Buffett's Berkshire Hathaway issues annual shareholder letter for 2010

Berkshire Hathaway has released its 2010 Annual Shareholder letter (see full letter at http://www.berkshirehathaway.com/letters/2010ltr.pdf).

Some key highlights are:

• The per share book value of Class and Class B stock increased by 13% in 2010. Over the last 46 years, book value has grown from $19 to $95,453, a rate of 20.2% compounded annually (compared with 9.4% for the S&P 500 with dividends included)
• On the acquisition of Burlington North Santa Fe (rail road company) - It now appears this railroad company will increase Berkshire's "normal" earning power by nearly 40% pre-tax and by well over 30% after tax. Berkshire bought the outstanding 77% of Burlington on November 3, 2009, for $100 per share in cash and stock - a deal valued at $44 billion.
• Money will always flow toward opportunity, and there is an abundance of that in America. Commentators today often talk of "great opportunity". But think back, for example, to December 6, 1941, October 18, 1987 and September 20, 2001. No matter how serene today may be, tomorrow is always uncertain.
• Cultures self propagate. Winston Churchill once said "You shape your houses and then they shape you.". That wisdom applies to businesses as well. Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce imperious behaviour. (As one wag put it, "You know you're no longer CEO when you get in the back seat of your car and it doesn't move."). At Berkshire's "world headquarters" our annual rent is $270,212. Moreover, the home office investment in furniture, art, Coke dispenser, lunch room, high tech equipment - you name it-totals $301,363. As long as Charlie and I treat your money as if it were your own, Berkshire's managersare likely to be careful with it as well.

On the latter point, I wish more of the fund managers on Wall Street and in London had the same attitude as Mr Buffett and Charlie Munger! The "sage of omaha's" treat for the day is his Diet Coke and steak in the local diner, not Krug and a Michelin star lunch. Less costs = more returns for investors.

The succession to Buffett and Munger is the key question for Berkshire Hathaway investors given their respective, 80 years and 85 years. It will be a hard act to follow. Why can't we have a Berkshire type fund on this side of the Atlantic that could have said to have delivered twice the FTSE All share over decades?

Warren Buffett's tips for investment success

As an avid Buffett and Berkshire Hathaway follower, I try to remember his investment advice which has served him well. If readers are wondering why I took the decision to top up on Rockhopper (despite its relatively high risk profile) and sell some Xcite (despite my liking of the company and its excellent prospects), please see points 1 "stay liquid", point 2 "buy when everyone else is selling",  point 7 "defense beats offense" below. 

As another of my investment heroes Jim Cramer also says, "diversify, diversify, diversify". I am failing badly here, too many oil and gas stocks and too much in Xcite Energy. But I have known this for some time, and hence taking exit points when they arise on Xcite. Though I am in loss positions on both Rockhopper and Bowleven  (though made some profits on both in earlier sales in 2011), I won't be selling these at a loss. The fundamentals still justify an investment on a risk versus reward basis. Lets not forget that Buffett was buying preferred shares in Goldman Sachs in 2009 when everyone else on Wall Street wouldn't touch the sector and for his risk he got an 8% coupon! This is the contrarian style of investing that I favour....and sometimes its damned hard being a Contrarian when the momentum is the other way.

Extract from March 2010 post (http://contrarianinvestoruk.blogspot.com/2010/03/warrne-buffets-berkshire-hathaway-shows.html).

Buffet’s advice for investment success is :

