Dear Fellow Investors:
The Berkshire Hathaway 2013 Annual Shareholder Letter came out on Saturday the 1st of March, 2014. Mr. Buffett was in rare form and we’d like to share some of his key thoughts which speak directly to what we do at Smead Capital Management.
Buffett on Long Duration Ownership
We completed two large acquisitions, spending almost $18 billion to purchase all of NV Energy and a major interest in H. J. Heinz. Both companies fit us well and will be prospering a century from now.
Those building blocks rest on a rock-solid foundation. A century hence, BNSF and MidAmerican Energy will still be playing major roles in our economy. Insurance will concomitantly be essential for both businesses and individuals – and no company brings greater human and financial resources to that business than Berkshire.
In our opinion, no other theme was more prevalent than using long durations to get your success. He shared about a farm he bought in 1986 and a building in New York City he bought with partners in 1993. The point was that they have done well over long time periods and he looks for investments which have strong long-duration possibilities. This keeps frictional costs low and capital gains taxes minimal. The net-present-value of a 100-year earnings stream is mathematically higher than a 50-year stream, especially in an era of low discount rates.
Buffett on Owning Quality
Berkshire increased its ownership interest last year in each of its “Big Four” investments – American Express, Coca-Cola, IBM and Wells Fargo. We purchased additional shares of Wells Fargo (increasing our ownership to 9.2% versus 8.7% at yearend 2012) and IBM (6.3% versus 6.0%). Meanwhile, stock repurchases at Coca-Cola and American Express raised our percentage ownership. Our equity in Coca- Cola grew from 8.9% to 9.1% and our interest in American Express from 13.7% to 14.2%. And, if you think tenths of a percent aren’t important, ponder this math: For the four companies in aggregate, each increase of one-tenth of a percent in our share of their equity raises Berkshire’s share of their annual earnings by $50 million.
The four companies possess excellent businesses and are run by managers who are both talented and shareholder-oriented. At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business; it’s better to have a partial interest in the Hope diamond than to own all of a rhinestone.
Academic studies show that low earnings volatility and consistently high profitability add alpha over long durations. It also enhances the ability to stay on the quality train. We like to think our eight criteria can unearth some Hope diamonds when contentious circumstances occur and securities get marked down in the future.
Buffett on Investment Geography
Late in 2009, amidst the gloom of the Great Recession, we agreed to buy BNSF, the largest purchase in Berkshire’s history. At the time, I called the transaction an “all-in wager on the economic future of the United States.”
Indeed, who has ever benefited during the past 237 years by betting against America? If you compare our country’s present condition to that existing in 1776, you have to rub your eyes in wonder. And the dynamism embedded in our market economy will continue to work its magic. America’s best days lie ahead.
Our subsidiaries spent a record $11 billion on plant and equipment during 2013, roughly twice our depreciation charge. About 89% of that money was spent in the United States. Though we invest abroad as well, the mother lode of opportunity resides in America.
Our regular readers have listened to our references to what Buffett calls the “mother lode of opportunity” in America. To us, it is the emergence of Americans currently between the age of 18 and 37. They are 86 million strong, will automatically get ten years older in 2024, and appear to be the most interesting emerging market in the world. Remember, average GDP per capita in the US is around $50,000, far outstripping the buying power of the 400 million middle-class citizens emerging elsewhere in the world.
Buffett on Bank of America
Berkshire has one major equity position that is not included in the table: We can buy 700 million shares of Bank of America at any time prior to September 2021 for $5 billion. At yearend these shares were worth $10.9 billion. We are likely to purchase the shares just before expiration of our option. In the meantime, it is important for you to realize that Bank of America is, in effect, our fifth largest equity investment and one we value highly.
Buffett on BRKB Intrinsic Value
As I’ve long told you, Berkshire’s intrinsic value far exceeds its book value. Moreover, the difference has widened considerably in recent years. That’s why our 2012 decision to authorize the repurchase of shares at 120% of book value made sense. Purchases at that level benefit continuing shareholders because per-share intrinsic value exceeds that percentage of book value by a meaningful amount. We did not purchase shares during 2013, however, because the stock price did not descend to the 120% level. If it does, we will be aggressive.
Charlie Munger, Berkshire’s vice chairman and my partner, and I believe both Berkshire’s book value and intrinsic value will outperform the S&P in years when the market is down or moderately up. We expect to fall short, though, in years when the market is strong – as we did in 2013. We have underperformed in ten of our 49 years, with all but one of our shortfalls occurring when the S&P gain exceeded 15%.
At Smead Capital Management we recently added to our position in Berkshire Hathaway. First, it trades at a big book value discount to the S&P 500 and to a bigger discount to intrinsic value than two years ago. Second, it is a great way to get at some of the cyclical sectors of the US economy over the next ten years. Buffett’s mixture of cyclical and non-cyclical businesses gives us access to his “mother lode of opportunities” in a way which our other 27 holdings cannot. It also allows us more ownership of common holdings like Wells Fargo (WFC) and Bank of America (BAC). Overall, we were thrilled to hear from the “Oracle of Omaha.”
The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.
This Missive and others are available at smeadcap.com