Berkshire's Corporate Performance vs.the S&P500 Annual Percentage Change in Per-Sha e of (1) (2) -2 38 29 14590036690479043 9 2008 2007 1.0 200 5053 -1965-2011 62 10.6 in rule req on hold anged rules.in all ults are calcul d the S&P 5 costs would have caused the
Berkshire’s Corporate Performance vs. the S&P 500 Annual Percentage Change Year in Per-Share Book Value of Berkshire (1) in S&P 500 with Dividends Included (2) Relative Results (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 2008 ..................................................... (9.6) (37.0) 27.4 2009 ..................................................... 19.8 26.5 (6.7) 2010 ..................................................... 13.0 15.1 (2.1) 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.6 2.1 2.5 Compounded Annual Gain – 1965-2011 ......................... 19.8% 9.2% 10.6 Overall Gain – 1964-2011 .................................... 513,055% 6,397% 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 aftertax. 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. 2
BERKSHIRE HATHAWAY INC. To the Shareholders of Berkshire Hathaway Inc. The per-share book value of both our Class A and Class B stock increased by 4.6%in 2011.Over the last 47 years(that is.since present management took over).book value has grown from $19 to $99.860.a rate of 19.8%compounded annually. Berkshire's Vice Chairman and my partner.and I feel good about the company's progress during2011.Here are the highlights: The prim y job of a Board of Directors is to see that the right people are running the business and t 19 care th have devoted to succession pln What's more,their efforts have paid off. and sho fter yearend Ted to Berkshire.Each will be handling a few billion dollars in 2012.but they have the brains,judgmen and character to manage our entire portfolio when Charlie and I are no longer running Berkshire. Your Board is qua ave had Berkshire's prospects will remain bright.More than 9 8%of my net v orth is in Berkshire stock,all o va so h de ve own and the caliber of the nle who m e them.With thes essor will enioy a running start.Do not,however,infer from this discussion that Charlie and I are going anywhere;we continue to be in excellent health,and we love what we do with pre-tax profits increasing from $147 million to $1.085 million.Lubrizol will have many e ve alrea Our major busines es did well last year.In fact.hof our five largest non-insurance companies-BNSE armon Group and M c201.C economy weakens in 2012.each of our fabulous five should again set a record.with aggregate eamings comfortably topping S10 billion
BERKSHIRE HATHAWAY INC. To the Shareholders of Berkshire Hathaway Inc.: The per-share book value of both our Class A and Class B stock increased by 4.6% in 2011. Over the last 47 years (that is, since present management took over), book value has grown from $19 to $99,860, a rate of 19.8% compounded annually.* Charlie Munger, Berkshire’s Vice Chairman and my partner, and I feel good about the company’s progress during 2011. Here are the highlights: • The primary job of a Board of Directors is to see that the right people are running the business and to be sure that the next generation of leaders is identified and ready to take over tomorrow. I have been on 19 corporate boards, and Berkshire’s directors are at the top of the list in the time and diligence they have devoted to succession planning. What’s more, their efforts have paid off. As 2011 started, Todd Combs joined us as an investment manager, and shortly after yearend Ted Weschler came aboard. Both of these men have outstanding investment skills and a deep commitment to Berkshire. Each will be handling a few billion dollars in 2012, but they have the brains, judgment and character to manage our entire portfolio when Charlie and I are no longer running Berkshire. Your Board is equally enthusiastic about my successor as CEO, an individual to whom they have had a great deal of exposure and whose managerial and human qualities they admire. (We have two superb back-up candidates as well.) When a transfer of responsibility is required, it will be seamless, and Berkshire’s prospects will remain bright. More than 98% of my net worth is in Berkshire stock, all of which will go to various philanthropies. Being so heavily concentrated in one stock defies conventional wisdom. But I’m fine with this arrangement, knowing both the quality and diversity of the businesses we own and the caliber of the people who manage them. With these assets, my successor will enjoy a running start. Do not, however, infer from this discussion that Charlie and I are going anywhere; we continue to be in excellent health, and we love what we do. • On September 16th we acquired Lubrizol, a worldwide producer of additives and other specialty chemicals. The company has had an outstanding record since James Hambrick became CEO in 2004, with pre-tax profits increasing from $147 million to $1,085 million. Lubrizol will have many opportunities for “bolt-on” acquisitions in the specialty chemical field. Indeed, we’ve already agreed to three, costing $493 million. James is a disciplined buyer and a superb operator. Charlie and I are eager to expand his managerial domain. • Our major businesses did well last year. In fact, each of our five largest non-insurance companies – BNSF, Iscar, Lubrizol, Marmon Group and MidAmerican Energy – delivered record operating earnings. In aggregate these businesses earned more than $9 billion pre-tax in 2011. Contrast that to seven years ago, when we owned only one of the five, MidAmerican, whose pre-tax earnings were $393 million. Unless the economy weakens in 2012, each of our fabulous five should again set a record, with aggregate earnings comfortably topping $10 billion. * All per-share figures used in this report apply to Berkshire’s A shares. Figures for the B shares are 1/1500th of those shown for A. 3
