A lesson in retained earnings, succession at Berkshire with hints to potential successors, trends in boards & a counter-view on board independence, and a unique take on acquisitions were the top themes in the 2019 shareholder letter,
Every year, the letter the world's most legendary investor and Chairman of Berkshire Hathaway, Warren Buffett, writes to the shareholders of his company is eagerly awaited by investors across the globe, looking to pick on the legend's brain. In today's post, we look at some of the most important themes discussed in the much-awaited letter.
The power of Retained earnings - While the Oracle of Omaha has firms that pay rich dividends in his portfolio, his focus for the letter was on retained earnings. Stressing on how these high-quality, well-managed companies can steadily compound wealth by retaining parts of what they earn in their good years and deploying it effectively creating multifold higher returns for their shareholders, this was a rare argument for firm's retaining money (in the short term, to return multifold long term) as opposed to the general Wall Street focus on capital return. For the top 10 companies in the portfolio, earnings retained in the period was 2.2x dividends paid! Amongst portfolio companies, Coca-Cola had the highest proportion of earnings distributed to earnings retained, while Delta Air had the lowest.
Succession at Berkshire - A good one page, and a hint in the notes that followed, seemed to indicate that both Buffett and Munger seem to have taken the succession issues seriously. Buffett provided clarity and reassurance on the factors that would hold the firm in good stead after either of their death, first by talking about the positives at the company - 1. Ownership of extra-ordinary companies 2. Single entity for controlled businesses create economic moats 3. Sound financial management to guard against external shocks 4. Dedicated high-quality managers 5. Trustworthy directors. He also provided clarity on his will, and how it was structured to prevent short term liquidity-driven shocks to the company.
In the firm's notes, he also spoke about giving two managers -Ajit Jain & Greg Abel center stage at the Berkshire AGM, in what could be preparation for succession.
The themes in Company Boards - With composition and actions of the board of directors being talking points across Wall-Street, especially with the emergence of ESG funds, Buffett's segment on boards will probably be the most talked about.
He defined the key challenge for the board quite simply - To find and retain a talented CEO, possessing integrity, who will be devoted to the company for his/her lifetime. This was the second highlighted reference to devotion in the letter, the first when he spoke about senior leaders at Berkshire who would succeed him. The section also spoke about the need for improvement in women's representation on boards, the benefits of a dedicated board session without the CEO to help discuss critical issues including CEO skills, acquisition decisions, and compensation.
He also covered an issue that generally doesn't get enough attention, director compensation, which currently stands at US$200K+, and its impact on their independence. "When seeking directors, CEOs don’t look for pit bulls. It’s the cocker spaniel that gets taken home." he quipped, pointing to how the director who doesn't oppose the CEO is much more likely to get a referral at a second directorship, and consequently larger pay. In this regard, he questioned Wall Street's obsession over board 'independence' and presented a counter argument for directors who had a real stake in the company.
A unique take on acquisitions - Buffett also presented an interesting take on acquisition decisions, something that a lot of investors practice quite often. Having a competent counter-opinion. While the model he proposed of pitting two bankers, each pitting for and against the deal seems unlikely, given the large upside to bankers proposing for the deal, a new niche of companies acting as 'pure-play opposers', could emerge if the theme were to grow.
All in all, a very insightful letter, providing some time-tested, and some extremely unique takes on key business decisions. If you liked the post, please do share it in finance groups who might be interested in reading the same!
About the Author: The post is written by Ganesh Nagarsekar. Ganesh is a graduate from IIM Calcutta and has worked with J.P. Morgan and Goldman Sachs, before founding GSN Invest.