Berkshire Hathaway Annual Shareholder Meeting

Someone is sitting in the shade today because someone planted a tree a long time ago.
– Warren Buffett, January 1991

This article is about innovative money making, which true to the underlying meaning of innovation is about creative use of already existing knowledge. As the Ghaff tree in the UAE desert below brings shadows in the heat of day, true fortunes are likely to be seeded over a very long period of time. This may sound boring or worrying to today´s impatient investors but measuring both return and risk, it is likely the best strategy over time. The likely outcome of current short term patience among investors is something I wrote about in the previous article “Margin call”.

Ghaff tree picture, courtesy of Hussein Al Amery

Warren Buffett, nick-named “The Sage of Omaha”, was born August 30th 1930. He is an American investor and philanthropist and he was the most successful investor of the 20th century, through his investment vehicle Berkshire Hathaway, where he  the chairman, CEO and largest shareholder. Click on the link above to see the companies homepage. It will be a chocking experience, but very telling about the frugal Buffett, who lives in a house he bought in 1958 and drives a modest 2006 Cadillac DTS. However as he is aging the car is up for auction, with the proceeds going to a good cause.

Buffet, who consistently ranks among the world’s wealthiest people, lives a lifestyle that has not changed much since before he before he made his billions. Underlying his legend is one simple fact: Buffett is a value investor. It’s the hallmark trait of both his professional and personal success.

Value Investing

Value investing is an investment paradigm that derives from the ideas on investment that Benjamin Graham began teaching at Columbia Business School in 1928 and subsequently developed in his 1949 book The Intelligent Investor.

In the book, Graham argued that investors should follow the philosophy of value investing, which would shield them from substantial valuation errors and teach them to develop long term strategies. About ten years ago, my friend Magnus Caspar gave me a copy of this book and its lessons holds just as well today, as it did in past decades. 

Although value investing has taken many forms since its inception, it generally involves buying securities that appear under priced by some form of fundamental analysis. In brief, it means avoid to buy shares in companies that are hyped or trendy or that looks good through technical analysis, and focus on buying assets that look good by the real numbers. Such securities may be stock in public companies that trade at discounts to book value, have high dividend yields, have low price-to-earning multiples or have low price-to-book ratios. Simple. Anyone with a bachelor degree in accounting can easily identify such companies on public stock markets. In the table below from The Economist we can see Berkshire Hathaway´s biggest controlling holdings in 2013.

How come then that investors overall do not follow Benjamin Grahams teachings and Warren Buffett´s example? One reason is people´s short term thinking today. In general, we do not have patience. We want it all and we want it now, is the catch phrase of ambitious people. Value investing means to buy assets and gradually see them increase in value over years and decades.  

The Investment Vehicle

Berkshire Fine Spinning Associates and Hathaway Manufacturing Co. merged in 1955. Warren Buffett first bought into the declining concern in 1965 and eventually ended up in control of it.

In 1967 Buffett officially made Berkshire Hathaway a conglomerate, using textile proceeds to purchase National Indemnity, the first of what would be the many insurance companies that provided Berkshire Hathaway’s cashflow and enabled it to continue acquiring.

Berkshire Hathaway has over the years consistently given its shareholders better return than most other investments. As can be seen in the graph below, showing the value of USD 100 invested in Berkshire Hathaway in 1976, compared with the value of the same USD 100 invested in the Standard C& Poor 500 index.

Academic studies of Berkshire Hathaway confirm that Mr Buffett does what he says he does. Berkshire Hathaway has beaten the market over the long run by investing in relatively low-risk stocks the market was under-pricing, according to “Buffett’s Alpha”, a study by three economists at Yale, Andrea Frazzini, David Kabiller and Lasse Pedersen.

The study found that when it comes to outperforming the market on a sustained basis, Berkshire Hathaway is arguably without equal. The company’s Sharpe ratio, a measure of return per unit of risk, is at 0.76 higher than that of any other share or mutual fund that has traded for a period of at least 30 years since 1926.

The study also says that decomposing Berkshires’ portfolio into ownership in publicly traded stocks versus wholly-owned private companies, the researchers found that the former performs the best, suggesting that Buffett’s returns are more due to competent stock selection and holding than to Buffett´s effect on management.

What is the secret of Buffett´s unique success story? It is not all that complicated. There are mainly three lessons to be learned.