。 in total our entire string of onerating t $8 2 hillion for ent ir the U.S.,a fact that may surprise those who believe our country lacks investment opportunities.We welcome projects abroad,but the overwhelming majority of Berkshire's future capital commitments to be ese expenditures will agam set a recor Our insurance operations continued their delivery of costless capital that funds a myriad of othe unties.This business produces "float"-money that doesn't belong to us,but that we get invest for Berk re s enehit.And if we pay out less in I expenses than v years of underwriting profits,totaling about $17 billion.Over the same nine years our float increased from $41 billion to its current record of $70 billion.Insurance has been good to us Finally ities (1)a $5 hillion 6 Bank of America that came with warrants allowing us to buy 700 million common shares at $7.14 per share any time before September 2.2021:and ()63.9 million shares of IBM that cost us $10.9 billion Counting IBM.we now have large owr emany smaller.but in or course We view these holdings as partnership interests in wonderful businesses.not as marketable securities to e bought or d based on their n em prospects.Our s the carnings,however,are far fron se bus the of th nies that are attributable to our ownership are of huge importance to us.That's because they will be used in a variety of ways to increase future earnings and dividends of the investee.They may also be devoted to stock repurchases. which will increase our share of the company's future eamings Had we owned our nt positions throughout last year.our dividends from the "Big Four"would have been$862 million.That's all that would have b n reported in Berkshire's income statement.Ou share of earnings,however,would have far greate Ch and billion that ast that amou alue f the fo their dividends as wellto inerease in 2012 and.for that matter.almost every vear for a long time to I've run out of good news.Here are some developments that hurt us during 2011 A few years back.I spent about billion buying several bond issues of Energy Holdings.an n serving pom m arge measur purchase,the company's ability to pay will soon be exhausted unless gas prices rise substantially.We wrote down our investment by SI billion in 2010 and by an additional S390 million last year. At ve ried the honde at thei ain at levels,we will likely face a further loss.perhaps inan amount that will wipe out our ure mOr8 Cov,.subaanal in吧iS出 ed the gain/loss pro
• In total, our entire string of operating companies spent $8.2 billion for property, plant and equipment in 2011, smashing our previous record by more than $2 billion. About 95% of these outlays were made in the U.S., a fact that may surprise those who believe our country lacks investment opportunities. We welcome projects abroad, but expect the overwhelming majority of Berkshire’s future capital commitments to be in America. In 2012, these expenditures will again set a record. • Our insurance operations continued their delivery of costless capital that funds a myriad of other opportunities. This business produces “float” – money that doesn’t belong to us, but that we get to invest for Berkshire’s benefit. And if we pay out less in losses and expenses than we receive in premiums, we additionally earn an underwriting profit, meaning the float costs us less than nothing. Though we are sure to have underwriting losses from time to time, we’ve now had nine consecutive years of underwriting profits, totaling about $17 billion. Over the same nine years our float increased from $41 billion to its current record of $70 billion. Insurance has been good to us. • Finally, we made two major investments in marketable securities: (1) a $5 billion 6% preferred stock of Bank of America that came with warrants allowing us to buy 700 million common shares at $7.14 per share any time before September 2, 2021; and (2) 63.9 million shares of IBM that cost us $10.9 billion. Counting IBM, we now have large ownership interests in four exceptional companies: 13.0% of American Express, 8.8% of Coca-Cola, 5.5% of IBM and 7.6% of Wells Fargo. (We also, of course, have many smaller, but important, positions.) We view these holdings as partnership interests in wonderful businesses, not as marketable securities to be bought or sold based on their near-term prospects. Our share of their earnings, however, are far from fully reflected in our earnings; only the dividends we receive from these businesses show up in our financial reports. Over time, though, the undistributed earnings of these companies that are attributable to our ownership are of huge importance to us. That’s because they will be used in a variety of ways to increase future earnings and dividends of the investee. They may also be devoted to stock repurchases, which will increase our share of the company’s future earnings. Had we owned our present positions throughout last year, our dividends from the “Big Four” would have been $862 million. That’s all that would have been reported in Berkshire’s income statement. Our share of this quartet’s earnings, however, would have been far greater: $3.3 billion. Charlie and I believe that the $2.4 billion that goes unreported on our books creates at least that amount of value for Berkshire as it fuels earnings gains in future years. We expect the combined earnings of the four – and their dividends as well – to increase in 2012 and, for that matter, almost every year for a long time to come. A decade from now, our current holdings of the four companies might well account for earnings of $7 billion, of which $2 billion in dividends would come to us. I’ve run out of good news. Here are some developments that hurt us during 2011: • A few years back, I spent about $2 billion buying several bond issues of Energy Future Holdings, an electric utility operation serving portions of Texas. That was a mistake – a big mistake. In large measure, the company’s prospects were tied to the price of natural gas, which tanked shortly after our purchase and remains depressed. Though we have annually received interest payments of about $102 million since our purchase, the company’s ability to pay will soon be exhausted unless gas prices rise substantially. We wrote down our investment by $1 billion in 2010 and by an additional $390 million last year. At yearend, we carried the bonds at their market value of $878 million. If gas prices remain at present levels, we will likely face a further loss, perhaps in an amount that will virtually wipe out our current carrying value. Conversely, a substantial increase in gas prices might allow us to recoup some, or even all, of our write-down. However things turn out, I totally miscalculated the gain/loss probabilities when I purchased the bonds. In tennis parlance, this was a major unforced error by your chairman. 4
