Warren Buffett, Berkshire Hathaway — 2007
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 2007 .................................................... 11.0 5.5 5.5 Compounded Annual Gain – 1965-2007 21.1% 10.3% 10.8 Overall Gain – 1964-2007 400,863% 6,840% 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 2007 was $12.3 billion, which increased the per-share book value of both our Class A and Class B stock by 11%. Over the last 43 years (that is, since present management took over) book value has grown from $19 to $78,008, a rate of 21.1% compounded annually.*
Overall, our 76 operating businesses did well last year. The few that had problems were primarily those linked to housing, among them our brick, carpet and real estate brokerage operations. Their setbacks are minor and temporary. Our competitive position in these businesses remains strong, and we have first- class CEOs who run them right, in good times or bad.
Some major financial institutions have, however, experienced staggering problems because they engaged in the “weakened lending practices” I described in last year’s letter. John Stumpf, CEO of Wells Fargo, aptly dissected the recent behavior of many lenders: “It is interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine.”
You may recall a 2003 Silicon Valley bumper sticker that implored, “Please, God, Just One More Bubble.” Unfortunately, this wish was promptly granted, as just about all Americans came to believe that house prices would forever rise. That conviction made a borrower’s income and cash equity seem unimportant to lenders, who shoveled out money, confident that HPA – house price appreciation – would cure all problems. Today, our country is experiencing widespread pain because of that erroneous belief. As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out – and what we are witnessing at some of our largest financial institutions is an ugly sight.
Turning to happier thoughts, we can report that Berkshire’s newest acquisitions of size, TTI and Iscar, led by their CEOs, Paul Andrews and Jacob Harpaz respectively, performed magnificently in 2007. Iscar is as impressive a manufacturing operation as I’ve seen, a view I reported last year and that was confirmed by a visit I made in the fall to its extraordinary plant in Korea.
Finally, our insurance business – the cornerstone of Berkshire – had an excellent year. Part of the reason is that we have the best collection of insurance managers in the business – more about them later. But we also were very lucky in 2007, the second year in a row free of major insured catastrophes.
That party is over. It’s a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008. Prices are down, and exposures inexorably rise. Even if the U.S. has its third consecutive catastrophe-light year, industry profit margins will probably shrink by four percentage points or so. If the winds roar or the earth trembles, results could be far worse. So be prepared for lower insurance earnings during the next few years.
Yardsticks
Berkshire has two major areas of value. The first is our investments: stocks, bonds and cash equivalents. At yearend these totaled $141 billion (not counting those in our finance or utility operations, which we assign to our second bucket of value).
*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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Insurance float – money we temporarily hold in our insurance operations that does not belong to us – funds $59 billion of our investments. This float is “free” as long as insurance underwriting breaks even, meaning that the premiums we receive equal the losses and expenses we incur. Of course, insurance underwriting is volatile, swinging erratically between profits and losses. Over our entire history, however, we’ve been profitable, and I expect we will average breakeven results or better in the future. If we do that, our investments can be viewed as an unencumbered source of value for Berkshire shareholders.
Berkshire’s second component of value is earnings that come from sources other than investments and insurance. These earnings are delivered by our 66 non-insurance companies, itemized on page 76. In our early years, we focused on the investment side. During the past two decades, however, we have put ever more emphasis on the development of earnings from non-insurance businesses.
The following tables illustrate this shift. In the first we tabulate per-share investments at 14-year intervals. We exclude those applicable to minority interests.
Year Per-Share Investments
Years Compounded Annual Gain in Per-Share Investments
1965 $ 4 1979 577 1965-1979 42.8% 1993 13,961 1979-1993 25.6% 2007 90,343 1993-2007 14.3%
For the entire 42 years, our compounded annual gain in per-share investments was 27.1%. But the trend has been downward as we increasingly used our available funds to buy operating businesses.
Here’s the record on how earnings of our non-insurance businesses have grown, again on a per- share basis and after applicable minority interests.
Year Per Share Pre-Tax Earnings
Years Compounded Annual Gain in Per- Share Pre-Tax Earnings
1965 $ 4 1979 18 1965-1979 11.1% 1993 212 1979-1993 19.1% 2007 4,093 1993-2007 23.5%
For the entire period, the compounded annual gain was 17.8%, with gains accelerating as our focus shifted.