1) Long Term Focus

Warren Buffett has said that his favourite holding period for an investment is to buy and hold forever. Living up to his words, a number of his positions have been in the Berkshire Hathaway portfolio for years and even decades, and as those holdings increase in value, so does Berkshire Hathaway.

Buffett once said, “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.” By focusing on the long term, short term hurdles, recessions and economic crises becomes less important, including the recent great recession.

In 2008 while many were fleeing the markets, Buffett wrote an opinion piece in the New York Times titled, "Buy American. I Am." He started the text by saying: “The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary. So … I’ve been buying American stocks.” He can say so with confidence, as he buys for the long term.

2) Diversification

Through his investments and subsidiaries, Buffett has expanded his reach into numerous investments in the global marketplace. By diversifying into sectors including health care, industry, finance and consumer goods, the Berkshire Hathaway has been able to weather market turmoil and profit in times of strength.

With the Capital Asset Pricing Model (CAPM) and following investment theories, students of financial economics, such as myself,  have been told that we should buy companies that focus on an industry or field that can be understood and mastered by the corporate management, and following such ideas Berkshire Hathaway can be seen as a pariah. However by looking at the company as an investment vehicle or very long term investment fund, that consistently invests an holds following value investment principles, the company´s diversified holdings does make sense. To judge book values of a company over time has nothing to do with what the company really does and the numbers do not lie. Warren Buffett and his team are experts on evaluating real numbers, disregarding short term marketing fads and hype.

3) Dividend

Berkshire Hathaway pays no dividend. However, yield-bearing companies still represent a majority of the holdings in Buffett’s portfolio. Aside from being leaders in their respective fields, Buffett positions, including giants like IBM, American Express, Coca-Cola, Proctor & Gamble and Johnson & Johnson, are notable dividend payers.

One of the primary lessons by Buffett’s mentor, Benjamin Graham, is that dividends are an investor’s secret weapon. Many of the Fortune 500 companies that Berkshire Hathaway has large positions in have a steady history of maintaining or increasing dividends every year, and this is one reason Berkshire Hathaway has chosen to invest in them. Coca Cola has increased its annual dividend 52 years in a row.

The accumulated dividends paid to Berkshire Hathaway is then used to make new acquisitions. The money for this comes from real dividend cash flow. Not from profit of selling previously held stock.

However, the the bigger Berkshire Hathaway gets, the bigger the deals it needs to make to keep growing. Buffett touches upon this in this years “letter”, where he writes: “Eventually – probably between ten and twenty years from now – Berkshire’s earnings and capital resources will reach a level that will not allow management to intelligently reinvest all of the company’s earnings. At that time our directors will need to determine whether the best method to distribute the excess earnings is through dividends, share repurchases or both. If Berkshire shares are selling below intrinsic business value, massive repurchases will almost certainly be the best choice. You can be comfortable that your directors will make the right decision.”

The Annual Letter

Warren Buffett writes an extensive annual letter to Berkshire Hathaway’s shareholders, each year published a couple of months before the annual shareholder meeting.  I started reading the letters from 1989 when I studied finance in business school. The letters are usually very well written and funny and below are some highlights from this years letter: 

On cash:

“At a healthy business, cash is sometimes thought of as something to be minimized – as an unproductive asset that acts as a drag on such markers as return on equity. Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent.”

On the possibility of Berkshire paying a dividend:

“Eventually – probably between ten and twenty years from now – Berkshire’s earnings and capital resources will reach a level that will not allow management to intelligently reinvest all of the company’s earnings. At that time our directors will need to determine whether the best method to distribute the excess earnings is through dividends, share repurchases or both. If Berkshire shares are selling below intrinsic business value, massive repurchases will almost certainly be the best choice. You can be comfortable that your directors will make the right decision.”

On mergers and spin-offs:

“Investment bankers, being paid as they are for action, constantly urge acquirers to pay 20% to 50% premiums over market price for publicly-held businesses. The bankers tell the buyer that the premium is justified for “control value” and for the wonderful things that are going to happen once the acquirer’s CEO takes charge. (What acquisition-hungry manager will challenge that assertion?) A few years later, bankers – bearing straight faces – again appear and just as earnestly urge spinning off the earlier acquisition in order to “unlock shareholder value.” Spin-offs, of course, strip the owning company of its purported “control value” without any compensating payment. The bankers explain that the spun-off company will flourish because its management will be more entrepreneurial, having been freed from the smothering bureaucracy of the parent company. (So much for that talented CEO we met earlier.)”