securities that wer incm to repace.thoughourLubrizol purchasedidoffsetos Last yea was dead connection is direct at Clayton Homes.which is the largest producer of homes the ou accounting for about7%of those constructed during 2011. Additionally.Acme Brick.Shay )Johns Manville (insulatior and MiTek (building pro all p agg te.our five housing-related companies had pre-tax profits of $513 million in 2011.That's similar to 2010 but down from S1.8 billion in 2006. Hou ing will come hack- years prior to 2008.however.America added more housing units than households.Inevitably.we ended up with 心 That devastating supply/demand equation is now reversed:Every day we are creating more households People may hit considerably less than the number of ne s left of the old ove supply.(Thi widely by locae While this healing takes place.however.our housing-related companies sputter employing only 43.315 people compared to 58.769 in 2006.This hugely important sector of the economy,which includ not onl y construction but everything that feeds off of it,remains in a own. stantiat this as so seve Wise monetary and fiscal policies play an important role in tempering recessions,but these tools don't create ho iseholds e excess ho raphics and our mark ally. will b com rised at how fa unemployment drops once that happens.They will then reawake to what has been true since 1776 America's best days lie ahead. Intrinsic Business Value Charlie and I measure our performance by the rate of gain in Berkshire's per-share intrinsic business value.If our gain over time outstrips the performance of.we have eamed our paychecks.Ifit L we are overpald at any pnce We have no way to pinpoint intrinsic value.But we do have a useful.though considerably understated. proxy for it:per-shar hly tracks busin timer.on a percentage basis as both the numerator and denominator of the business-value/book-value equation increase
• Three large and very attractive fixed-income investments were called away from us by their issuers in 2011. Swiss Re, Goldman Sachs and General Electric paid us an aggregate of $12.8 billion to redeem securities that were producing about $1.2 billion of pre-tax earnings for Berkshire. That’s a lot of income to replace, though our Lubrizol purchase did offset most of it. • Last year, I told you that “a housing recovery will probably begin within a year or so.” I was dead wrong. We have five businesses whose results are significantly influenced by housing activity. The connection is direct at Clayton Homes, which is the largest producer of homes in the country, accounting for about 7% of those constructed during 2011. Additionally, Acme Brick, Shaw (carpet), Johns Manville (insulation) and MiTek (building products, primarily connector plates used in roofing) are all materially affected by construction activity. In aggregate, our five housing-related companies had pre-tax profits of $513 million in 2011. That’s similar to 2010 but down from $1.8 billion in 2006. Housing will come back – you can be sure of that. Over time, the number of housing units necessarily matches the number of households (after allowing for a normal level of vacancies). For a period of years prior to 2008, however, America added more housing units than households. Inevitably, we ended up with far too many units and the bubble popped with a violence that shook the entire economy. That created still another problem for housing: Early in a recession, household formations slow, and in 2009 the decrease was dramatic. That devastating supply/demand equation is now reversed: Every day we are creating more households than housing units. People may postpone hitching up during uncertain times, but eventually hormones take over. And while “doubling-up” may be the initial reaction of some during a recession, living with in-laws can quickly lose its allure. At our current annual pace of 600,000 housing starts – considerably less than the number of new households being formed – buyers and renters are sopping up what’s left of the old oversupply. (This process will run its course at different rates around the country; the supply-demand situation varies widely by locale.) While this healing takes place, however, our housing-related companies sputter, employing only 43,315 people compared to 58,769 in 2006. This hugely important sector of the economy, which includes not only construction but everything that feeds off of it, remains in a depression of its own. I believe this is the major reason a recovery in employment has so severely lagged the steady and substantial comeback we have seen in almost all other sectors of our economy. Wise monetary and fiscal policies play an important role in tempering recessions, but these tools don’t create households nor eliminate excess housing units. Fortunately, demographics and our market system will restore the needed balance – probably before long. When that day comes, we will again build one million or more residential units annually. I believe pundits will be surprised at how far unemployment drops once that happens. They will then reawake to what has been true since 1776: America’s best days lie ahead. Intrinsic Business Value Charlie and I measure our performance by the rate of gain in Berkshire’s per-share intrinsic business value. If our gain over time outstrips the performance of the S&P 500, we have earned our paychecks. If it doesn’t, we are overpaid at any price. We have no way to pinpoint intrinsic value. But we do have a useful, though considerably understated, proxy for it: per-share book value. This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values. That’s because the amount by which Berkshire’s intrinsic value exceeds book value does not swing wildly from year to year, though it increases in most years. Over time, the divergence will likely become ever more substantial in absolute terms, remaining reasonably steady, however, on a percentage basis as both the numerator and denominator of the business-value/book-value equation increase. 5
We've regularl hasized that our hook-value ce is almost certain to ce the S&P 500 emal e iod当 kshiren ,1965-69,1966-70,etc). beating th S&p and ou ich it may d put together a five-year 水薄率海率带奉海率漆奉海 I also included two tables last year that set forth the key quantitative ingredients that will help you to S98,366,and our pre-tax earnings from businesses other than insurance and investments increased 18%to$6,990 per share Chadlie and ilike to se large operations that will give usa further boost.We now have eight subsidiaries that would each be included in the Fortune 500 were they stand-alone companies.That leaves only 492 to go.My task is clear.and I'm on the prowl. Share Repurchases that Berkshire e its share aprice of up to1 of boc tance of share ses sugge stsIshould focus fora bit on the subeet Charlie and I favor repurchases when two conditions are met:first,a company has ample funds to take care of the operational and liquidity needs of its business:second,its stock is selling at a material discount to the company's intrinsic business value,conservatively calculated We have wi nessed many b outs of test.S offset the dilution from stock issuances or simply because a company has excess cash.Continuing shareholders are hurt unle ed shares are e.The first law of capital allocation whether the in is tha recommend that you read hisa ltter. Charlie and I have mixed emotions when Berkshire shares sell well below intrinsic