Stay liquid. "We will never become dependent on the kindness of strangers," he wrote. "We will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses."
Buy when everyone else is selling. "We've put a lot of money to work during the chaos of the last two years. It's been an ideal period for investors: A climate of fear is their best friend ... Big opportunities come infrequently. When it's raining gold, reach for a bucket, not a thimble."
Don't buy when everyone else is buying. "Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance," Mr. Buffett wrote. The obvious corollary is to be patient. You can only buy when everyone else is selling if you have held your fire when everyone was buying.
Value, value, value. "In the end, what counts in investing is what you pay for a business-through the purchase of a small piece of it in the stock market-and what that business earns in the succeeding decade or two."
Don't get suckered by big growth stories. Mr. Buffett reminded investors that he and Berkshire Vice Chairman Charlie Munger "avoid businesses whose futures we can't evaluate, no matter how exciting their products may be.". Most investors who bet on the auto industry in 1910, planes in 1930 or TV makers in 1950 ended up losing their shirts, even though the products really did change the world. "Dramatic growth" doesn't always lead to high profit margins and returns on capital. China, anyone?
Understand what you own. "Investors who buy and sell based upon media or analyst commentary are not for us," Mr. Buffett wrote.
Defense beats offense. "Though we have lagged the S&P in some years that were positive for the market, we have consistently done better than the S&P in the eleven years during which it delivered negative results. In other words, our defense has been better than our offense, and that's likely to continue." All timely advice from Mr. Buffett for turbulent times.

(original source: marketwatch.com)

Some of the top contrarian investors of our time and what we can learn from them

David Dreman
Dreman was once described by Kiplinger's magazine as the "consummate contrarian". His Kemper-Dreman High Return Fund was one of the best performing mutual funds ever in the U.S., being no.1 versus its comparative group for ten years from 1998. Dreman is author of the books, "Contrarian Investment Strategies: The next generation", "Psychology and the stock market".Dreman's investment strategy whilst running his High Return Fund was to focus on buying stocks that were either overlooked by other investors or beaten down by the market. In Dreman's view, investors tend to overreact to market conditions and routinely either under value or over value companies depending on what sector is "hot" at the current time and also overeact to market surprises such as profits warnings. Dreman's view was that by owning stocks that were currently in favour, any negative event has a serious downside whilst positive "surprises" would have little impact. He advises going against the crowd by buying stocks that are cheap because of an overreaction or fear on the basis of key financial measures. He also believes that a major market crisis like the one that occurred during 2008 and early 2009 as an outstanding opportunity to profit - "buy during a panic, don't sell".

In Contrarian Investment Strategies, there is an analysis of he calls the "major postwar crises" e.g. Gulf War, 1979 oil crisis. Apart from the Berlin blockade, one year after these crises the market on average was up between 22.9% and 43.6%, with an average of 25%. Two years after these events, the average gain was 37.5%.

Dreman bought stocks on the basis of 4 measures: earnings, cash flow (after tax earnings, adding back depreciation and other non cash charges), book value (value of a company's stock less all liabilities and preferred shares), and yield. His company focuses on those stocks with a market capitalisation of around $2 billion, a rising earnings trend quarter on quarter, a strong current ratio of at least 2 (measures the ratio of current assets to liabilities which is a measure of a company's ability to pay its short term debts).


However a valuable lesson for potential contrarian investors is to avoid being over aggressive in a concentrated sector when the market is in a particularly volatile positon. In April 2009, Dreman was fired as manager of the $2.2 billion DWS Dreman High Return Equity Fund after the fund lost 47% of its value over the previous 12 months. He aggressively bought beaten down financial stocks, based on a belief that the widespread pessimism on the industry was overdone. Unfortunately he was proved to be very wrong in his contrarian view of these financial stocks. In 1999, Dreman was also fired after his decision to avoid internet stocks led to his funds significantly under performing over the period. After being fired, he made returns well ahead of the market in the following few years. The difference between this period and that of 2008/2009 is that Dreman avoided try to generate big speculative gains in pursuit of a more conservative and medium-term approach. 