This year it is 50 years since Warren Buffett bought Berkshire Hathaway, and therefore the letters contains a description of the 50-year history on page 23, “Berkshire – Past, Present and Future.” It is fascinating even if you never read annual reports and know nothing about the company.

Below is a video from Wall Street Journal with highlights of the 2015 Berkshire Hathaway shareholder meeting in Omaha, Nebraska, that took place last week. The devoted, about 40,000 of them, came out in full force to celebrate, meet other investors and do some shopping, as portfolio companies have stands to sell their goods at the annual event.

According to Wall Street Journal, the doors opened at 7 a.m. with shareholders rushing in to grab seats, save chairs for their friends and browse an exhibit hall with booths from Berkshire-owned companies. Attendees eating ice cream, shopping and chatting with one another before Mr. Buffett and his even older deputy Mr. Charlie Munger took the stage.

Best of 2015 Berkshire Shareholder Meeting

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How to Handle a Common Buyer Objection: Your Fees Are Too High!

Have you ever had a buyer tell you that “your fees are too high?” Or that they can’t “afford your fees?” If you’ve never heard those words before you’re likely not charging enough. Consultants often make a mistake in believing that these objections are about price. They’re not. Buyers don’t make decisions solely based on […]

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Collaboration is over-rated

Okay, I said it.  I have seen too many organizations put together committees to drive “alignment”, when in actuality, they are trying to mollify a miscreant or hedge away the risk by legislating an answer.  Too often, it fails to achieve either of these … Continue reading →

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A Diversified World – Valborg in Uppsala

This weekend started with the Walpurgis Night, the eve of the feast day of Saint Walpurga, an 8th-century abbess in Germany. In German folklore Walpurgisnacht is also called Hexennacht (literally "Witches’ Night"). It was believed to be the night of a witches’ meeting on the Brocken, the highest peak in the Harz Mountains, a range of wooded hills in central Germany between the rivers Weser and Elbe.

In my native Sweden the feast is called “Valborg” and it is nowadays a festivity to welcome the spring, where bonfires are burned and students are singing traditional a capella songs to the arrival of the warmer season.

As we currently work with regional innovation strategy development in Uppsala, Sweden (which is a highly multi-cultural student city) I thought it could be appropriate this weekend, to write a brief note about our multi-cultural world.

The Walpurgis celebrations at Uppsala University are truly extraordinary, with student floats running the Fyris River, herring lunches, the donning of the caps at the Carolina Rediviva main university building, parties and much more. Toward the evening bonfires are lit to warm the soul and  to burn winter refuse, whilst a male student choir sings hymns to the spring.

The truths of history are what we make them, in how we interpret historical events. This is a thought that struck me during a memorable life event in Cagnes-Sur-Mer last Sunday. As current events are interpreted and understood in the light of historical experiences, truth itself relies more on interpretation that on an absolute understanding of reality. Whether this is a flaw in our minds or a blessing is best left to individual interpretation.

About 23 years ago, I studied World History for a year at Stockholm University, and the main course book was A History of World Societies by McKay, Hill and Buckler, third edition published in 1992. In this year I learned more about the world and it provoked more thought, than much of my economics education and the book remains a centrepiece in my library.

The massive 1300 page book describes how civilisations began to emerge as peoples formed organized communities to support stable and secure life. True civilization appeared when these communities developed individual languages and writing to preserve past knowledge and sustain complex economic and political activity. The book explores the stories of the peoples of the world within a political framework. With coverage of non-western topics, the text provides a global approach to world history, and as McKay starts the preface:

“A History of World Societies grew out of the authors´desire to infuse new life into the study of world civilizations. We knew full well that historians were using imaginative questions and innovative research to open up vast new areas of historical interest and knowledge. We also recognized that these advances had dramatically affected the subject of economic, intellectual, and, especially, social history, while new research and fresh interpretations were also revitalizing the study of the traditional mainstream of political, diplomatic and religious development. (…)

With this book (…) we made a determined effort to strike an effective global balance. We were acutely aware of the great drama of our times – the passing of the European era and the simultaneous rise of Asian and African peoples in world affairs. Increasingly the whole world interacts, and to understand that interaction and what it means for today´s citizens we must study the whole world´s history.”

Back in 1992 this writing was prophetic, as the age of Globalisation and the decline of the western world has become obvious to most people only after the recent great recession.

