Warren Buffett, Berkshire Hathaway — 2006
Note: The following table appears in the printed Annual Report on the facing page of the Chairman's Letter and is referred to in that letter. 2 Berkshire’s Corporate Performance vs. the S&P 500
Annual Percentage Change
in Per-Share in S&P 500 Book Value of with Dividends Relative Berkshire Included Results Year (1) (2) (1)-(2) 1965 .................................................. 23.8 10.0 13.8 1966 .................................................. 20.3 (11.7) 32.0 1967 .................................................. 11.0 30.9 (19.9) 1968 .................................................. 19.0 11.0 8.0 1969 .................................................. 16.2 (8.4) 24.6 1970 .................................................. 12.0 3.9 8.1 1971 .................................................. 16.4 14.6 1.8 1972 .................................................. 21.7 18.9 2.8 1973 .................................................. 4.7 (14.8) 19.5 1974 .................................................. 5.5 (26.4) 31.9 1975 .................................................. 21.9 37.2 (15.3) 1976 .................................................. 59.3 23.6 35.7 1977 .................................................. 31.9 (7.4) 39.3 1978 .................................................. 24.0 6.4 17.6 1979 .................................................. 35.7 18.2 17.5 1980 .................................................. 19.3 32.3 (13.0) 1981 .................................................. 31.4 (5.0) 36.4 1982 .................................................. 40.0 21.4 18.6 1983 .................................................. 32.3 22.4 9.9 1984 .................................................. 13.6 6.1 7.5 1985 .................................................. 48.2 31.6 16.6 1986 .................................................. 26.1 18.6 7.5 1987 .................................................. 19.5 5.1 14.4 1988 .................................................. 20.1 16.6 3.5 1989 .................................................. 44.4 31.7 12.7 1990 .................................................. 7.4 (3.1) 10.5 1991 .................................................. 39.6 30.5 9.1 1992 .................................................. 20.3 7.6 12.7 1993 .................................................. 14.3 10.1 4.2 1994 .................................................. 13.9 1.3 12.6 1995 .................................................. 43.1 37.6 5.5 1996 .................................................. 31.8 23.0 8.8 1997 .................................................. 34.1 33.4 .7 1998 .................................................. 48.3 28.6 19.7 1999 .................................................. .5 21.0 (20.5) 2000 .................................................. 6.5 (9.1) 15.6 2001 .................................................. (6.2) (11.9) 5.7 2002 .................................................. 10.0 (22.1) 32.1 2003 .................................................. 21.0 28.7 (7.7) 2004 .................................................. 10.5 10.9 (.4) 2005 .................................................. 6.4 4.9 1.5 2006 .................................................. 18.4 15.8 2.6 Compounded Annual Gain – 1965-2006 21.4% 10.4% 11.0 Overall Gain – 1964-2006 361,156% 6,479% Notes: Data are for calendar years with these exceptions: 1965 and 1966, year ended 9/30; 1967, 15 months ended 12/31. Starting in 1979, accounting rules required insurance companies to value the equity securities they hold at market rather than at the lower of cost or market, which was previously the requirement. In this table, Berkshire’s results through 1978 have been restated to conform to the changed rules. In all other respects, the results are calculated using the numbers originally reported. The S&P 500 numbers are pre-tax whereas the Berkshire numbers are after-tax. If a corporation such as Berkshire were simply to have owned the S&P 500 and accrued the appropriate taxes, its results would have lagged the S&P 500 in years when that index showed a positive return, but would have exceeded the S&P 500 in years when the index showed a negative return. Over the years, the tax costs would have caused the aggregate lag to be substantial.
BERKSHIRE HATHAWAY INC.
To the Shareholders of Berkshire Hathaway Inc.:
Our gain in net worth during 2006 was $16.9 billion, which increased the per-share book value of both our Class A and Class B stock by 18.4%. Over the last 42 years (that is, since present management took over) book value has grown from $19 to $70,281, a rate of 21.4% compounded annually.*
We believe that $16.9 billion is a record for a one-year gain in net worth – more than has ever been booked by any American business, leaving aside boosts that have occurred because of mergers (e.g., AOL’s purchase of Time Warner). Of course, Exxon Mobil and other companies earn far more than Berkshire, but their earnings largely go to dividends and/or repurchases, rather than to building net worth.