Warren Buffett
Buffett is known as the greatest investor of all time and is one of the richest men in the world. The so called "sage of Omaha" is Chairman and CEO of Berkshire Hathaway, a company which has an average annual return to investors of 24% since the 1960's. Berkshire Hathaway was originally acquired in the 1960's and was a textile mill in Massachussets before being used a vehicle for acquisitions of other unrelated businesses. Buffett uses the same investment philosophy as Benjamin Graham in his famous book, "The Intelligent Investor". In 2008, Buffett said "It comes about from having an investment philosophy grounded in the idea that a stock is a piece of a business. If you look at it that way, there's no reason to get excited whether some analyst is recommending it or the company is splitting the shares two-for-one, or whatever. The only way to drive the extraneous thoughts out of your mind is to have a philosophy. And for us that philosophy comes from benjamin Graham and the Intelligent Investor, especially chapters 8 and 20. It's not very complicated stuff." He famously avoided the tech crash in 2000 because he said he didn't undertstand tech companies and he only invests in companies he can "get his head around". He avoids speculation and invests for the long term. He guiding principles when buying stocks are: 1) Consistent earnings growth 2) good return on equity 3) a simple business model 4) good management 5) large purchase 6) will to take an offer price. He also looks for an "enduring moat" i.e. a competitive advantage that is difficult to replicate. Buffett looks for "consumer monopolies" where a company's positon is virtually unassailable because of a strong market position or premier brand. Alternatively he may look at a company with the lowest production costs in the industry which would be difficult to replicate by a competitor.

Marc Faber
Faber, known as "Dr Doom" and for his newletter, "Gloom, Boom and Doom Report " He was a managing director at Drexel Burnham Lambert Ltd Hong Kong office from the beginning of 1978 until the firm's collapse in 1990, a company known for its dominance of junk bond trading during his tenure. The company ultimately failed after being mired in criminal and SEC investigations. In 1990, he set up his own business, Marc Faber Limited, which acts as an investment advisor concentrating on value investments with tremendous upside often based on contrarian investment philosophies. Faber is famous for advising his clients to get out of the stock market one week before the October 1987 crash, forecasting the end of the Japanese bubble in 1990 and calling the bottom of the market in March 2009.

John Neff
John Neff managed the Windsor Fund for more than 30 years which averaged a return of 13.7% during the years 1964 to 1995 when he was running the fund against a gain of 10.6% in the S&P 500. He had a similar approach to Buffett in not spending lavishly on corporate premises and buying a modest property. In his book, "John Neff on Investing" he talks about his focus on beaten down stocks with low price/earning's ratio's, that had posted new 52 week lows or had published a particularly bad piece of news. In fact Neff described himself as a "low price-earnings investor" targeting companies with a p/e 40-60% below the market average, believing that stocks with a high p/e had so much expectation built into them that they often fell at the slightest piece of bad or even expected news. On the contrary, companies with low p/e's, had the benefit that "indifferent financial performance by low p/e companies seldom exacts a penalty". Neff seperated the badly run low p/e companies by looking at earnings growth, buying companies with consistent and "reasonable" growth i.e. more than 6% but not more than 20%. He believed that firms with a very high earnings growth had too much risk. Another Key part of his approach, was to look for stocks with a good dividend payout, for this reason he focused on total return (EPS Growth plus dividend yield). Finally he would make sure the free cash flow was strong.

Neff talks about the the difficulty of deciding when to sell a stock. He says "investors fall in love with a winning stock and hold onto it too long - particulary when their contrarian stance has been vindicated". May investors fear that they will sell winners too soon and miss out on even greater gains but Neff said "Instead of groping for the last dollar, we gladly left some upside on the table. Catching market tops was not our game. This was preferable to getting caught in a subsequent downdraft, which is never a pretty picture". Neff sold stocks when there was deterioration in the stock's fundamentals (earnings growth) or it's price approached the target set when it is was bought.

Anthony Bolton
Anthony Bolton is widely regarded to be the U.K.'s most successful fund manager. Over twenty five years he delivered a market-beating annual return of 20% in his Fidelity Special Situations Fund, 7 % higher than for for the FTSE All-Share index. In his book, "Investing Against the Tide - lessons from a life running money", he talks about his contrarian style. Much of his success came from buying stocks in turnaround situations. A key element in this approach is to meet with the management and satisfying himself that they know what they're doing and can execute their plans.