Though these tables may help you gain historical perspective and be useful in valuation, they are completely misleading in predicting future possibilities. Berkshire’s past record can’t be duplicated or even approached. Our base of assets and earnings is now far too large for us to make outsized gains in the future.
Charlie Munger, my partner at Berkshire, and I will continue to measure our progress by the two yardsticks I have just described and will regularly update you on the results. Though we can’t come close to duplicating the past, we will do our best to make sure the future is not disappointing.
In our efforts, we will be aided enormously by the managers who have joined Berkshire. This is an unusual group in several ways. First, most of them have no financial need to work. Many sold us their businesses for large sums and run them because they love doing so, not because they need the money. Naturally they wish to be paid fairly, but money alone is not the reason they work hard and productively.
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A second, somewhat related, point about these managers is that they have exactly the job they want for the rest of their working years. At almost any other company, key managers below the top aspire to keep climbing the pyramid. For them, the subsidiary or division they manage today is a way station – or so they hope. Indeed, if they are in their present positions five years from now, they may well feel like failures.
Conversely, our CEOs’ scorecards for success are not whether they obtain my job but instead are the long-term performances of their businesses. Their decisions flow from a here-today, here-forever mindset. I think our rare and hard-to-replicate managerial structure gives Berkshire a real advantage.
Acquisitions
Though our managers may be the best, we will need large and sensible acquisitions to get the growth in operating earnings we wish. Here, we made little progress in 2007 until very late in the year. Then, on Christmas day, Charlie and I finally earned our paychecks by contracting for the largest cash purchase in Berkshire’s history.
The seeds of this transaction were planted in 1954. That fall, only three months into a new job, I was sent by my employers, Ben Graham and Jerry Newman, to a shareholders’ meeting of Rockwood Chocolate in Brooklyn. A young fellow had recently taken control of this company, a manufacturer of assorted cocoa-based items. He had then initiated a one-of-a-kind tender, offering 80 pounds of cocoa beans for each share of Rockwood stock. I described this transaction in a section of the 1988 annual report that explained arbitrage. I also told you that Jay Pritzker – the young fellow mentioned above – was the business genius behind this tax-efficient idea, the possibilities for which had escaped all the other experts who had thought about buying Rockwood, including my bosses, Ben and Jerry.
At the meeting, Jay was friendly and gave me an education on the 1954 tax code. I came away very impressed. Thereafter, I avidly followed Jay’s business dealings, which were many and brilliant. His valued partner was his brother, Bob, who for nearly 50 years ran Marmon Group, the home for most of the Pritzker businesses.
Jay died in 1999, and Bob retired early in 2002. Around then, the Pritzker family decided to gradually sell or reorganize certain of its holdings, including Marmon, a company operating 125 businesses, managed through nine sectors. Marmon’s largest operation is Union Tank Car, which together with a Canadian counterpart owns 94,000 rail cars that are leased to various shippers. The original cost of this fleet is $5.1 billion. All told, Marmon has $7 billion in sales and about 20,000 employees.
We will soon purchase 60% of Marmon and will acquire virtually all of the balance within six years. Our initial outlay will be $4.5 billion, and the price of our later purchases will be based on a formula tied to earnings. Prior to our entry into the picture, the Pritzker family received substantial consideration from Marmon’s distribution of cash, investments and certain businesses.
This deal was done in the way Jay would have liked. We arrived at a price using only Marmon’s financial statements, employing no advisors and engaging in no nit-picking. I knew that the business would be exactly as the Pritzkers represented, and they knew that we would close on the dot, however chaotic financial markets might be. During the past year, many large deals have been renegotiated or killed entirely. With the Pritzkers, as with Berkshire, a deal is a deal.
Marmon’s CEO, Frank Ptak, works closely with a long-time associate, John Nichols. John was formerly the highly successful CEO of Illinois Tool Works (ITW), where he teamed with Frank to run a mix of industrial businesses. Take a look at their ITW record; you’ll be impressed.