We attended the Berkshire Hathaway (NYSE:BRK.B) annual meeting held on May 3, 2014 in Omaha along with a record crowd of about 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. Here are a few highlights from the meeting.
First Quarter Results
Warren Buffett began the meeting with a brief recap of Berkshire Hathaway's first quarter financial results with operating earnings down 7% and net income down 4% (see our detailed first quarter analysis for Berkshire Hathaway on our website). Book value increased 2.6% from year end to $138,426 per A share. Insurance float as of 3/31/14 was approximately $78 billion. Buffett noted that the $78 billion in float was his to invest and that the underwriting profits were satisfactory in the first quarter. He added, "The insurance business is marvelous!"
The proxy this year included a shareholder proposal for Berkshire to pay a "meaningful" dividend. "Whereas the corporation has more money than it needs, and since the owners unlike [Warren Buffett] are not multibillionaires, the board shall consider paying a meaningful annual dividend on the shares," the proposal stated. The proposal was soundly defeated by shareholders. Buffett marveled that by a vote of 45 to 1, Berkshire shareholders said, "Don't pay us a dividend." Shareholders believe Buffett can create much more value by reinvesting the bountiful cash Berkshire generates than by distributing it as a dividend.
Five Year Performance
Buffett was asked about Berkshire's book value growth lagging the S&P 500 index over the last five years. This was the first time that Berkshire's book value performance lagged the S&P 500's performance over a rolling five-year period. Buffett explained that Berkshire will likely underperform in very strong years for the stock market, match the S&P 500 in moderate years and will outperform in down years. Over any market cycle, Buffett expects Berkshire will continue to outperform the S&P 500 index. Charlie noted that Berkshire's book value performance is after full corporate taxes while the S&P 500 index performance is without taxes. He said Buffett has set a "ridiculously difficult standard" and still beat it over time. Charlie concluded, "If this is failure, I want more of it!"
Spin Off Berkshire Units?
A shareholder asked if Buffett would consider spinning off units to help narrow the discount between Berkshire's intrinsic value and stock price. Buffett said the simple answer is "No!" He did admit that there is a significant discrepancy between the firm's intrinsic value and book value. As a specific example, he noted that GEICO is carried on Berkshire's books at approximately $1 billion when he believes the intrinsic value is closer to $20 billion, which will grow larger in the future. Buffett said one way to narrow the gap is to buy back Berkshire Hathaway shares when they are trading at 1.2 times book value or less, which he considers a "bargain."
Charlie commented that they never have wanted to get Berkshire's stock to trade way over intrinsic value. He added that folks that want the stock to trade over intrinsic value want "egg in their beer." However, he predicted that "Berkshire's stock will trade above intrinsic value over the long term whether we like it or not."
Buffett was asked if he would consider selling positions in Wells Fargo (NYSE:WFC), Coca-Cola (NYSE:KO) or IBM if a large acquisition became available. Buffett said those investments could become a source of funds, although it was unlikely. He would likely sell some of his smaller investment positions first, if needed. He added that Berkshire's goal is to buy really big businesses with the objective of building the company's earnings power every day. Big acquisition opportunities don't come along that often. If Buffett needed the money to do a big deal, he could dip into his marketable securities, although with $40 billion in cash, it has not come to that. Berkshire would have the capacity today to do a $50 billion acquisition without issuing equity. Charlie added that acquisitions are irregular, but Berkshire will get the opportunity to intelligently redeploy capital. Buffett remarked, "What really turns us on is buying businesses that will grow earnings for us 10-20 years from now."
Buffett was questioned about Berkshire's business model, given that it has more than 70 unrelated businesses selling everything from bricks to chocolate. Buffett explained that owning a group of good businesses is not a terrible business plan. Berkshire owns diversified and great businesses, which are conservatively capitalized and run by great management teams.
By having Berkshire's various businesses under one umbrella, Buffett is able to allocate capital to the businesses without tax consequences. For example, Buffett can move cash generated by See's Candies to other businesses which can more usefully employ the capital. This is what capitalism is all about.
Charlie said Berkshire has alternatives for its cash. If they cannot find businesses to acquire, they can buy marketable securities. He stated, "Berkshire is not a standard conglomerate and will likely continue to do well." No one has the same business model as Berkshire in terms of buying wonderful businesses.
Charlie emphasized that Berkshire's business model "has legs" and will go on for a long time. It is a credible business model with enough advantages to last a long time. He said Berkshire will "keep doing what we are doing and learn from our mistakes." The momentum and ecosystem are in place. He advised young folks, "Do not be too eager to sell Berkshire stock."
There are not more copycats of Berkshire's business model because there is nothing in business school that teaches them about the business model. Buffett added that it also is a slow process that takes patience, which deters people from copying the model. Charlie chuckled, "The problem with being slow is that you are dead before it is finished."
GEICO's Market Share
A shareholder noted that GEICO has the largest advertising budget in the auto insurance industry and has increased its market share to 10% compared to State Farm's 19% market share. Buffett was asked if GEICO would overtake State Farm. He responded that GEICO passed Allstate (NYSE:ALL) this year in terms of market share to become the number two player in the industry. Buffett said, "If I live to be 100, projections are for GEICO to be number one in the industry." Buffett joked that he has told GEICO employees that he will do his best to live up to his part of the deal. He added that Tony Nicely, GEICO's CEO, deserves to be in the Hall of Fame. He has taken GEICO's market share from 1%-2% in 1993 up to 10% today, and the market share will continue to increase. Charlie noted that GEICO is like Costco. They both feel they have a "holy duty" to have great products at great prices. They then tend to do well and take market share. It is easy to "talk this game, but difficult to live this game."
Decisions During Panic
Buffett was asked about his investment decisions during the financial panic of 2008/2009. Buffett said Berkshire cash was spent too early during the panic with the low in the market being set in March 2009. He had already committed $6 billion to Mars to help finance Wrigley and then spent another $16 billion in Sept./Oct. 2008 with other deals like Goldman Sachs and GE.
He noted, "We did not do as remotely well with these investments as we would have if we had spent all the dollars at the bottom, but we don't know how to time the market. We did buy BNSF during the period so we did do reasonably well." Berkshire's goal is to buy big businesses with good management at reasonable prices and build them over the long term. When Berkshire is right about the private businesses it acquires, it will show up in the firm's earnings power over the long term.
Charlie added that when Berkshire buys private businesses, they can put huge chunks of cash to work. They cannot invest that much in common stocks. Charlie chortled, "I love it when we buy transmission lines in Alberta. Nothing will happen to Alberta!" Change at Berkshire is inevitable. How Berkshire adapts to it is all important.
(For a complete copy of all our notes from the 2014 Berkshire Hathaway annual meeting, please see our website.)
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Disclosure: The author is long BRK.B. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.