Strategic Direction – Warren Buffett's Letter to Shareholders

Strategic Direction – Warren Buffett's Letter to Shareholders

Warren Buffett has a remarkable track record for knowing what companies to invest in and when to invest.  He is extremely strategic in his investments,  and he understands what type of business strategies and cultures is needed for businesses to be successful.  This is demonstrated by his successes.  For instance, the per-share gain since Berkshire Hathaway Inc. was established in 1964 to 2011 was 513,055%

Warren Buffett letter to shareholders in his 2011 annual report of Berkshire Hathaway Inc.,  is enlightening.  See highlights below.

Role of Board of Directors

The primary job of a Board of Directors is to see that the right people are running the business and to be sure that the next generation of leaders is identified and ready to take over tomorrow. I have been on 19 corporate boards, and Berkshire’s directors are at the top of the list in the time and diligence they  have devoted to succession planning. What’s more, their efforts have paid off.

Cash Flow Leverage

Our insurance operations continued their delivery of cost, less capital that funds a myriad of other opportunities. This business produces “float” – money that doesn’t belong to us, but that we get to invest for Berkshire’s benefit.

Value Investments: Long-Term Perspective

We made two major investments in marketable securities: (1) a $5 billion 6% preferred stock of Bank of America that came with warrants allowing us to buy 700 million common shares at $7.14 per share any time before September 2, 2021; and (2) 63.9 million shares of IBM that cost us $10.9 billion.

Counting IBM, we now have large ownership interests in four exceptional companies: 13.0% of American Express, 8.8% of Coca-Cola, 5.5% of IBM and 7.6% of Wells Fargo. (We also, of course,  have many smaller, but important, positions.)   We view these holdings as partnership interests in wonderful businesses, not as marketable securities to be bought or sold based on their near-term prospects.

Humility and Trustworthiness

I try to look out ten or twenty years when making an acquisition, but sometimes my eyesight has been poor.  Charlie’s has been better; he voted no more than “present” on several of my errant purchases.

A few years back, I spent about $2 billion buying several bond issues of Energy Future Holdings, an electric utility operation serving portions of Texas. That was a mistake – a big mistake. In large measure, the company’s prospects were tied to the price of natural gas, which tanked shortly after our purchase and remains depressed.

Operational Skills Isn’t Enough

As all business observers know, CEOs Lou Gerstner and Sam Palmisano did a superb job in moving IBM from near-bankruptcy twenty years ago to its prominence today. Their  operational accomplishments were truly extraordinary.  But their financial management was equally brilliant, particularly in recent years as the company’s financial flexibility improved.

Indeed, I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders. The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock.

Buy Low

If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.

In my early days I, too, rejoiced when the market rose. Then I read Chapter Eight of Ben  Graham’s The Intelligent Investor, the chapter dealing with how investors should view fluctuations in stock prices. Immediately the scales fell from my eyes, and low prices became my friend. Picking up that book was one  of the luckiest moments in my life.

Acquisition Principles

We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:

(1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),

(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),

(3) Businesses earning good returns on equity while employing little or no debt,

(4) Management in place (we can’t supply it),

(5) Simple businesses (if there’s lots of technology, we won’t understand it),

(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).

The larger the company, the greater will be our interest: We would like to make an acquisition in the $5-20 billion range.

We prefer to buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give. We don’t participate in auctions. Charlie and I frequently get approached about acquisitions that don’t come close to meeting our tests: We’ve found that if you advertise an interest in buying collies, a lot of people will call hoping to sell you their cocker spaniels. A line from a country song expresses our feeling about new ventures, turnarounds, or auction-like sales: “When the phone don’t ring, you’ll know it’s me.”


Strategic Direction – Warren Buffett's Letter to Shareholders

Extracts provided by David Willden