value.We like making money for ontinuing shareholders,and there isno surer way to do that than by buying an asset ou wn stock w to D ess tha hat Nevertheless,we don't enjoy cashing out partners at a discount,even though our doing so may give the selling shareholders a slightly higher price than they would receive if our bid was absent.When we are buying therefore,we want those exiting partners to be fully informed about the value of the assets they are selling. alue.repu resper-share intrins the opportunity.we will likely repurchase stock ssively at our price limit or lower.You should know. however.that we have no interest in supporting the stock and that our bids will fade in particularly weak markets. oldings are below $20 billion.At Berkshire.financial strength e takes precedence over all else. This diser he chance to addn events:First.we have the normal hope that eamings of the business will increase at a good clip for a long time to come;and sec d,we so hope tha e stock und erperforms in the mark et for a long time as well corollary t a stoc
We’ve regularly emphasized that our book-value performance is almost certain to outpace the S&P 500 in a bad year for the stock market and just as certainly will fall short in a strong up-year. The test is how we do over time. Last year’s annual report included a table laying out results for the 42 five-year periods since we took over at Berkshire in 1965 (i.e., 1965-69, 1966-70, etc.). All showed our book value beating the S&P, and our string held for 2007-11. It will almost certainly snap, though, if the S&P 500 should put together a five-year winning streak (which it may well be on its way to doing as I write this). ************ I also included two tables last year that set forth the key quantitative ingredients that will help you estimate our per-share intrinsic value. I won’t repeat the full discussion here; you can find it reproduced on pages 99-100. To update the tables shown there, our per-share investments in 2011 increased 4% to $98,366, and our pre-tax earnings from businesses other than insurance and investments increased 18% to $6,990 per share. Charlie and I like to see gains in both areas, but our primary focus is on building operating earnings. Over time, the businesses we currently own should increase their aggregate earnings, and we hope also to purchase some large operations that will give us a further boost. We now have eight subsidiaries that would each be included in the Fortune 500 were they stand-alone companies. That leaves only 492 to go. My task is clear, and I’m on the prowl. Share Repurchases Last September, we announced that Berkshire would repurchase its shares at a price of up to 110% of book value. We were in the market for only a few days – buying $67 million of stock – before the price advanced beyond our limit. Nonetheless, the general importance of share repurchases suggests I should focus for a bit on the subject. Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated. We have witnessed many bouts of repurchasing that failed our second test. Sometimes, of course, infractions – even serious ones – are innocent; many CEOs never stop believing their stock is cheap. In other instances, a less benign conclusion seems warranted. It doesn’t suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value. The first law of capital allocation – whether the money is slated for acquisitions or share repurchases – is that what is smart at one price is dumb at another. (One CEO who always stresses the price/value factor in repurchase decisions is Jamie Dimon at J.P. Morgan; I recommend that you read his annual letter.) Charlie and I have mixed emotions when Berkshire shares sell well below intrinsic value. We like making money for continuing shareholders, and there is no surer way to do that than by buying an asset – our own stock – that we know to be worth at least x for less than that – for .9x, .8x or even lower. (As one of our directors says, it’s like shooting fish in a barrel, after the barrel has been drained and the fish have quit flopping.) Nevertheless, we don’t enjoy cashing out partners at a discount, even though our doing so may give the selling shareholders a slightly higher price than they would receive if our bid was absent. When we are buying, therefore, we want those exiting partners to be fully informed about the value of the assets they are selling. At our limit price of 110% of book value, repurchases clearly increase Berkshire’s per-share intrinsic value. And the more and the cheaper we buy, the greater the gain for continuing shareholders. Therefore, if given the opportunity, we will likely repurchase stock aggressively at our price limit or lower. You should know, however, that we have no interest in supporting the stock and that our bids will fade in particularly weak markets. Nor will we buy shares if our cash-equivalent holdings are below $20 billion. At Berkshire, financial strength that is unquestionable takes precedence over all else. ************ This discussion of repurchases offers me the chance to address the irrational reaction of many investors to changes in stock prices. When Berkshire buys stock in a company that is repurchasing shares, we hope for two events: First, we have the normal hope that earnings of the business will increase at a good clip for a long time to come; and second, we also hope that the stock underperforms in the market for a long time as well. A corollary to this second point: “Talking our book” about a stock we own – were that to be effective – would actually be harmful to Berkshire, not helpful as commentators customarily assume. 6
O品BAb did a uptcy twenty years ago to its pron recent years as the company's y proved.I I can thimk l that value-addn quisitions almost exelusively for repurchased itsown stock. Naturally happens to nd that the ill lik day:What should a long-term shareholder.such as Berkshire.cheer for during that period? I won't keep you in suspense.We should wish for IBM's stock price to languish throughout the five years. Let's do the math.If IBM's stock price a erages.say.S200 during the y will acquire of which wewoud own 6.5 If IBM were to ear.say.$20 billion in the fifth year.our share of those earnings would be a full $100 million greate r unc er the disappo hey would the The logic is simple:If you are going to be a net buyer of stocks in the future,either directly with your own nip or a company tha nares),you are nrt when st a commuter who rejoices after the price of gas increases,simply because his tank contains a day's supply. o way of t king- In a v too tiired whe th r Th ou over to Graham's The Intelligent Imvestor,the chapter dealing with how investors should view fluctuations in stock I from my eyes,and low prices became my friend.Picking up that book was one In the end,the success of our IBM investment will be determined primarily by its future earnings.But an important secondary factor will be how many shares the company purchases with the substantia Sums1【1 shares outstanding to 63.9 million,I will them as four separate businesses.which is how Charlie and I view them.Because we may be repurchasing Berkshire shares from some of you.we will offer our thoughts in each section as to how intrinsic value compares to carrying value. 7