All that said, a confession about our 2006 gain is in order. Our most important business, insurance, benefited from a large dose of luck: Mother Nature, bless her heart, went on vacation. After hammering us with hurricanes in 2004 and 2005 – storms that caused us to lose a bundle on super-cat insurance – she just vanished. Last year, the red ink from this activity turned black – very black.
In addition, the great majority of our 73 businesses did outstandingly well in 2006. Let me focus for a moment on one of our largest operations, GEICO. What management accomplished there was simply extraordinary.
As I’ve told you before, Tony Nicely, GEICO’s CEO, went to work at the company 45 years ago, two months after turning 18. He became CEO in 1992, and from then on the company’s growth exploded. In addition, Tony has delivered staggering productivity gains in recent years. Between yearend 2003 and yearend 2006, the number of GEICO policies increased from 5.7 million to 8.1 million, a jump of 42%. Yet during that same period, the company’s employees (measured on a fulltime-equivalent basis) fell 3.5%. So productivity grew 47%. And GEICO didn’t start fat.
That remarkable gain has allowed GEICO to maintain its all-important position as a low-cost producer, even though it has dramatically increased advertising expenditures. Last year GEICO spent $631 million on ads, up from $238 million in 2003 (and up from $31 million in 1995, when Berkshire took control). Today, GEICO spends far more on ads than any of its competitors, even those much larger. We will continue to raise the bar.
Last year I told you that if you had a new son or grandson to be sure to name him Tony. But Don Keough, a Berkshire director, recently had a better idea. After reviewing GEICO’s performance in 2006, he wrote me, “Forget births. Tell the shareholders to immediately change the names of their present children to Tony or Antoinette.” Don signed his letter “Tony.”
Charlie Munger – my partner and Berkshire’s vice chairman – and I run what has turned out to be a big business, one with 217,000 employees and annual revenues approaching $100 billion. We certainly didn’t plan it that way. Charlie began as a lawyer, and I thought of myself as a security analyst. Sitting in those seats, we both grew skeptical about the ability of big entities of any type to function well. Size seems to make many organizations slow-thinking, resistant to change and smug. In Churchill’s words: “We shape our buildings, and afterwards our buildings shape us.” Here’s a telling fact: Of the ten non-oil companies having the largest market capitalization in 1965 – titans such as General Motors, Sears, DuPont and Eastman Kodak – only one made the 2006 list.
*All per-share figures used in this report apply to Berkshire’s A shares. Figures for the B shares are 1/30 th of those shown for the A.
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In fairness, we’ve seen plenty of successes as well, some truly outstanding. There are many giant- company managers whom I greatly admire; Ken Chenault of American Express, Jeff Immelt of G.E. and Dick Kovacevich of Wells Fargo come quickly to mind. But I don’t think I could do the management job they do. And I know I wouldn’t enjoy many of the duties that come with their positions – meetings, speeches, foreign travel, the charity circuit and governmental relations. For me, Ronald Reagan had it right: “It’s probably true that hard work never killed anyone – but why take the chance?”
So I’ve taken the easy route, just sitting back and working through great managers who run their own shows. My only tasks are to cheer them on, sculpt and harden our corporate culture, and make major capital-allocation decisions. Our managers have returned this trust by working hard and effectively.
For their performance over the last 42 years – and particularly for 2006 – Charlie and I thank them.
Yardsticks
Charlie and I measure Berkshire’s progress and evaluate its intrinsic value in a number of ways. No single criterion is effective in doing these jobs, and even an avalanche of statistics will not capture some factors that are important. For example, it’s essential that we have managers much younger than I available to succeed me. Berkshire has never been in better shape in this regard – but I can’t prove it to you with numbers.
