Warren Buffett's Annual Letter For Fiscal Year 2014
Fifty years ago Warren Buffett took control of a textile company named Berkshire Hathaway. In the years following, he built that small company into a diversified conglomerate that employs 340,499 people and whose stock price has appreciated 1,826,163%. It is an incredible record.
To commemorate the 50 years Warren Buffett has led Berkshire Hathaway, Buffett and Charles Munger have written a special annual letter to shareholders. In their annual letter, Buffett and Munger share their thoughts on the past 50 years and the next 50 years for Berkshire Hathaway. As Buffett and Munger describe it, the investment approach underlying the success of Berkshire Hathaway has evolved significantly over the past 50 years. They also discuss the roles focus and culture have played in making Berkshire Hathaway the distinctive company it is today. In this edition of my newsletter, I discuss a few of the lessons about building companies to succeed that can be learned from the annual letter and from their comments at the May 2 annual meeting.
Warren Buffett's Annual Letter
Thoughts on the Value on Continual Learning, Focus and Culture.
The Value of Continually Refining How You Invest
The investment style upon which Berkshire Hathaway has been built has evolved over the years. As Buffett notes in the annual letter, he initially pursued a value-focused approach of investing in “cigar-butt” companies:
My cigar-butt strategy worked very well while I was managing small sums. Indeed, the many dozens of free puffs I obtained in the 1950s made that decade by far the best of my life for both relative and absolute investment performance.
But cigar-butt investing had its limits. Investing in small companies that traded at bargain prices was “scalable only to a point.” It would not work well for investing larger and larger amounts of money. Additionally, cigar-butt investing did not create a strong foundation upon which to build a large company capable of continuing to grow over the long term.
As the limitations of cigar-butt investing became more apparent, Buffett’s investment philosophy evolved. Buffett writes:
It took Charlie Munger to break my cigar-butt habits and set the course for building a business that could combine huge size with satisfactory profits.
Munger’s insight was to invest in “wonderful businesses at fair prices” rather than “fair businesses at wonderful prices.” By investing this way, Buffett and Munger were able to invest significantly larger amounts of money profitably. This insight provided the basis for the ongoing growth we continue to see at Berkshire Hathaway.
Over time, Buffett and Munger’s investment style took on a number of additional refinements as well. The investment in See’s Candy provided valuable insight into the value of investing in well-established brands. Buffett and Munger also broadened their investment style to include large investments in companies in a variety of industries with very different economic characteristics, including insurance, finance, manufacturing, service and consumer brands, utilities, housing, newspapers and a railroad system.
Today Berkshire Hathaway is a highly-diversified conglomerate with investments in dozens of business sectors and major equity positions in leading Fortune 500 companies. Buffett notes that “Berkshire now owns 9 ½ companies that would be listed on the Fortune 500 were they independent (Heinz is the ½ .)” As illustrated by the relatively recent purchases of BNSF Railway, the H.J. Heinz Company and Kraft Foods Group, Inc., Buffett and Munger’s investment style continues to evolve and expand.
Markets, businesses and investing have all changed dramatically over the past 50 years. In spite of these dramatic changes, Berkshire Hathaway has continued to grow and expand. One important lesson to be learned from the history of Berkshire Hathaway is the value of continual learning and of continuing to refine how you invest.
The Value of Focus
The success of Berkshire Hathaway is built upon a number of important investment and business insights. In addition to Buffett and Munger’s insight on the value of investing in quality companies and well-established brands, these insights include a nuanced understanding of the value of “float,” the value of a conglomerate structure and the value of a conservative balance sheet. Each of these insights shares one characteristic in common: they are all the result of Buffett and Munger spending a considerable amount of time reading and thinking.
Thus, a second important lesson to be learned from the history of Berkshire Hathaway is the value of focus.
Charles Munger writes:
… Buffett’s decision to limit his activities to a few kinds and to maximize his attention to them, and to keep doing so for 50 years, was a lollapalooza.
As Munger notes in the annual letter, Buffett has focused on a relatively short list of primary activities. These activities include managing investments, choosing the Chief Executive Officers of important operating subsidiaries, allocating capital, making himself available for consultation with the CEOs of subsidiaries, writing a long and educational annual letter, and, probably most importantly, being an exemplar of Berkshire Hathaway’s culture and reserving much time for quiet reading and thinking. Munger also observes that Berkshire Hathaway has been very consciously organized and managed (a small conglomerate headquarters staff, “very extreme autonomy” for the CEOs of subsidiaries) to permit Buffett to focus on these primary activities.
By focusing on a short list of primary activities for such a long period of time, Buffett has been able to build upon and refine his principle strengths and the strengths of what Munger calls “the Berkshire system.” Buffett’s disciplined focus has produced a variety of valuable insights that have built upon each other and grown in value over the years, enabling Berkshire Hathaway to evolve and grow into the huge, highly-diversified conglomerate it is today. The results for Berkshire Hathaway have been growth in per-share book value at a rate of 19.4% compounded annually over the last 50 years and a “lollapalooza.”
The Value of Culture
The culture of an organization is very much a reflection of the people leading it. Thus, what Buffett and Munger write about the qualities that a future CEO should have says much about the distinctive culture of Berkshire Hathaway.
