A few comments on the Berkshire Hathaway letter to shareholders

Over the years, we’ve consistently discussed our four part investment process of searching for profitable businesses with good returns on capital, run by honest and talented management teams, with reinvestment opportunities [and] capital discipline, at fair prices. I believe that each and every word of that distilled statement packs incredible freight. As such, I’m reluctant to pick any single notion as more or less important than another. They all tie together.

That said, if you held a gun to my head and said which of the four ideas is most important, I would respond with point #3, reinvestment opportunities and capital discipline.

One of the reasons that I propose such a simplification is that the idea of reinvestment and capital discipline embeds the other concepts. If the business is not profitable, there is no money to reinvest. If the management team is not talented and honest, there will either be no money to reinvest or it will be hived off by the management before it ever gets to the shareholders. And finally, and this is the most nuanced and misunderstood aspect of investing, a fair price may be a lot more than you would think if profitable reinvestment really can take place.

In effect, the world is Berkshire’s oyster – a world offering us a range of opportunities far beyond those realistically open to most companies. We are limited, of course, to businesses whose economic prospects we can evaluate. And that’s a serious limitation: Charlie and I have no idea what a great many companies will look like ten years from now. But that limitation is much smaller than that borne by an executive whose experience has been confined to a single industry. On top of that, we can profitably scale to a far larger size than the many businesses that are constrained by the limited potential of the single industry in which they operate.

I mentioned earlier that See’s Candy had produced huge earnings compared to its modest capital requirements. We would have loved, of course, to intelligently use those funds to expand our candy operation. But our many attempts to do so were largely futile. So, without incurring tax inefficiencies or frictional costs, we have used the excess funds generated by See’s to help purchase other businesses. If See’s had remained a stand-alone company, its earnings would have had to be distributed to investors to redeploy, sometimes after being heavily depleted by large taxes and, almost always, by significant frictional and agency costs.

Compounders can also be managers or investment teams that reinvest cash flows or float at a healthy rate of return, in a flexible manner…. But keep in mind that these are very hard to identify ahead of time, it can be easy to be fooled by people, and that a bad business can overwhelm even the best operators and capital allocators.

His first priority would be reservation of much time for quiet reading and thinking, particularly that which might advance his determined learning, no matter how old he became; and

He would also spend much time in enthusiastically admiring what others were accomplishing.

...When Buffett developed the Berkshire system, did he foresee all the benefits that followed? No. Buffett stumbled into some benefits through practice evolution. But, when he saw useful consequences, he strengthened their causes.

What were the big mistakes made by Berkshire under Buffett? Well, while mistakes of commission were common, almost all huge errors were in not making a purchase, including not purchasing Walmart stock when that was sure to work out enormously well. The errors of omission were of much importance. Berkshire’s net worth would now be at least $50 billion higher if it had seized several opportunities it was not quite smart enough to recognize as virtually sure things.

I believe that the chance of permanent capital loss for patient Berkshire shareholders is as low as can be found among single-company investments. That’s because our per-share intrinsic business value is almost certain to advance over time.

At both BPL and Berkshire, we have never invested in companies that are hell-bent on issuing shares. That behavior is one of the surest indicators of a promotion-minded management, weak accounting, a stock that is overpriced and – all too often – outright dishonesty.

My successor will need one other particular strength: the ability to fight off the ABCs of business decay, which are arrogance, bureaucracy and complacency. When these corporate cancers metastasize, even the strongest of companies can falter.