Lawrence Cunningham’s new book, Berkshire Beyond Buffett, takes readers on a deep dive into the world of one of America’s richest men and how he built a fortune for himself and his shareholders through his holding company, Berkshire Hathaway. At 84, the question of succession looms large. Would the company survive if Warren Buffett decides to step down? Cunningham thinks the company is built to last. Here’s an excerpt adapted from his book.
Just how huge is Berkshire Hathaway? If it were a country and its revenues its gross domestic product, the company would be among the world’s top 50 economies, rivaling Ireland, Kuwait and New Zealand. Berkshire’s cash alone – $40 billion or more in recent years – exceeds the total assets of all but the largest 100 American corporations.
Berkshire’s substantial achievements over a sustained period of time are well known. The company and its iconic leader, Warren E. Buffett, became famous for savvy stock picking through the 1990s. They acquired lucrative minority stakes in public companies, including American Express, Coca-Cola, the Washington Post Company and Wells Fargo. Today the huge Berkshire conglomerate has wholly owned businesses in every artery of commerce, finance and marketing.
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Berkshire owns the second most popular car insurer in the United States (GEICO), one of the major trans-continental railroads in North America (Burlington Northern Santa Fe), two of the biggest reinsurers in the world (Gen Re and National Indemnity), a global energy supplier (Berkshire Hathaway Energy, formerly MidAmerican Energy), and pacesetters in fields as different as diamonds and mobile homes.
All of this is why, when IBM and Coke, two of Berkshire’s biggest investments, fell short of earnings expectations in late October and “cost” the company about $2.5 billion, garnering a great deal of media attention – I doubted that Buffett lost any sleep over those market events.
Most people assume that if the price of a stock they own falls, they’ve lost money. But Buffett and other value investors don’t think the way most people think.
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The value investor’s creed holds that a price decline of a stock you own and like is often not remotely a loss, but an investment opportunity. It’s related to price and value being different things. The $2.5 billion figure in terms of Buffett’s recent losses was the price decline in the stocks. It’s not the same as the relative value of the underlying businesses.
Here’s a quick primer of value investing to put the story about Berkshire’s stock positions in perspective:
(A) Price and value are different (so Berkshire did not “lose” anything when
prices of stocks such as Coca-Cola or IBM tumbled recently);
(B) If the economic characteristics of a business have permanently eroded, sell the stock (which is why Berkshire recently sold half its stake in Tesco); and
(C) Shareholder activists who interfere with management may obtain short-term gains from a given stake – but sacrifice potential value that a partnership attitude yields. For example, Berkshire’s 2008 investments in Bank of America, GE, Goldman and others were spectacularly profitable because investees valued its patient quiet capital.
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Overall, Berkshire has outperformed the broader stock market for its shareholders 80 percent of the time, often by double digits. Through 2013, Berkshire’s average annual gain was 19.7 percent, more than double that of the Standard & Poor’s 500 index, a cross-section of public company stocks. With a market value of $300 billion, Berkshire has generated considerable wealth, direct and indirect, for employees, customers, suppliers and other constituencies.
This past Friday, Berkshire posted third-quarter earnings of $2,876 per share, topping estimates of $2,594 per share. The company said operating earnings rose to $4.72 billion, up 29 percent from a year ago, while net income fell nearly 9 percent in the same period, to $4.62 billion.
But how does it function so successfully given that it is made up of a diverse group of subsidiaries? Besides a portfolio of minority interests in scores of public companies, Berkshire wholly owns 50 significant direct subsidiaries, which in turn own another 200 subsidiaries. The Berkshire corporate empire encompasses more than 500 entities engaged in hundreds of different lines of business.
As someone who has long studied the company, I can tell you that its distinctive features are tailor-made for its special circumstances. Berkshire boasts an atypical shareholder body that relishes the company’s distinctiveness – and one that understands that corporate culture matters.
So what lessons can others take away from Berkshire?
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Berkshire’s secret to managing a large complex organization is to manage parsimoniously – as little as possible. There are no organizational charts, budget reviews, deal pitches, human resources management, or present value analysis or other business school staples at Berkshire. Instead, it goes by these fundamentals:
- Be budget conscious, especially by cost minimization. This underlies the business model at GEICO, for example, where low prices multiple volume and profits. A related implication: Avoid costly debt.
- Reinvest profits in promising businesses; but avoid adding capital to businesses that don’t generate high returns. A residual point: Commit to permanence but know when to walk away, as Buffett shuttered the mills of Berkshire Hathaway in the 1980s.
- Nurture entrepreneurship, where rewards can be great, as evidenced by the multiple revenue streams Clayton Homes built around the manufactured housing business.
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- Encourage small businesses to grow and expand one step at a time, even if haphazardly, as the accumulation of individual achievement can add up to huge enterprises, like the many success stories in building Dairy Queen.
- But also stick to your knitting, as BNSF Railway has done for a century and a half, and as other Berkshire subsidiaries teach by their mistaken diversions, such as GEICO offering credit cards to insurance customers.
- Offer autonomy to business teammates, as they are likely to thrive on it. And have their backs. But do not allow anyone to damage business reputation, being ruthless with managers who skate close to the edge of thin ice.
- For family businesses, address the inherent vexing challenges by promoting the values of family identity and legacy. Family businesses sold to Berkshire – among them See’s, Nebraska Furniture Mart, and Helzberg Diamonds, for example – all boast strong cultures that likely would have sustained the companies absent of Berkshire.
- Make money, lots of money, but without losing sight of the long term. Manage knowing that people value intangibles, especially permanence, as seen in numerous Berkshire acquisitions made at discounts to business value: most of the family companies; all those acquired out of bankruptcy, such as Fruit of the Loom and Johns Manville; and several others, including Dairy Queen and NetJets.
- Above all, stress integrity, which is central to so many Berkshire stories. Warren Buffett, above all, has made his word his bond.
Excerpted from Berkshire Beyond Buffett: The Enduring Value of Values by Lawrence A. Cunningham. Copyright © 2014 Lawrence A. Cunningham. Used by arrangement with the publisher, Columbia University Press. All rights reserved.
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