Let’s use IBM as an example. As all business observers know, CEOs Lou Gerstner and Sam Palmisano did a superb job in moving IBM from near-bankruptcy twenty years ago to its prominence today. Their operational accomplishments were truly extraordinary. But their financial management was equally brilliant, particularly in recent years as the company’s financial flexibility improved. Indeed, I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders. The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock. Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%. Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares. Our quiz for the day: What should a long-term shareholder, such as Berkshire, cheer for during that period? I won’t keep you in suspense. We should wish for IBM’s stock price to languish throughout the five years. Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%. If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the “disappointing” scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $11⁄2 billion more than if the “high-price” repurchase scenario had taken place. The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply. Charlie and I don’t expect to win many of you over to our way of thinking – we’ve observed enough human behavior to know the futility of that – but we do want you to be aware of our personal calculus. And here a confession is in order: In my early days I, too, rejoiced when the market rose. Then I read Chapter Eight of Ben Graham’s The Intelligent Investor, the chapter dealing with how investors should view fluctuations in stock prices. Immediately the scales fell from my eyes, and low prices became my friend. Picking up that book was one of the luckiest moments in my life. In the end, the success of our IBM investment will be determined primarily by its future earnings. But an important secondary factor will be how many shares the company purchases with the substantial sums it is likely to devote to this activity. And if repurchases ever reduce the IBM shares outstanding to 63.9 million, I will abandon my famed frugality and give Berkshire employees a paid holiday. ************ Now, let’s examine the four major sectors of our operations. Each has vastly different balance sheet and income characteristics from the others. Lumping them together therefore impedes analysis. So we’ll present them as four separate businesses, which is how Charlie and I view them. Because we may be repurchasing Berkshire shares from some of you, we will offer our thoughts in each section as to how intrinsic value compares to carrying value. 7
Insurance Let's look first at insurance,Berkshire's core operation and the engine that has propelled our expansion over the years. Property-casualty("P/C)insurers receive premiums upfront and pay claims later.In extreme case such as those arising from certain workers'compensation accidents.payme scan stretch over decades.This aves us money we individual entually go to Cce le uhe the unt of float we hold Year Float (in millions) 1970 39 198 237 199 1.632 2010 2011 心心 If our premiums the total of our and eventual los s,we register an underwnting profi 1n urs.we enj operate at a significant underwritingloss.Forexample.State Farm.by farthe country's largest insurer and a well-managed se money in insurance,and the industry is resource in creating new ones ow op ated at an underwriting profit for nine consecutive yea our gain for the period having lota that we will continue to yea ited $ for holding its money and then let us invest its funds for our own benefit. ect alculati float is de replenish it.But that's an incorrect way to view float.which should instead be viewed asa revolving fund.If float is both costless and long-enduring.the true value of this liability is far lower than the accounting liability. tated liability is $15 5 billion companies that is included in book value as an asset.In effect.this goodwill re sents the price we paid for the float-generating capabilities of our insurance operations.The cost of the goodwill,however,has no bearing on its produce large and sustained underwriting losses,any goodwill asse e deemed valueless,whatever its original cos Fortunately,that's not the case at Berkshire.Charlie and I believe the true economic value of ou insuranceg -what we would pay to purchase float of similar quality -【o be far in exce -a nuge reason why we beleve Ber Let me emphasize once again that cost-free flo is nor an ou tcome to be expected for the P/C industry 5dig201,h uate to cover
Insurance Let’s look first at insurance, Berkshire’s core operation and the engine that has propelled our expansion over the years. Property-casualty (“P/C”) insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers’ compensation accidents, payments can stretch over decades. This collect-now, pay-later model leaves us holding large sums – money we call “float” – that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit. Though individual policies and claims come and go, the amount of float we hold remains remarkably stable in relation to premium volume. Consequently, as our business grows, so does our float. And how we have grown, as the following table shows: Year Float (in $ millions) 1970 $ 39 1980 237 1990 1,632 2000 27,871 2010 65,832 2011 70,571 It’s unlikely that our float will grow much – if at all – from its current level. That’s mainly because we already have an outsized amount relative to our premium volume. Were there to be a decline in float, I will add, it would almost certainly be very gradual and therefore impose no unusual demand for funds on us. If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit occurs, we enjoy the use of free money – and, better yet, get paid for holding it. Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous in most years that it causes the P/C industry as a whole to operate at a significant underwriting loss. For example, State Farm, by farthe country’slargestinsurer and a well-managed company besides, has incurred an underwriting loss in eight of the last eleven years. There are a lot of ways to lose money in insurance, and the industry is resourceful in creating new ones. As noted in the first section of this report, we have now operated at an underwriting profit for nine consecutive years, our gain for the period having totaled $17 billion. I believe it likely that we will continue to underwrite profitably in most – though certainly not all – future years. If we accomplish that, our float will be better than cost-free. We will profit just as we would if some party deposited $70.6 billion with us, paid us a fee for holding its money and then let us invest its funds for our own benefit. So how does this attractive float affect intrinsic value calculations? Our float is deducted in full as a liability in calculating Berkshire’s book value, just as if we had to pay it out tomorrow and were unable to replenish it. But that’s an incorrect way to view float, which should instead be viewed as a revolving fund. If float is both costless and long-enduring, the true value of this liability is far lower than the accounting liability. Partially offsetting this overstated liability is $15.5 billion of “goodwill” attributable to our insurance companies that is included in book value as an asset. In effect, this goodwill represents the price we paid for the float-generating capabilities of our insurance operations. The cost of the goodwill, however, has no bearing on its true value. If an insurance business produces large and sustained underwriting losses, any goodwill asset attributable to it should be deemed valueless, whatever its original cost. Fortunately, that’s not the case at Berkshire. Charlie and I believe the true economic value of our insurance goodwill – what we would pay to purchase float of similar quality – to be far in excess of its historic carrying value. The value of our float is one reason – a huge reason – why we believe Berkshire’s intrinsic business value substantially exceeds book value. Let me emphasize once again that cost-free float is not an outcome to be expected for the P/C industry as a whole: We don’t think there is much “Berkshire-quality” float existing in the insurance world. In most years, including 2011, the industry’s premiums have been inadequate to cover claims plus expenses. Consequently, the 8
because we have some terrific man nagers running som the major units. y float size is the Berkshire Hathaway Reinsurance Gr n by Aiit lain Aiit ins most importantly,brains in a manner that is unique in the insurance business.Yet he never exposes Berkshire to isks that are o our resource Indeed we are far more cons e in nat respect tha it ha moderate profit for the year because of its many streams of eamings.Concurrently.all other major insurers and reinsurers would be far in the red,and some would face insolvency. 1985. of $34 biu: meeedgret may iooolarso te aue reChane w trade me for a second Ajit.Alas.there is none. We have another insurance powerhouse in General Re.managed by Tad Montross At bottom.a sound insurance operation needs to adhere to four disciplines.It must(1)understand all exposures that might cause a policy toinc (2)conservatively evaluate the likelihood o I any exposure after both a tive loss nd oper ting overed:and (4)to walk away ifh appropriate premium can't be obtained. that their Many insurers pass the first thre s and Tunk th trouble in mindset akin to that of the senior citizen who received a call from his wife while driving home."Albert.be eareful. Tad h ed all fo of the ts and it shows in his ults General re's Finally there is GFICo the insurer on which I cut my teeth 61 ve s ago.GEICO is run by Tony Nicely.who joined the company at 18 and completed 50 years of service in 2011. 'much-envied comes Tony's brillia t execution of hod ine as it had for r would now be $3.3 billion rather than the $15.4 billion we attained in 2011.The extra value created by Tony and his ssociates is a major element in Berkshire's excess of intrinsic value over book value. Tony to rake in Americans discover that the Gecko is doing them a favor when he urges them to visit GEICO.com for a quote (Our lizard has another endearing quality:Unlike human spokesmen or spokeswomen who expensively represent other insurance companies,our little fellow has no agent. 水海率海水体率体水本水 In addition to our three major insurance operations,we own a group of smaller companies.most of 9
industry’s overall return on tangible equity has for many decades fallen far short of the average return realized by American industry, a sorry performance almost certain to continue. Berkshire’s outstanding economics exist only because we have some terrific managers running some extraordinary insurance operations. Let me tell you about the major units. ************ First by float size is the Berkshire Hathaway Reinsurance Group, run by Ajit Jain. Ajit insures risks that no one else has the desire or the capital to take on. His operation combines capacity, speed, decisiveness and, most importantly, brains in a manner that is unique in the insurance business. Yet he never exposes Berkshire to risks that are inappropriate in relation to our resources. Indeed, we are far more conservative in that respect than most large insurers. For example, if the insurance industry should experience a $250 billion loss from some mega-catastrophe – a loss about triple anything it has ever faced – Berkshire as a whole would likely record a moderate profit for the year because of its many streams of earnings. Concurrently, all other major insurers and reinsurers would be far in the red, and some would face insolvency. From a standing start in 1985, Ajit has created an insurance business with float of $34 billion and significant underwriting profits, a feat that no CEO of any other insurer has come close to matching. By these accomplishments, he has added a great many billions of dollars to the value of Berkshire. Charlie would gladly trade me for a second Ajit. Alas, there is none. ************ We have another insurance powerhouse in General Re, managed by Tad Montross. At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained. Many insurers pass the first three tests and flunk the fourth. They simply can’t turn their back on business that their competitors are eagerly writing. That old line, “The other guy is doing it so we must as well,” spells trouble in any business, but in none more so than insurance. Indeed, a good underwriter needs an independent mindset akin to that of the senior citizen who received a call from his wife while driving home. “Albert, be careful,” she warned, “I just heard on the radio that there’s a car going the wrong way down the Interstate.” “Mabel, they don’t know the half of it,” replied Albert, “It’s not just one car, there are hundreds of them.” Tad has observed all four of the insurance commandments, and it shows in his