“Character is crucial,” Buffett writes. “A Berkshire CEO must be ‘all in’ for the company, not for himself.” The example a CEO sets has a huge influence on the people a CEO leads and manages. “If it’s clear to them that shareholders’ interests are paramount to him, they will, with few exceptions, also embrace that way of thinking.”
The primary responsibilities of a future CEO of Berkshire Hathaway will be allocating capital and selecting and retaining managers to lead the company’s operating subsidiaries, Buffett writes. These duties will require that Berkshire Hathaway’s CEO “be a rational, calm and decisive individual who has a broad understanding of business and good insights into human behavior.” Buffett notes that his successor will also need the ability to fight off “arrogance, bureaucracy and complacency.” Buffett writes that he feels that the very high level of delegation of authority at Berkshire Hathaway is “the ideal antidote to bureaucracy.”
To help ensure the continuation of the company’s distinctive culture, Buffett has suggested that his son, Howard Buffett, succeed him as non-executive Chairman of Berkshire Hathaway. Buffett writes that he suggested that Howard Buffett be made Chairman “to make change easier if the wrong CEO should ever be employed and there occurs a need for the Chairman to move forcefully.” Buffett notes that he thinks there is a “very low probability” of this issue arising at Berkshire Hathaway, but he adds that it is difficult to remove a CEO if that person is also Chairman. “The deed usually gets done, but almost always very late.”
The distinctive culture that Buffett has developed at Berkshire Hathaway plays an important role in the company’s continuing growth. One important component of the culture is the high degree of autonomy with which the managers of the company’s operating subsidiaries operate. By being able to delegate heavily to operating managers, Buffett is able to focus much of his time on a few key value-creating activities. A third important lesson to be learned from the history of Berkshire Hathaway is the role corporate culture can play in company growth and value creation.
Building Companies to Succeed:
Three Lessons from the Annual Newsletter
Berkshire Hathaway has changed significantly since Warren Buffett first took control of the company 50 years ago. What was once a struggling textile company is now a huge, successful and highly-diversified conglomerate. The phenomenal growth of Berkshire Hathaway is the result of a number of factors, including intelligent investing, disciplined focus, highly capable managers and a distinctive culture.
While it may not be possible to emulate what Charles Munger calls “the Berkshire system” in all respects, there is much to be learned from Buffett and Munger’s annual letter and the history and future plans for Berkshire Hathaway. Three of the most important lessons to be taken from the annual letter are the following:
The first lesson is the value of continual learning. Businesses and markets have changed fundamentally in the five decades since Buffett bought Berkshire Hathaway. During this period, Buffett and Munger have made significant changes to the way in which they invest and manage their business. This ability to evolve and adapt has proven to be one of the keys to Berkshire Hathaway’s success. Given the increasingly fast pace at which business, technology and global linkages are changing, it will become increasingly important for companies and individuals to continually learn and to adapt to change.
The second lesson is the value of focus. As Munger describes in the annual letter, Buffett has focused his considerable intellect on a relatively short and well-chosen list of priority activities for a very long time. The result of Buffett’s highly disciplined focus has been a series of investment and business insights and business decisions that have built upon each other and enabled Berkshire Hathaway to grow into the huge, successful conglomerate it is today. To succeed in an increasingly competitive and global marketplace, companies and individuals need to have a very clear sense of their priorities, goals and objectives.
The third lesson is the value of culture. Buffett and Munger have developed a distinctive culture at Berkshire Hathaway. This culture is based upon the example set by Buffett, Munger and the leaders of Berkshire Hathaway’s operating subsidiaries. One central element of the culture is the high degree of autonomy with which managers of the company’s operating subsidiaries manage their businesses. By being able to delegate heavily to operating managers, Buffett is able to focus on a few key priority activities (including capital allocation, advising managers and new investments) where he can add the most value. Corporate culture can play an important role in company growth and value creation.
The lessons that can be learned from the growth and success of Berkshire Hathaway have much wider application than just to business. Lessons like the value of continual learning, focus and culture are as important to the success of countries, communities, families and individuals as they are to companies. No doubt many of the more than 40,000 people who attended the Berkshire Hathaway annual meeting in Omaha May 2 appreciate this point.
 Data are from Warren Buffett’s most recent annual letter. Warren Buffett’s annual letter to shareholders of Berkshire Hathaway for the year 2014 is available at: http://www.berkshirehathaway.com/letters/2014ltr.pdf
The complete 2014 Berkshire Hathaway annual report is available at: http://www.berkshirehathaway.com/2014ar/2014ar.pdf
 Full disclosure: I am a big fan of Warren Buffett and Charles Munger and a shareholder of Berkshire Hathaway.
 In the insurance industry, “float” is used to describe money that is collected up front as premiums and invested before any losses are paid.
 Buffett’s practice of writing an annual letter has probably contributed to the success of Berkshire Hathaway more than many people realize. Writing an annual letter has permitted Buffett to educate shareholders, subsidiary managers and others about his investment and business practices (thus helping build a stable investor base, among other things), to communicate the types of investments he is seeking and to help reinforce Berkshire Hathaway’s distinctive culture. Writing an annual letter is hard work. It forces the writer to clarify his or her own thinking and priorities, which leads to better focus and results. Everyone would benefit from writing an annual letter, even if it is written only to their family or to themselves.
 See page 3 of the Berkshire Hathaway annual letter.