Mike King

Highlights from Warren Buffett’s Annual Letter

Berkshire Hathaway recently posted Warren Buffet’s annual letter to shareholders. I had a chance to read this year’s letter over the weekend and have included my highlights and comments on the letter below.

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But subpar it was. For the ninth time in 48 years, Berkshire’s percentage increase in book value was less than the S&P’s percentage gain (a calculation that includes dividends as well as price appreciation). In eight of those nine years, it should be noted, the S&P had a gain of 15% or more. We do better when the wind is in our face.

It is incredible that Berkshire has outperformed the S&P 500 in 39 out of 48 years. Not many companies can tout a half-century track record that beats the market. It reminds me of Buffett’s “10 Year Million-Dollar-Bet” which he is now winning.

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There was a lot of hand-wringing last year among CEOs who cried “uncertainty” when faced with capital-allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash). At Berkshire, we didn’t share their fears, instead spending a record $9.8 billion on plant and equipment in 2012, about 88% of it in the United States.

We will keep our foot to the floor and will almost certainly set still another record for capital expenditures in 2013. Opportunities abound in America.

This is good news for commercial real estate. Capital expenditures drive growth and create opportunities for investors. I like that Mr. Buffet knows most CEOs will read this letter and uses it as a pitch for Berkshire Hathaway’s capital.

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The risks of being out of the game are huge compared to the risks of being in it.

If you are a CEO who has some large, profitable project you are shelving because of short-term worries, call Berkshire. Let us unburden you.

Agreed. Investors that try to time the market are rarely successful. The following example is from a few years back, but still holds true. “In the past 20 years there have been 5,040 trading days. If you stayed fully invested (in the Dow Jones Industrials) your annualized total return would have been 11.48 percent per year. If you attempted to time the market and missed just the 10 best days your annualized return would have dropped to 8.45 percent. If you missed the best 20 days you dropped to 6.3 percent; 30 best days yielded 4.54 percent; and missing the best 40 days dropped your average annual return to a measly 2.94 percent, which was far below the rates you could have gotten in a money market account. Market timing requires virtual perfection.”

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A further unpleasant reality adds to the industry’s dim prospects: Insurance earnings are now benefitting from “legacy” bond portfolios that deliver much higher yields than will be available when funds are reinvested during the next few years — and perhaps for many years beyond that. Today’s bond portfolios are, in effect, wasting assets. Earnings of insurers will be hurt in a significant way as bonds mature and are rolled over.

We are seeing this in the commercial real estate industry. Investors are seeking yield and can’t find it with their traditional investments. Bond rates are persistently low which is driving investors to alternative investments.

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Sharp-eyed readers will notice an incongruity in the MidAmerican earnings tabulation. What in the world is HomeServices, a real estate brokerage operation, doing in a section entitled “Regulated, Capital-Intensive Businesses?”

Well, its ownership came with MidAmerican when we bought control of that company in 2000. At that time, I focused on MidAmerican’s utility operations and barely noticed HomeServices, which then owned only a few real estate brokerage companies.

Since then, however, the company has regularly added residential brokers — three in 2012 — and now has about 16,000 agents in a string of major U.S. cities. (Our real estate brokerage companies are listed on page 107.) In 2012, our agents participated in $42 billion of home sales, up 33% from 2011.

Additionally, HomeServices last year purchased 67% of the Prudential and Real Living franchise operations, which together license 544 brokerage companies throughout the country and receive a small royalty on their sales. We have an arrangement to purchase the balance of those operations within five years. In the coming years, we will gradually rebrand both our franchisees and the franchise firms we own as Berkshire Hathaway HomeServices.

Ron Peltier has done an outstanding job in managing HomeServices during a depressed period. Now, as the housing market continues to strengthen, we expect earnings to rise significantly.

Berkshire is bullish on the housing recovery. A strong housing market is good for retail real estate. As the saying goes, “Retail follows rooftops”.

On another note, a residential real estate firm with the Berkshire Hathaway name could be a good move. It sure beats the name Real Living.

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More than 50 years ago, Charlie told me that it was far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price.

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I have made plenty of mistakes in acquisitions and will make more. Overall, however, our record is satisfactory, which means that our shareholders are far wealthier today than they would be if the funds we used for acquisitions had instead been devoted to share repurchases or dividends.

Mr. Buffett continues to argue against Berkshire issuing dividends. So far he has proven to be right.