Using technical indicators and charts, he attempts to establish where we a company is in its cycle and invests accordingly. Bolton's philosophy is that you have to do something different to the market in order to achieve superior returns, "if you want to outperform other people, you have got to hold something different from other people. If you want to outperform the market, as everyone expects you to do, the one thing you mustn't hold is the market itself." He focused on stocks with recovery potential, who had unrecognised growth, had a unusually low and unjustified valuation based on its earnings or had takeover potential,.

Anniversary of market rebound gives opportunity for reflection

The Dow Jones Industrials and the Standard & Poor's 500 both bottomed on March 9, 2009. It is incredible to think that 12 months ago, the S&P 500 stood at 672 and now is at 1,139, a 69% increase, the DOW Jones Industrials stood at 6,547 and are now at 10,550 (a 61% increase) and the FTSE 100 stood at 3,532, having increased 58% to today's 5,584. You could have picked up great stocks like Google (GOOG) for $289 (now $558), Caterpillar (CAT) for $23 (now $59), Apple (AAPL) for $83 (now $219), BP (BP.) for £4.29 (now £6.35) and HSBC (HSBA) for £3.04 (now £6.98). Despite having strong balance sheets, good profitability and great in-market positions these stocks were swept up in the negative spiral precipitated by the near collapse of the financial system, as exemplified by the demise of Lehman Brothers in September 2008. It really was the "sale of the century" for those brave enough to take a contrarian position back in the dark days of early 2009. For investors in more specialist vehicles such as commodity related stocks or emerging markets, returns in 2009 have been even more spectacular. For "value" investors, the signs of an oversold market were plain to see - forward price/earnings ration's close to the single digits for the DOW and FTSE, a yield on the FTSE of close to 5% and many quality companies close to cash value. But the fear gripping the market was such that with the exception of investors like Buffett's Berkshire Hathaway (who invested too early in cases such as Goldman Sachs despite highly favourable terms), many chose to stay on the sidelines and waited for a signal of a turn. The volatility even frightened me and despite buying heavily back in March 2009, I chose to take quick profits rather than hold with a hope of higher returns.


So now in March 2010, the investment case is less certain. It may seem a crazy thing to say, but despite all the positive signals that the U.S. economy is slowly coming out of a painful recession, the risks of buying the market are higher than back 12 months ago. Whereas at the peak of the panic, you could have bought almost anything with a reasonable balance sheet, the market is much more tricky now with the big gains in the second half of 2009. Contrarian Investor UK is inclined to stay on the side lines for a time now and let the established positions run. The risk of a correction (albeit modest) is very much concerning me. Bad news has been largely discounted by the market during 2010, but any significant set back in U.S. or European recovery may well be a catalyst for profit taking and volumes are already so low in the U.S. that it suggests that the major players are not active in the market and waiting for a better investing opportunity.

Warren Buffett's Top Ten Quotes

1."We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."

2. "Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1"

3. "Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results."

4. "Try to buy stock in businesses that are so wonderful that an idiot can run them because sooner or later one will."

5. "Derivatives are financial weapons of mass destruction."

6. "I buy expensive suits. They just look cheap on me."

7. "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is usually the reputation of the business that remains intact."

8. "In the business world, the rearview mirror is always clearer than the windshield."

9. "Our favourite holding period is forever"

10. "Why not invest your assets in the companies you really like? As Mae West said, "Too much of a good thing can be wonderful""

Warren Buffet's Berkshire Hathaway shows strong growth in 2009 but behind market

This weekend Berkshire Hathaway Inc. (NYSE: BRK-B, BRK-A) sent out its annual shareholder letter. The company said its annual shareholder value rose by 19.8% and book value per share rose to $84,487.00 (though this was behind the 25% rebound in the S&P 500 in 2009). It was the strongest gain since 2003 with net earnings rising 61% last year to $5,193 per share. Total Common Stocks Carried at Market are listed as $34,646 billion cost basis and $59,034 billion in market value. In 2005, Berkshire’s book value rose 6.4 per cent, against 4.9 per cent for the S&P; in 2006 it was 18.4 per cent versus 15.8 per cent; in 2007 11 per cent against 5.5 per cent; and in 2008 -9.6 per cent versus -37 per cent. Today the B shares were down 1% to $79.3.

