Secrets of the world’s greatest investor
Warren Buffett’s main message at this year’s AGM: Management matters!
I have just returned from my fourth annual trip to the US to attend the Berkshire Hathaway annual general meeting, in Omaha Nebraska. Most will recognise the corporate name, but allow me a brief introduction.
Berkshire Hathaway is a corporate giant, currently fifth on the scoreboard of US stockmarket capitalisation (Apple is the largest listed company). But fifth place understates the reality. Berkshire Hathaway is actually running close to second in the corporate cap contest. At US$364 billion it is neck and neck with fellow second-place contenders, Microsoft, Google and Exxon Mobil.
For the past 50 years, Berkshire Hathaway has been controlled and managed by the world’s wealthiest investor, Warren Buffett.
Why do I travel 30,000 kilometres each year to attend an AGM? My motive is probably best compared to why people go to their doctor for an annual flu vaccination. For me it’s an inoculation of the three corporate Cs: Corporate common sense, Corporate culture and Corporate correctness.
This article explains how important these three factors are to successful investing. But first, let’s get the obvious discussion out of the way.
Yes, the AGM has become a circus
Most articles describing the Berkshire Hathaway AGM focus on the excesses, so let’s dispense with the big numbers right away, to appease those who get a kick from reading them.
More than 40,000 people attended this year’s AGM, which meant more than half those who flew in from 53 countries were unable to find a seat in the venue. Omaha’s largest indoor sports and entertainment arena, the Century Link Stadium, has a capacity of just under 20,000. The other half were ushered into overflow rooms at Century Link’s adjacent convention area and the Omaha Hilton across the street.
You would expect the drawcard pulling those sorts of numbers to be something akin to a Rolling Stones concert. While the entertainment was no less captivating, it did consist of two elderly gentlemen sitting front and centre, fielding questions from the massive audience for six hours.
The elderly entertainers were CEO Warren Buffett, aged 84, and vice-chairman Charlie Munger, aged 91. But the clincher for me isn’t that they’ve both managed to avoid admission to a retirement village, but rather the opposite.
Buffett has just clocked up 50 years as top dog at Berkshire Hathaway. Where else – or for that matter, when again – would you see a CEO’s reign span six decades? What’s more, shareholders are not calling for his corporate departure; instead they live in fear of when that will inevitably occur. Which leads me to the focus of this article.
There must be something profoundly correct about the management culture at Berkshire Hathaway. Not only has it transformed an ailing 1960s New Bedford linen mill into the strongest conglomerate in the world, but the rags-to-riches metamorphosis has been singularly overseen by a person who still yields the highest degree of respect I’ve ever seen dispensed in any corporate environment.
To me, Berkshire Hathaway provides a model of corporate success, measured not simply in terms of dollars, but in terms of corporate behavior and values. For any investor, a study of the company delivers an insight into how desirable managerial qualities should be measured when sizing up any potential sharemarket investment.
In 2006, Buffett began the process of returning his personal wealth back to society, principally through a commitment of ongoing donations to the Bill and Melinda Gates Foundation. Had Buffett not started that process, today his personal worth would be US$112 billion, easily eclipsing that of the world’s wealthiest person, Bill Gates.
More importantly, his personal wealth was achieved without being gifted a single share option or company share. Buffett bought his shares, just as every other shareholder did, on the open market. In terms of corporate compensation, he is currently paid $100,000 a year (it’s always been low). Remember this occurs in an environment where CEOs of Corporate America are receiving self-enriching pay packets measured in terms of tens, and sometimes hundreds, of millions of dollars a year.
How does this relate to your own search for companies on ASX?
I would suggest you search for corporate leaders that, like Buffett, align their financial success with yours. Look for leaders with plenty of “skin in the game” in terms of their own share ownership, but equally ask how they obtained those shares. If that ownership resides with the legacy of having started the company themselves, or having made substantial on-market purchases of shares using their own money, then give them a tick of approval.