Another favourite source of historical and world society knowledge of mine is Sir Kenneth Clark´s TV series Civilisation – A Personal View from 1969, commissioned by no-less than David Attenborough when he was Controller of BBC2.

The series is focused on western European society and if you have never seen this series before and are interested in art history, you just landed in a honey jar. Through more than eleven hours of film in 13 episodes, Clark takes us on a 1,500 year journey through Western Civilization starting roughly at the end of the Roman Empire and ending in mid 20th century.

Clark tells us straight out that his aim was to follow the history of Western European civilization as seen through the eyes of its artists and with his focus on western art, watching the series today can only emphasise the thinking of the time of western civilisations dominance in the world. A period that has by now, 45 years later, come to an absolute end.

A key metrics of our civilisations diversity are the use of languages, so let us look at some statistics of languages, courtesy of the Washington Post, to illustrate the multi-diversity of the world we live in.

In 2015, Europe has only 286 living languages compared with a multitude on other continents, as we can see in the graph above. However it should be noted that about 3 percent of the world’s population accounts for 96 percent of all languages spoken today. Out of all languages in the world, 2,000 have fewer than 1,000 native speakers. How long will they remain used, in a borderless world of internet and globalisation?

According to UNESCO estimates, about half of the world’s spoken languages will disappear by the end of the 21st century. Linguistic extinction will hit some countries and regions harder than others. In the United States, endangered languages are primarily located along the West coast, which I noted as I travelled through many minority Indian settlements along the Pacific coast in a Mustang Cabriolet many years ago, as well as in reservations of indigenous people in the Midwest. Globally, the Amazon rain forest, sub-Saharan Africa, Oceania, Australia and Southeast Asia are about to lose the most languages.

As we can see in the next graph, Chinese has more native speakers than any other language, followed by Hindi and Urdu, which have the same linguistic origins in northern India. English comes next with 527 million native speakers. Arabic is used by nearly 100 million more native speakers than Spanish and its usage is growing fast with strong nativity among Arabic speakers, despite the many conflicts in the MENA region.

The numbers are fascinating because they reflect the fact that two-thirds of the world’s population share only 12 native languages. Those numbers were recently published by the University of Düsseldorf’s Ulrich Ammon, who conducted a 15-year-long study.

Whereas English lags behind in the number of native speakers, it is by far the world’s most commonly studied language. Overall, more people learn English than French, Spanish, Italian, Japanese, German and Chinese combined.

Some languages have only recently gained attention. The number of U.S. colleges that teach Chinese has risen by 110 percent between 1990 and 2013, making the language more accessible. Place Managers should note that local education in Chinese is a no-brainer winning place attraction for economic growth. During the same time, the number of offered Russian college courses decreased by 30 percent, as Washington Post notes.

Some language skills could be more rewarding than others. If you are able to speak German, Americans could earn $128,000 extra throughout their career, according to MIT scientist Albert Saiz. At least financially, German is worth twice as much as French and nearly three times as much as Spanish, for instance. Unfortunately, this is no comfort to me, being a Swede once fluent in German, but having lost most of my fluency as I live since 18 years in France and nowadays rarely work in Germany.

With this thought, and about to make an over day drive to the French speaking parts of Switzerland, I wish our readers a relaxing and enjoyable weekend.

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The Creative Design Process of Apple

Creativity is at the core of innovation, and every product at Apple Corporation starts with creative design.

Design is a core activity at Apple, where the entire product development process conforms to the designers vision. This the polar opposite of the way it works at most other companies. Instead of the design being restricted to limits imposed by the finance, sourcing, logistics or manufacturing departments, these all conform to the will of the Apple design department headed by Jonathan Ive.

Once a new product has been decided on, a team is organized and segregated from the rest of the company by confidentiality agreements and sometimes physical barriers. Sections of the building may be locked or cordoned off to make room for the teams working on a sensitive new project. This effectively creates a ‘start-up’ inside the company that is only responsible to the executive team, to which they report on Mondays, freeing them from the overall reporting structure of a big company. This is the way it has been ever since the foundation of Apple Computer Corporation, where Steve Jobs himself led the new product team for early products such as Lisa.

Below is a recent video where Jonathan Ive reveals thoughts behind the product design process in dialogue with Graydon Carter. The video has many lessons to learn from for other consumer product companies.

