I’ve been following Warren Buffett and his company, Berkshire Hathaway, for more than 10 years now, ever since I was at university, so it’s only suitable that this is the first company I write about. Warren Buffett says that he never looks at a share’s price before reading its annual report because he’s afraid that it might influence his decision (one way or the other), and this is what I intend to do for every company I analyse in the future. The trouble with this one is that I know exactly what price Berkshire Hathaway is trading at, but I’ll try not to let it influence me if we get to the valuation stage (which will only happen after and only if this annual report goes into the ‘Yes’ tray).
To determine which tray I will put each company, I will use a very simple and effective tool popularized by a Founding Father of the United States of America and one of my personal heroes: the pro and con list (derived from the Latin ‘pro et contra’, meaning ‘for and against’). Benjamin Franklin used this tool when he needed to make difficult decisions. He would simply divide a sheet of paper in two columns, write pro on top of the first and con on top of the second and then, during the course of several days, he would write hints in each of the columns as they came to his mind. When he could think of no other arguments pro or con, he would weigh their respective value and start to strike them out. If he found that a pro was equal to a con, he would strike both out. If he found a pro that matched two cons, those would also go, and so on until he could find no more matches. At the end he would more clearly see where the balance was, and make the decision accordingly.
The Berkshire Cotton Manufacturing Company was established in 1889 in Adams, Massachusetts. The Valley Falls Company was a textile manufacturing company established by Oliver Chace in 1839 in Valley Falls, Rhode Island. In 1929 both companies merged to create Berkshire Fine Spinning Associates. In 1955 it merged with the Hathaway Manufacturing Company, which was founded in 1888 in New Bedford, Massachusetts, and was being run by Seabury Stanton who increased its profitability after the Depression. After the merger, Berkshire Hathaway had 15 plants, employed 12,000 people, had over $120 million in revenue, and was based in New Bedford, Massachusetts.
The November 1, 1965 Buffett Partnership letter was the first time Warren mentioned Berkshire Hathaway, disclosing that the partnership owned a controlling interest in the company. At this time, the company was down to two mills and 2,300 employees. Because of the illiquid nature of its shares, he was valuing the company at 100 cents per dollar for current assets and 50 cents per dollar for fixed assets (demonstrating the reliance he had on Benjamin Graham’s valuation methods at that time).
More information is supplied in the 1965 performance letter, dated January 20, 1966. Warren began buying Berkshire in 1962 at a price of $7.60 per share and continued buying until acquiring control in spring 1965. The average cost was $14.86 per share and the company had net working capital of $19 per share (without putting any value on plant, property and equipment) at the end of 1965. Realising that the textile business would not improve, he started to invest the proceeds in insurance companies, buying the National Indemnity Company in 1968 for $8.6 million, and eventually closed down the textile operations in 1985. It has been a legendary journey. Today that same share that he started buying for $7.60 is selling for $248,000.
Pros and cons
Having read all 122 pages of the 2016 annual report, I summed up the most important points (at least, to me) into two pages split in half between pros and cons. You can find the file here:
With 28 Pro arguments and 13 Con arguments, it’s safe to say that Berkshire Hathaway is in very positive territory. Actually, Pro 1 and 2 are more than enough to strike out all Con arguments. Over 50 years of such out-performance is an extraordinary achievement. You can read Warren Buffett’s Shareholder Letters since 1965 and get an amazing education as an investor.
The two Con arguments that I’m still a bit concerned about are Con 4 and Con 13. Because of its huge size, it is highly unlikely that Berkshire Hathaway will grow at the same rate as previous decades, and I would prefer that my investments compound faster than a market index (otherwise I would simply put my money in an index fund, but I’m already doing that with my company pension plan). Also, if I were to invest now, I would be a bit nervous about the effect that Warren’s passing would have on the share price at the time (even knowing it would probably be just a temporary decline; maybe one can use this to buy more shares cheaper, if I have money available) and on the company’s policies and investments.
This annual report easily goes into the ‘Yes’ tray.
I would invest in Berkshire Hathaway in the absence of better ideas (smaller companies that would grow and compound capital faster) and depending on the price I pay for the shares. Even though I know the chances of permanent capital loss are nonexistent, and the chances of quotational capital loss are tiny due to the $137.69 floor price for the B shares (Pro 8), I would still require a significant margin of safety to intrinsic value.
Would I feel comfortable owning it for 10 years or more? Yes. I like and admire this company, trust that my money will be in good, honest hands, and am reasonably confident that I will at least get a decent result over time.
The questions that still remain are: How much is it worth? Can I buy it at a substantial discount?
Stay tuned for my valuation of Berkshire Hathaway…