But if they’ve sourced their shares at shareholders’ expense via overly generous share delivery schemes, or the self-gifting of copious volumes of free options, then question their motives for being in the top job.
Pay close attention to the annual report
Let’s face it, when you buy shares in a company you become a part owner of the business. So when the chairman or CEO communicates with you (particularly through their statements in the annual report) you are entitled to know exactly what is going on.
Their report to you should to be akin to a chat with your best mate over a few beers, not some homogenous whitewash delivered by a public relations machine.
Buffett personally writes his annual letter to fellow shareholders, and takes the process very seriously. His letters sound like few others I’ve read. It is not surprising then, that for years publishers have been compiling his letters into books and selling them in their thousands. There are certain distinguishing qualities his letters carry:
- Buffett claims none of the company’s success as his own. Rather, he bestows it on others within the organisation and he makes a habit of naming them in the report.
- His report is written in a language free of ambiguity; simple language that every shareholder can understand.
- Not only does he avoid financial jargon, but he avoids the use of motherhood statements typically employed by many CEOs to allay blame. For example, phrases relating substandard corporate performance to “soft market conditions” or “the present state of the economy”.
- He alerts shareholders to poorly performing divisions rather than burying their substandard results in consolidated financial statements.
- He refers to all shareholders as his partners.
- Finally, Buffett does something you will rarely, if ever, see from any other CEO: he alerts shareholders to his faults of omission. That is, he quantifies how much better off shareholders would be today if he had made different choices in the past. It’s worth exploring a perfect example of how Buffett does this.
In 1993 Berkshire Hathaway acquired a US shoe manufacturing business, Dexter, for $420 million. Cash didn’t change hands; Buffett paid for the acquisition using company stock. Cheap shoe imports from Asia have since rendered Dexter’s business extinct. But rather than sweeping the mistake under the carpet, Buffett still reminds shareholders today of his folly.
It would be easy for Buffett to quantify the cost of the mistake to shareholders as the $420-million acquisition price. Instead, he continues to equate it to the current value of the stock he used to make the acquisition. He recently told shareholders that’s now close to $7 billion.
What can you take from this behaviour? The fact is, a lot can be learnt regarding the key management of any company by a thorough reading of its annual report.
First, ask whether the letters from the chairman and CEO sound like they’ve been written by a well-oiled public relations department, or whether they sound like a warts-and-all discussion of how the company’s been performing. Second, if problems have arisen, ask whether senior management is providing concrete ways of improving corporate performance in the future.
It is also a useful exercise to compare successive annual reports, to note past promises (particularly those embellished with rosy forecasts) and see how things actually turned out.
Finally, ask whether the CEO’s letters to shareholders sound self-serving or do they recognise the efforts of other members of the corporate team, particularly the unsung heroes – the workers and managers behind the scenes.
Facts not fanaticism
In addition to spending more than three decades as an investor, my several visits to Omaha have added plenty of perspective. They have provided me the opportunity to:
- Spend a total of more than 60 hours with the CEOs of several of Berkshire Hathaway’s fully owned subsidiaries (mostly behind closed doors), listening to their views on Buffett and the company culture.
- Twice listen to long-time board member, Ron Olson, express his views on corporate culture.
- Become friends with, and discuss the issues with, Bob Miles, author of several Buffett books, including ‘The Warren Buffett CEO’.
- Spend a total of five hours with one of Buffett’s children.
And, most importantly, I have spent more than 20 hours listening to Buffett and Munger discuss the principles that guide them in running the company.
The most important message from all of these interactions is that when investing, don’t simply seek out CEOs with a strong mercenary streak. Also seek those with a strong moral compass. Over time, they will perform well as the custodians of your invested capital.
To me, the search for exceptional management is the most neglected aspect in the search for great investments.
About the author
Michael Kemp is chief analyst at The Barefoot Blueprint.
Michael Kemp is chief analyst at The Barefoot Blueprint.
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