“Those of you who after we are gone sell your Berkshire stock and do something else with it, I think are going to do worse. So I would advise you to keep the faith.”
Introduction
On February 24, Warren Buffett will publish his letter to shareholders reporting on the fifty-ninth year of his tenure. A few days after the annual meeting in May, Mr. Buffett will begin his sixtieth year in control of Berkshire Hathaway. To say that he has had a remarkable run is clearly an understatement. Warren Buffett’s record will be studied in business schools for decades to come and his place in American history is secure, both as a business leader and as one of history’s greatest philanthropists.
I have had the good fortune of being a shareholder of Berkshire Hathaway over the past twenty-four years which accounts for over 40% of Mr. Buffett’s leadership of the company. As I look at my very first purchase of Berkshire shares made on February 15, 2000, I am amazed at how $9,200 was transformed into over $119,000 which represents an annual compound return of “only” 11.3%. That initial purchase was followed by many more. While it would have been far better to have been a shareholder during Mr. Buffett’s first 24 years at the helm, I can hardly complain about my experience.
To say that I did not expect Warren Buffett to manage my capital for nearly a quarter century is another understatement. He was nearly seventy years old at the time and the age issue was discussed constantly. Yet here we are in early 2024 with Mr. Buffett still showing up for work every day at the age of ninety-three. While he has delegated day-to-day operational control of Berkshire subsidiaries to Vice Chairmen Greg Abel and Ajit Jain since 2018, Mr. Buffett remains very much at the helm when it comes to capital allocation which has long been Berkshire’s main competitive advantage.
Charlie Munger’s death last year at the age of ninety-nine was a sobering reminder that no human being has yet to discover the elusive keys to immortality. But the fact is that Berkshire has been preparing for life without Warren Buffett for at least the past quarter century, ever since I became a shareholder. Under Greg Abel’s leadership, Berkshire is likely to endure in its current configuration once he takes over as CEO, although the more distant future is murky due to likely shifts in voting control driven by the changing composition of Class A shareholders.
In the weeks and months following Charlie Munger’s passing, a great deal was written about his many contributions to Berkshire Hathaway but I do not recall a discussion of Mr. Munger’s letter to shareholders to commemorate the fiftieth year of Warren Buffett’s leadership. Vice Chairman’s Thoughts — Past and Future was published on February 27, 2015 along with Berkshire Hathaway’s 2014 annual report. At the time, Mr. Munger was ninety-one years old and he had no way of knowing that he would live many more years. In some ways, the letter seemed to me like a farewell.
In just over four pages, Mr. Munger explains how Berkshire’s unique system produced such extraordinary results, predicts whether the system will continue producing such results after he and Mr. Buffett leave the scene, and considers whether the lessons of Berkshire’s success can be applied elsewhere. I’ll explore each of these areas in more detail in this article with a focus on the future rather than the past which has been extensively documented, both on my website and in many other places over the years.
The Playbook
Charlie Munger wrote that the Berkshire system was “fixed early” in Warren Buffett’s tenure. Thanks to a vast amount of publicly available information, we can see how this unfolded on a year-to-year basis. Jacob McDonough’s book, Capital Allocation: The Financials of a New England Textile Mill, which I reviewed in 2020, does an excellent job of describing the highlights in a concise format.
Berkshire Hathaway was not initially intended to become Warren Buffett’s primary investment vehicle. In fact, he has called purchasing control of Berkshire a mistake on several occasions. However, a period of profitability shortly after he took control in 1965 provided the funds needed to purchase National Indemnity in 1967 and launch Berkshire’s insurance business. From that point, Berkshire’s policy was to retain its earnings and to seek investments in non-insurance subsidiaries, with the first massive success coming in 1972 with the purchase of See’s Candies via Blue Chip Stamps.
The CEOs of subsidiaries were permitted to run with nearly compete autonomy, with Mr. Buffett making himself available but not exerting policy influence aside from matters of capital allocation. Excess capital from subsidiaries was recycled into new subsidiaries and securities in a tax efficient manner over many decades. This was well communicated to shareholders in a long annual letters followed by a shareholder meeting in which Mr. Buffett made himself available for hours of questioning, acting as an exemplar for subsidiary managers, shareholders, and others.