There are two statistics, however, that are of real importance. The first is the amount of investments (including cash and cash-equivalents) that we own on a per-share basis. Arriving at this figure, we exclude investments held in our finance operation because these are largely offset by borrowings. Here’s the record since present management acquired control of Berkshire:
Year
Per-Share Investments*
1965 ..................................................................... $ 4 1975 ..................................................................... 159 1985 ..................................................................... 2,407 1995 ..................................................................... 21,817 2006 ..................................................................... $80,636 Compound Growth Rate 1965-2006 .................... 27.5% Compound Growth Rate 1995-2006 .................... 12.6% *Net of minority interests
In our early years we put most of our retained earnings and insurance float into investments in marketable securities. Because of this emphasis, and because the securities we purchased generally did well, our growth rate in investments was for a long time quite high.
Over the years, however, we have focused more and more on the acquisition of operating businesses. Using our funds for these purchases has both slowed our growth in investments and accelerated our gains in pre-tax earnings from non-insurance businesses, the second yardstick we use. Here’s how those earnings have looked:
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YearPre-Tax Earnings Per Share*
1965 ..................................................................... $ 4 1975 ..................................................................... 4 1985 ..................................................................... 52 1995 ..................................................................... 175 2006 ..................................................................... $3,625 Compound Growth Rate 1965-2006 .................... 17.9% Compound Growth Rate 1995-2006 .................... 31.7% *Excluding purchase-accounting adjustments and net of minority interests
Last year we had a good increase in non-insurance earnings – 38%. Large gains from here on in, though, will come only if we are able to make major, and sensible, acquisitions. That will not be easy. We do, however, have one advantage: More and more, Berkshire has become “the buyer of choice” for business owners and managers. Initially, we were viewed that way only in the U.S. (and more often than not by private companies). We’ve long wanted, nonetheless, to extend Berkshire’s appeal beyond U.S. borders. And last year, our globe-trotting finally got underway.
Acquisitions
We began 2006 by completing the three acquisitions pending at yearend 2005, spending about $6 billion for PacifiCorp, Business Wire and Applied Underwriters. All are performing very well.
The highlight of the year, however, was our July 5 th acquisition of most of ISCAR, an Israeli company, and our new association with its chairman, Eitan Wertheimer, and CEO, Jacob Harpaz. The story here began on October 25, 2005, when I received a 1¼-page letter from Eitan, of whom I then knew nothing. The letter began, “I am writing to introduce you to ISCAR,” and proceeded to describe a cutting- tool business carried on in 61 countries. Then Eitan wrote, “We have for some time considered the issues of generational transfer and ownership that are typical for large family enterprises, and have given much thought to ISCAR’s future. Our conclusion is that Berkshire Hathaway would be the ideal home for ISCAR. We believe that ISCAR would continue to thrive as a part of your portfolio of businesses.”
Overall, Eitan’s letter made the quality of the company and the character of its management leap off the page. It also made me want to learn more, and in November, Eitan, Jacob and ISCAR’s CFO, Danny Goldman, came to Omaha. A few hours with them convinced me that if we were to make a deal, we would be teaming up with extraordinarily talented managers who could be trusted to run the business after a sale with all of the energy and dedication that they had exhibited previously. However, having never bought a business based outside of the U.S. (though I had bought a number of foreign stocks), I needed to get educated on some tax and jurisdictional matters. With that task completed, Berkshire purchased 80% of ISCAR for $4 billion. The remaining 20% stays in the hands of the Wertheimer family, making it our valued partner.
ISCAR’s products are small, consumable cutting tools that are used in conjunction with large and expensive machine tools. It’s a business without magic except for that imparted by the people who run it. But Eitan, Jacob and their associates are true managerial magicians who constantly develop tools that make their customers’ machines more productive. The result: ISCAR makes money because it enables its customers to make more money. There is no better recipe for continued success.
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In September, Charlie and I, along with five Berkshire associates, visited ISCAR in Israel. We – and I mean every one of us – have never been more impressed with any operation. At ISCAR, as throughout Israel, brains and ener