Apple´s Jonathan Ive in Conversation with Vanity Fair´s Graydon Carter

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Why Apple Watch will be a Success

Back in February, I wrote an article about the Apple Watch, and how it is Apple´s first potentially disruptive innovation since the launch of the iPad five years ago. My main point was that the Apple Watch, in true Apple style, was positioned as a status and fashion item more than as a functional item.

Disruptive innovation means the product will create a new market and value network, and eventually disrupts an existing market and value network, displacing earlier technology. In the case of the Apple Watch, it is the integration between the Watch and the iPhone and other Apple products like the MacBook, the iPad and the Apple TV that creates a stronger value network than the competitors Android based devices does.

But in order for the Apple Watch to achieve this, it needs to actually be useful. So what can make it useful for the wearer, considering that it will not really have standalone apps?

It seems the application model for the watch is that all that is going on on the screen of the watch will interact with main applications on the iPhone. Well, of course it will also have watch functionality, but that is not why people will buy it. Therefore, the phone will need apps that are really useful extensions of the corresponding iPhone app. It will need what in IT-terminology is called “killer apps”. 

In marketing terminology, a killer application (commonly shortened to “killer app”) is a computer program that is so necessary or desirable that it proves the core value of the host technology. My colleague Marlena Zakrzewska wrote an article the other day about some of the 3,500 apps that are already available for the watch, and she concluded that so far, there are no “killer apps”.

Apple seems to think that notifications will be the “killer app”. At the moment, all of us with smart phones frequently hear a buzz or a vibration from our phone, and we then need to look at the screen of the phone, maybe even enter the passcode, to see what we are notified about. This can be a source of unwanted distraction as it takes time and is noticed by people in the work environment around us.

With notifications instead appearing on the watch screen, so we can see them just by lifting our arm is if to check the time, that is in theory both less time consuming and more discreet.

For myself I think if I eventually get an Apple Watch, and I say eventually because this is one device that I will not get as a pioneer but rather in a later model after it is developed for a year or two, then the main reason will be just this. It will be an easier and less disturbing way to check notifications.

Below is a video from Wall Street Journal with a reporters view of what can be the “killer app”.

What´s the Apple Watch Killer App?

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Tesla Launches Energy Division to Disrupt Home Energy Usage

Elon Musk has hinted for years that Tesla really is about disruption through new battery technology, and today the corporation launched an energy division, Tesla Energy. After years of speculation, Tesla announced a series of battery systems for homes, utilities, and businesses, and the batteries are all under the umbrella of the new division.

Elon Musk has a vision of a world powered entirely with renewable energy and sleek-looking batteries built by Tesla. The new divisions first product, Powerwall, is a home battery that charges using electricity generated from solar panels, or in daytime and night when utility rates are low, and powers your home in the evenings. It also fortifies your home against power outages by providing a backup electricity supply. The idea with Powerwall is to offer independence from the utility grid and the security of an emergency backup.

At night we connect recharging wires to our phones, computers, smartwatches and tablets to recharge after the workday and with many electricity utilities the rates are higher during peak time.

As we recharge devices and turn on lights, home energy usage reaches peak consumption. Tesla says its Powerwall battery system can untether homes from the power grid for a few hours, which might not sound like much, but could have huge implications for both household energy costs and for CO2 pollution, as utilities dimension their output by burning carbon fuel for peak time.

Tesla’s move into so-called "stationary storage" is a market with enormous growth potential. As the world slowly moves away from fossil fuels, it is seen as critical to a more widespread adoption of "clean" energy sources like solar and wind. There is also a strong commercial rationale for Elon Musk to leverage Tesla’s expertise in building highly-efficient car batteries and also put them in a single unit in consumers’ residences.

The business strategy is a bit like the battery itself. High impact, but a slow release which will really only reap significant benefits over time. But it comes with risks. Tesla may face a challenge getting the cost-saving message across to potential customers, with a significant $3,500 upfront cost to buy and install the device in existing homes. The batteries are quite massive in size. Look at the picture below with a battery next to a Tesla car.

SolarCity, a US leader in full-service solar power systems for homes, businesses and governments co-founded and financed by Elon Musk, has announced that it will offer the Powerwall to its existing and new customers and that it will work with the company’s DemandLogic energy-storage system for businesses and government institutions.

Below is the 20 minutes launch video, where Elon Musk introduces Tesla Energy.

Elon Musk–Announcement of Tesla Energy

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