results. General Re’s huge float has been better than cost-free under his leadership, and we expect that, on average, it will continue to be. In the first few years after we acquired it, General Re was a major headache. Now it’s a treasure. ************ Finally, there is GEICO, the insurer on which I cut my teeth 61 years ago. GEICO is run by Tony Nicely, who joined the company at 18 and completed 50 years of service in 2011. GEICO’s much-envied record comes from Tony’s brilliant execution of a superb and almostimpossible-to-replicate business model. During Tony’s 18-year tenure as CEO, our market share has grown from 2.0% to 9.3%. If it had instead remained static – as it had for more than a decade before he took over – our premium volume would now be $3.3 billion rather than the $15.4 billion we attained in 2011. The extra value created by Tony and his associates is a major element in Berkshire’s excess of intrinsic value over book value. There is still more than 90% of the auto-insurance market left for GEICO to rake in. Don’t bet against Tony acquiring chunks of it year after year in the future. Our low costs permit low prices, and every day more Americans discover that the Gecko is doing them a favor when he urges them to visit GEICO.com for a quote. (Our lizard has another endearing quality: Unlike human spokesmen or spokeswomen who expensively represent other insurance companies, our little fellow has no agent.) ************ In addition to our three major insurance operations, we own a group of smaller companies, most of them plying their trade in odd corners of the insurance world. In aggregate, their results have consistently been profitable and the float they provide us is substantial. Charlie and I treasure these companies and their managers. 9
nce,a New Jersey writer of medical ma ctice nolicies this ction expands the m gerial domain of Tim Ken the star CEO of Medical Protective ou Indiana-based med-mal insurer.Princeton brings with it more than $600 million of float,an amount that is included in the following table. Here is the record of all fou segments of our property-casualty and life insurance businesses Underwriting Profit Yearend Float Insurance Operations 2011 2010 BH Reir s(7 44 GEICO 576 1117 11169 1027 Other Primary....... 242 268 5.960 5.141 $248 S2.013 $70.571 S65.832 Among large insurance operations.Berkshire's impresses me as the best in the world. Regulated,Capital-Intensive Businesses We have two very large businesses.BNSF and MidAmerican Energy.that have important common letter a osplit out their combine A key characteristic of both companies is the huge investment they have in very long-lived,regulated these partially funded by large amounts of long-term debt h guaranteed by Berkshire.Our ede s have eaming power that even unde 0 e busine amply coverage was 95x.At MidAmerican.meanwhile two key factors ensure its ability to service debt under a Mea red by es 42 of Am a's inter ity and RNSE any other railroad-about 37%of the industry total.A little math will tell you that about 15%ofinter-city All of this plac :a hu nsibility on us We must without fail maintain and im ove our 23 000 miles of track along with 13.000 bridges,80 tunnels,6900 locomotives and 78.600 freight cars.This job requires 二de esprea ed under las To fulfill its societal obligation.BNSF regularly invests far more than its depreciation charge,with the .8 billion in 201 Th three other major U.S s are mal ing simil spe mg. hat be levi needed to provide better and more extensive service in the future.were not making expenditures.our country's publicly-financed highway system would face even greater congestion and maintenance problems than exist today Massive investments of the sort that bnse is makin would be foolish if it could not earn a counseled,"Ke p thy shop,and thy shop will keep thee. Translating this to our od be yourcustomer's
At yearend, we acquired Princeton Insurance, a New Jersey writer of medical malpractice policies. This bolt-on transaction expands the managerial domain of Tim Kenesey, the star CEO of Medical Protective, our Indiana-based med-mal insurer. Princeton brings with it more than $600 million of float, an amount that is included in the following table. Here is the record of all four segments of our property-casualty and life insurance businesses: Underwriting Profit Yearend Float (in millions) Insurance Operations 2011 2010 2011 2010 BH Reinsurance ................ $(714) $ 176 $33,728 $30,370 General Re . . . . . . . . . . . . . . . . . . . . 144 452 19,714 20,049 GEICO . . . . . . . . . . . . . . . . . . . . . . . 576 1,117 11,169 10,272 Other Primary . . . . . . . . . . . . . . . . . . 242 268 5,960 5,141 $ 248 $2,013 $70,571 $65,832 Among large insurance operations, Berkshire’s impresses me as the best in the world. Regulated, Capital-Intensive Businesses We have two very large businesses, BNSF and MidAmerican Energy, that have important common characteristics distinguishing them from our many other businesses. Consequently, we assign them their own sector in this letter and also split out their combined financial statistics in our GAAP balance sheet and income statement. A key characteristic of both companies is the huge investment they have in very long-lived, regulated assets, with these partially funded by large amounts of long-term debt that is not guaranteed by Berkshire. Our credit is not needed: Both businesses have earning power that even under terrible business conditions amply covers their interest requirements. In a less than robust economy during 2011, for example, BNSF’s interest coverage was 9.5x. At MidAmerican, meanwhile, two key factors ensure its ability to service debt under all circumstances: The stability of earnings that is inherent in our exclusively offering an essential service and a diversity of earnings streams, which shield it from the actions of any single regulatory body. Measured by ton-miles, rail moves 42% of America’s inter-city freight, and BNSF moves more than any other railroad – about 37% of the industry total. A little math will tell you that about 15% of all inter-city ton-miles of freight in the U.S. is transported by BNSF. It is no exaggeration to characterize railroads as the circulatory system of our economy. Your railroad is the largest artery. All of this places a huge responsibility on us. We must, without fail, maintain and improve our 23,000 miles of track along with 13,000 bridges, 80 tunnels, 6,900 locomotives and 78,600 freight cars. This job requires us to have ample financial resources under all economic scenarios and to have the human talent that can instantly and effectively deal with the vicissitudes of nature, such as the widespread flooding BNSF labored