same for the next 5-10 years. He thinks Berkshire Hathaway Automotive, the new name for Van Tuyl, will be quite profitable and important to Berkshire Hathaway. Buffett noted that people want to negotiate when dealing with a big ticket item, whether it is cars, jewelry or real estate. He concluded, “We will do fine, whatever direction it goes.”

Answering another question on the synergies of acquiring more dealerships, Buffett said there are not huge advantages in owning lots of dealerships. Running dealerships well is a good business. Dealerships are local businesses with 17,000 dealers in the country. Berkshire Hathaway will be buying more dealerships but on a local basis. You don't widen profit margins by having 1,000 dealers vs. having 100 dealers or having just one. While Berkshire is able to borrow money at a low price, they do not plan to be in the auto finance business. Wells Fargo has a huge advantage as the largest provider of auto loans. Berkshire can’t come up with money as cheaply as the banks. They just hope that they run the local auto dealer operations very well.

Charlie added that Van Tuyl has a system of meritocracy--getting the right people into power and ownership. He said Van Tuyl and Omaha-based Kiewit are “kissing cousins” in terms of culture. They both have a very good thing going for them with the right people prospering.


In a related question on whether there may be national synergies between Van Tuyl and GEICO, Buffett said he didn’t think so. Most of the time synergies do not work especially with auto dealers and insurance. If Berkshire were to try and create synergies, they would probably have to compensate people that made the insurance sales. GEICO is a wonderful low-cost business model with its success dependent on delivering low costs and first-class service. The two companies will do better operating independently.

Charlie said. “I agree it's a dumb idea and we are not going to do it.”

Characterisitcs Of A Good Company

A shareholder asked if there were five characteristics of a company that gives one confidence to predict its earnings 10 years out in the future?

Charlie responded, “We don't have a one-size fits all. Every industry is different. We keep learning. What we did 10 years ago, we hope we are doing better now. We can't give you a formula.”

Buffett added that many items are considered before making a purchase. Most of their filters stop them from buying a business. Very different filters apply to different business, but they try to get a reasonable fix on what the business will look like in 5-10 years. It's not the same five questions. However, one question is, “Do we really want to be in a partnership with the management of this business?” If not, that will stop any further consideration. Buffett laughed, “We don't have a list of five. If we do, Charlie has kept it from me.”


In response to a similar question, Buffett said he looked for companies where he thought he could understand what their future was like. He added, “We had to know our limitations. We stayed away from a lot of things.” At the time, prices were different. It was a much easier decision than it is now. During the early years, Buffett said, “We kept reading and thinking, looking at things that came along, and in those days we were capital constrained. We usually had to sell something if we were to buy something else. We probably leaned toward things that we were certain to get a decent result than hopeful of getting a billion dollar result.”

With regard to the GEICO acquisition, Charlie added, “We had some good fortune. Not every 20-year old was going to buildings in Washington. We made some of our luck.” “Getting your own nose whacked hard also helps,” he chuckled.

Buffett agreed noting that they thought they knew more than they did about the Baltimore department store business that did not work out well for them. He stated, “We've had a lot of experience with bad businesses which sharpens your ability to make a distinction between good and bad ones. If you enjoy what you're doing, you're likely to get better results.”

Charlie concluded, “We owe a considerable amount to the families we were raised in.”

Convincing Early Investors

A similar question asked, “How were you able to persuade your early investors besides family and friends to overcome doubts and fears and believe in what you're doing?”

Buffett joked, “We didn't do very well prior to getting a winning record. I started selling stocks when I was 20. I looked like I was 16 and behaved like I was 12.” People joining Buffett early on as investors were family and friends. They had faith in him. His father-in-law was a dean at the University of Omaha and gave Buffett everything he had to manage. They knew he had done reasonably well by 1956. He had about $175,000 at a young age so they figured he was doing something right, and they gave him their money. Ben Graham was winding up his partnership and recommended Buffett to his investors. A year or two later, a doctor family friend called and introduced Buffett to Charlie. At the time, Charlie was practicing law. Buffett told him law was all right for a hobby, but a lousy business.

Charlie stated matter-of-factly, “Of course, that's the way you start [with family and friends]!” The people that avoided being “perfect idiots” and followed the Graham & Dodd investment path have all done well.