Mr. Munger emphasized many points which are often glossed over. It is insufficient to simply purchase businesses and allow CEOs free rein. Much effort was made to select subsidiaries that not only had solid economics but already had capable and honest management in place. Berkshire would offer a fair price for these subsidiaries without the drama typical in acquisition activity. Since only Mr. Buffett and a few others even knew about potential deals, total confidentiality was assured. CEOs of subsidiaries, while almost always already securely rich, would stay on board because they loved the business and drew energy from it, with compensation tied to subsidiary performance rather than options tied to Berkshire’s overall performance or stock price.
Those who have read Warren Buffett’s letters to shareholders during the 1970s will recall that the progress of Berkshire’s insurance business was hardly smooth sailing. As the company expanded its primary lines into new regions, there were material setbacks and course corrections. The average insurance company is not a great business, but insurance ultimately worked out “marvelously well” for Berkshire:
“… In the early decades of the Buffett era, common stocks within Berkshire’s insurance subsidiaries greatly outperformed the index, exactly as Buffett expected. And, later, when both the large size of Berkshire’s stockholdings and income tax considerations caused the index-beating part of returns to fade to insignificance (perhaps not forever), other and better advantage came. Ajit Jain created out of nothing an immense reinsurance business that produced both a huge ‘float’ and a large underwriting gain. And all of GEICO came into Berkshire, followed by a quadrupling of GEICO’s market share. And the rest of Berkshire’s insurance operations hugely improved, largely by dint of reputational advantage, underwriting discipline, finding and staying within good niches, and recruiting and holding outstanding people.”
Would the Berkshire playbook have worked as well without Ajit Jain’s arrival on the scene in 1986? Certainly not. Charlie Munger’s reference to Mr. Jain’s abilities in his letter was similar to many other comments over the years. Mr. Buffett once joked that if he, Mr. Munger, and Mr. Jain were aboard a sinking boat, it would make sense to “save Ajit first”, or something to that effect. He was only partly joking.
Purchasing control of GEICO was another key watershed moment. As Mr. Munger notes, under Berkshire’s ownership, GEICO massively increased its market share moving from a small player to trading places with Progressive for second place behind State Farm. GEICO could achieve this result due to its secure place within Berkshire and Mr. Buffett’s willingness to spend heavily on advertising, while being able to underwrite at a profit despite low premiums due to a highly efficient cost structure.
Berkshire After Buffett
Both Warren Buffett and Charlie Munger have been urging shareholders to trim their expectations for decades. There is obviously no way that Berkshire’s future results will come anywhere close to the results posted over Warren Buffett’s entire tenure. The law of large numbers and simple mathematics assures that this is true. But Charlie Munger was still optimistic about Berkshire’s future compared to the results that are likely from other large corporations:
“Provided that most of the Berkshire system remains in place, the combined momentum and opportunity now present is so great that Berkshire would almost surely remain a better-than-normal company for a very long time even if (1) Buffett left tomorrow, (2) his successors were persons of only moderate ability, and (3) Berkshire never again purchased a large business.”
Mr. Munger did not think that Warren Buffett would “leave tomorrow” nor did he think that Ajit Jain and Greg Abel are merely men of “moderate ability” and he was often more optimistic than Mr. Buffett regarding the possibility of large acquisitions. He had good reasons for his beliefs and, nine years after the letter, that optimism has proven to be warranted. Mr. Munger noted that both the railroad and the utility businesses have opportunities to deploy a great deal of capital internally, and he did not think that Mr. Jain or Mr. Abel would “leave Berkshire, no matter what someone else offered” or that they would “desire much change in the Berkshire system.”