under last summer. To fulfill its societal obligation, BNSF regularly invests far more than its depreciation charge, with the excess amounting to $1.8 billion in 2011. The three other major U.S. railroads are making similar outlays. Though many people decry our country’s inadequate infrastructure spending, that criticism cannot be levied against the railroad industry. It is pouring money – funds from the private sector – into the investment projects needed to provide better and more extensive service in the future. If railroads were not making these huge expenditures, our country’s publicly-financed highway system would face even greater congestion and maintenance problems than exist today. Massive investments of the sort that BNSF is making would be foolish if it could not earn appropriate returns on the incremental sums it commits. But I am confident it will do so because of the value it delivers. Many years ago Ben Franklin counseled, “Keep thy shop, and thy shop will keep thee.” Translating this to our regulated businesses, he might today say, “Take care of your customer, and the regulator – your customer’s representative – will take care of you.” Good behavior by each party begets good behavior in return. 10
At MidAr ate in a similar" compact.”W Midamerican 8o g owned by berkshire s stomers in the with electricity ine and as an im dant orovider in six other states a well.Our pipelines transport 8%of the country's natural gas.Obviously,many millions of Americans depend on us every day.They haven't been disappointed. When MidAmerican purchased Northem Natural Gas pipeline in 2002,that company's performance as most recent report. MidAmerica has a comparable ecord.In the most recent red the6 utility groups surveyed. story was Ia MidAmerican will have 3 316 ration in on nd of 2012 far than any other regulated ele ommitted to wind is a staggering $6 billion.We can make this sort of investment because MidAmerican retains all of its earnings,unlike other utilities that generally pay out most of what they earn.In addition,late las y more BNSF and by for Berkshire shareholders.Below are the relevant figures: MidAmerican Earnings (in millions 2011 2010 333 )70 70 Western utilities 783 Pipelines 38 37 36 Operating earnings be 13 20 Income tax 315 271 1.331 $1.238 Earnings applicable to Berkshire* s1.204 $1.131 *Includes interest eamed by Berkshire (net of related income taxes)of $8 in 2011 and $19in2010. (in millions 2011 2010 s16 ings s07 Pre-Tax earnings 4,741 Net earnings . 2.97 In the book value recorded on our balance sheet.BNSF and MidAmerican carry substantial goodwill components totaling $20 billion.In each instance.however.Charlie and I believe current intrinsic value is far greater than book value
At MidAmerican, we participate in a similar “social compact.” We are expected to put up ever-increasing sums to satisfy the future needs of our customers. If we meanwhile operate reliably and efficiently, we know that we will obtain a fair return on these investments. MidAmerican, 89.8% owned by Berkshire, supplies 2.5 million customers in the U.S. with electricity, operating as the largest supplier in Iowa, Utah and Wyoming and as an important provider in six other states as well. Our pipelines transport 8% of the country’s natural gas. Obviously, many millions of Americans depend on us every day. They haven’t been disappointed. When MidAmerican purchased Northern Natural Gas pipeline in 2002, that company’s performance as a pipeline was rated dead last, 43 out of 43, by the leading authority in the field. In the most recent report, Northern Natural was ranked second. The top spot was held by our other pipeline, Kern River. In its electric business, MidAmerican has a comparable record. In the most recent survey of customer satisfaction, MidAmerican’s U.S. utilities ranked second among 60 utility groups surveyed. The story was far different not many years back when MidAmerican acquired these properties. MidAmerican will have 3,316 megawatts of wind generation in operation by the end of 2012, far more than any other regulated electric utility in the country. The total amount that we have invested or committed to wind is a staggering $6 billion. We can make this sort of investment because MidAmerican retains all of its earnings, unlike other utilities that generally pay out most of what they earn. In addition, late last year we took on two solar projects – one 100%-owned in California and the other 49%-owned in Arizona – that will cost about $3 billion to construct. Many more wind and solar projects will almost certainly follow. As you can tell by now, I am proud of what has been accomplished for our society by Matt Rose at BNSF and by Greg Abel at MidAmerican. I am also both proud and grateful for what they have accomplished for Berkshire shareholders. Below are the relevant figures: MidAmerican Earnings (in millions) 2011 2010 U.K. utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 469 $ 333 Iowa utility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279 279 Western utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 771 783 Pipelines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 388 378 HomeServices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 42 Other (net) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 47 Operating earnings before corporate interest and taxes ............................ 1,982 1,862 Interest, other than to Berkshire .............................................. (323) (323) Interest on Berkshire junior debt .............................................. (13) (30) Income tax ............................................................... (315) (271) Net earnings ............................................................. $1,331 $1,238 Earnings applicable to Berkshire* ............................................ $1,204 $1,131 *Includes interest earned by Berkshire (net of related income taxes) of $8 in 2011 and $19 in 2010. BNSF (Historical accounting through 2/12/10; purchase accounting subsequently) (in millions) 2011 2010 Revenues ................................................................ $19,548 $16,850 Operating earnings ........................................................ 5,310 4,495 Interest (Net) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 560 507 Pre-Tax earnings .......................................................... 4,741 3,988 Net earnings .............................................................. 2,972 2,459 In the book value recorded on our balance sheet, BNSF and MidAmerican carry substantial goodwill components totaling $20 billion. In each instance, however, Charlie and I believe current intrinsic value is far greater than book value. 11