Berkshire’s Warren Buffett was less cautious than in the past and broadly optimistic about the future - “We entered 2008 with $44.3 billion of cash-equivalents, and we have since retained operating earnings of $17 billion. Nevertheless, at year-end 2009, our cash was down to $30.6 billion (with $8 billion earmarked for the BNSF acquisition). We’ve put a lot of money to work during the chaos of the last two years. It’s been an ideal period for investors: A climate of fear is their best friend. Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance. In the end, what counts in investing is what you pay for a business – through the purchase of a small piece of it in the stock market – and what that business earns in the succeeding decade or two.” Berkshire holds a strong porfolio of companies and has had a consistent and exceptional track record. However, the persistent threat of the retirement of the "sage of Omaha" Warren Buffett is now a real possibility at 80 years of age. Following the strong rise in the company's shares when Berkshire entered the S&P 500 following a stock split in February, Berkshire does not look cheap based on earnings expectations for 2010. As Buffett would say himself, "don't buy when everyone else is buying" and therefore BRK may be an ideal candidate for an entry point on any uncertainty about the future leadership of the company i.e. sell on current strength.

Buffet’s advice for investment success is (courtesy of Marketwatch.com) :
Stay liquid. "We will never become dependent on the kindness of strangers," he wrote. "We will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses."
Buy when everyone else is selling. "We've put a lot of money to work during the chaos of the last two years. It's been an ideal period for investors: A climate of fear is their best friend ... Big opportunities come infrequently. When it's raining gold, reach for a bucket, not a thimble."
Don't buy when everyone else is buying. "Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance," Mr. Buffett wrote. The obvious corollary is to be patient. You can only buy when everyone else is selling if you have held your fire when everyone was buying.
Value, value, value. "In the end, what counts in investing is what you pay for a business-through the purchase of a small piece of it in the stock market-and what that business earns in the succeeding decade or two."
Don't get suckered by big growth stories. Mr. Buffett reminded investors that he and Berkshire Vice Chairman Charlie Munger "avoid businesses whose futures we can't evaluate, no matter how exciting their products may be.". Most investors who bet on the auto industry in 1910, planes in 1930 or TV makers in 1950 ended up losing their shirts, even though the products really did change the world. "Dramatic growth" doesn't always lead to high profit margins and returns on capital. China, anyone?
Understand what you own. "Investors who buy and sell based upon media or analyst commentary are not for us," Mr. Buffett wrote.
Defense beats offense. "Though we have lagged the S&P in some years that were positive for the market, we have consistently done better than the S&P in the eleven years during which it delivered negative results. In other words, our defense has been better than our offense, and that's likely to continue." All timely advice from Mr. Buffett for turbulent times.

Cadbury - Buffett expresses doubts on takeover price

Yesterday, Kraft Foods (KFT) of the U.S. increased its bid for the UK confectioner Cadbury (CBRY) to £5 per share in cash and 0.1874 Kraft shares for each Cadbury share (up from its previous offer of £3 per share in cash and 0.2589 Kraft share for each Cadbury share). The deal values Cadbury at a 13 times 2009 earnings. Last night Warren Buffett, a major shareholder in Kraft, said that the company had over paid for the acquisition to proceed with the share price having almost doubled since the bid (closing yesterday at £8.34) was announced and valued the company at £11.5 billion.

The combined firm will overtake Mars/Wrigley to operate as the leading player in the global confectionery market but with margins under pressure as the price of raw materials continues to rise, U.K. workers union fears that that Kraft may take an axe to the Cadbury organisation to aggressively cut costs may be the key driver to deliver a return on this investment.

With Buffett, expressing his reservations about the deal, Kraft management have a lot to prove. As the history of these type of high premium takeovers shows, shareholders are often disappointed. Let’s see if Kraft management follow the trend.