It is often said that Berkshire’s acquisitions will end with Warren Buffett’s departure, but Charlie Munger did not agree with this assessment. Given Berkshire’s perennially high levels of cash, he felt that desirable opportunities would arise. Again, I think this boils down to culture. If it is true that Greg Abel will keep the culture intact, then opportunities for acquisitions deriving from the culture should still exist. In my opinion, the opportunities will be fewer since the prestige of the “Buffett seal of approval” will no longer exist, but this will not extinguish opportunities entirely.
Mr. Munger’s letter was written three years before Berkshire amended its repurchase program in 2018 to make it far easier to return capital to shareholders who wish to sell their shares. Since that change, Berkshire has used $72.9 billion to repurchase shares. The share count was reduced from 1,645,074 Class A equivalents on June 30, 2018 to 1,445,546 Class A equivalents on September 30, 2023. Opportunistic repurchases will almost certainly continue, if not accelerate, in the future.
Can Berkshire’s Playbook Work Elsewhere?
As many “mini-Berkshires” have discovered over the years, using insurance as the foundation of a conglomerate is hardly a bulletproof approach. Furthermore, it is not a result that Mr. Munger thought that Warren Buffett himself could reproduce if he returned to small base of capital today and attempted to recreate Berkshire!
“Berkshire’s marvelous outcome in insurance was not a natural result. Ordinarily, a casualty insurance business is a producer of mediocre results, even when very well managed. And such results are of little use. Berkshire’s better outcome was so astoundingly large that I believe that Buffett would now fail to recreate it if he returned to a small base while retaining his smarts and regaining his youth.” [Emphasis added]
Charlie Munger was hardly a naive Panglossian and could even seem dour and pessimistic to those who were exposed to him only rarely and did not understand his unique personality and manner of speaking. He constantly told investors to reduce their expectations, but he clearly believed in the fundamentals of the Berkshire system and considered it a model worthy of emulation. The fact that he was skeptical about Berkshire-like results being achieved by “mini-Berkshires” certainly does not mean that the Berkshire model is not one that should be emulated, only that investors should be skeptical that such attempts will produce Lollapaloozas.
He concluded the letter as follows:
“I believe that versions of the Berkshire system should be tried more often elsewhere and that the worst attributes of bureaucracy should much more often be treated like the cancers they so much resemble. A good example of bureaucracy fixing was created by George Marshall when he helped win World War II by getting from Congress the right to ignore seniority in choosing generals.”
Conclusion
For Berkshire Hathaway shareholders, especially those who have held shares for many decades, it is important to correctly judge whether results will continue to exceed the typical large public company in the future. If Berkshire can outperform, or merely keep pace, then shareholders with deferred capital gains in a concentrated positions would be well served to take Charlie Munger’s advice and “keep the faith” over the long run. On the other hand, if Berkshire is destined to mediocre or worse results, one should not allow tax considerations to prevent at least some diversification.
My personal opinion is that Berkshire’s culture and operating model will last for a very long time. I cannot say that it will last forever, or even for the next quarter century, because I do not know how voting control of the company will evolve in the future or who will eventually take over as CEO from Greg Abel when he retires.
I am increasingly convinced that investors who are attracted to the “Berkshire Way” should simply own Berkshire Hathaway rather than make heavy bets on companies seeking to emulate Berkshire Hathaway. While I agree with Charlie Munger’s hope that more companies will look to Berkshire’s model as a good option, it would be very difficult to replicate Berkshire’s success, or anything even close to it, with the model that was used to build Berkshire. Additionally, such attempts will come with higher fundamental business risks compared to Berkshire’s fundamental business risks.
Charlie Munger and Warren Buffett both stressed the importance of thinking about opportunity cost. When I think about investing in a smaller version of Berkshire Hathaway, I always consider whether there is a good reason to think that I could earn returns in excess of what I could earn invested in Berkshire itself. At the very least, a mini-Berkshire must offer a reasonable prospect of far higher returns than Berkshire given the higher risk inherent in smaller and less diversified companies. If one can argue that the return from a mini-Berkshire might be 50% higher than from Berkshire itself, it might be worth investing. Otherwise, I am content to simply own the original.
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