IBM

Charlie was asked if he tried to talk Buffett out of buying IBM.

Charlie emphatically said, “No!” He added that Berkshire Hathaway has owned lots of companies with temporary reversals, and that IBM is a very interesting company. It’s very rare when technology changes comes along that people adapt as well as IBM. Personal computers have been a mixed bag. However, IBM is an enormous enterprise and admirable.

Buffett said, “When we bought IBM, it was a 2-0 vote.” Buffett noted that they get asked questions about investments we own. However, they have no interest in encouraging other people to buy what they buy. He asked, “Why would we want the stock to go up if we're going to be buying more in a year or so?” He joked, “If we were talking our book, we would say pessimistic things about our Big Four investments as they all are buying back their shares.”

In classic Charlie fashion, Charlie chimed in with this zinger, “If people weren't often wrong, we wouldn't be so rich. “

Insurance Success At Berkshire Hathaway

Buffett noted he had three pieces of extraordinary luck in establishing a successful insurance business at Berkshire Hathaway :

1) When he was 20 years old, he traveled to Washington DC on a Saturday morning and banged on GEICO’s door until a janitor opened the door. The only fellow working there was Lorimer Davidson, the CEO, who was willing to spend four hours with a 20-year old kid, explaining the insurance business to him. Buffett said he couldn't have gotten better lessons than that in business school.

2) In 1967, Jack Ringwald got mad about something and wanted to sell his company. That is how Buffett bought National Indemnity. He said he couldn't have done it an hour later as Ringwald would have likely changed his mind as he had done in the past.

3) In the mid-1980s, on a Saturday, a guy came in the Berkshire Hathaway office looking for a job, who had never worked in the insurance business. Buffett hired Ajit Jain and asked how lucky can you get?
Buffett asked what are the odds of pulling off a trifecta like that? The insurance business was in a sweet spot of a business Buffett could understand. He said it is important to keep yourself open to good business ideas as they come along.

Charlie added that Berkshire Hathaway created its reinsurance business in Omaha, and it has turned into a huge business.

Berkshire Hathaway Culture

When a German investor asked how Berkshire Hathaway's culture will be maintained, Buffett simply stated, “You will be pleased with Berkshire’s culture after we are gone.” Berkshire’s culture runs as deep as could be in any large company. Buffett explained how Berkshire recently closed on a German transaction in which the family lovingly built a business over 35 years that owned retail shops, dealing with motorcycle owners. After the husband died a couple years ago, the wife wanted to sell to Berkshire Hathaway because of its culture. That wouldn’t have been the case 30-40 years ago because Europeans would have been unaware of Berkshire’s culture.

It is a vital part of Berkshire Hathaway to have a deeply embedded culture. It is even reflected in Berkshire shareholders, where 97% of them voted against a dividend. Berkshire directors also reflect the culture as they see their role as a great opportunity for stewardship, rather than serving as directors for the money. People who join Berkshire believe in the culture. People that shun Berkshire don't believe in it. Buffett is “virtually certain” that Berkshire’s culture will continue and become stronger as it has become self-reinforcing over the years. It's institutionalized. No one will doubt that it will last for decades.

Charlie added that Berkshire Hathaway has had a hard time buying companies in Europe. Traditions are different in Europe than in the U.S. and some other countries. Germany has a long tradition of being good at technology and capitalism. Charlie stated, “We admire the way Germans have performed. They work fewer hours and produce a lot more. Of course, Warren and I are pretty good at that. We admire the Germans, particularly the engineers.”

Buffett agreed but said that he thinks Berkshire is now more on the European radar screen as a potential acquirer than they were a few years ago. He said he’d be surprised if Berkshire doesn’t make more deals in Germany within the next five years. He said Berkshire needs a business they understand. Berkshire has the money, and European prices may be a little more attractive. There's a reasonable chance something might get Buffett’s attention in Europe given comparatively more attractive valuations than in the U.S.

Charlie added, “Berkshire will do fine after we are gone. In fact, it will do better in dollar terms. We will never gain as much in percentage terms as we did in the beginning years. There is a worse tragedy than having Berkshire Hathaway's growth slow a little.”

Buffett laughed, “Name one!”

Berkshire Hathaway decentralization
Chart via Larry Cunningham

See full notes below.

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