Warren Buffett’s Latest Berkshire Hathaway Shareholder Letter – Thro Poker (and PR) Lenses

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Following on from the encouraging success of my ebook launch I have become re-invigorated about Texas Holdem Investing and its potential. Hence I thought it an appropriate time to draft a new blog post.

And given the upcoming Berkshire Hathaway Annual Shareholders Meeting what better subject than a review of Warren Buffett’s 2010 Letter to Berkshire Hathaway Shareholders through the lense of poker. And, since the Masked Financier also has a few other Buffett / Berkshire investment theses, I thought that this post would be a good way to put them forward also.

Please bear in mind that all of my views are expressed in the context of the greatest admiration for Mr. Buffett, who has a peerless track record, and who has done so much for the education of investors. But, having said that, no-one is perfect…

I have italicised the quotes from the 2010 Letter in the remainder of the post.

Poker Points

There are a number of pieces of the letter that demonstrate poker concepts that can be applied to investing strategy.

Bankroll

At yearend we held $38 billion of cash equivalents that have been earning a pittance throughout 2010.

At Berkshire, we have taken his $1,000 solution a bit further and have pledged that we will hold at least $10 billion of cash, excluding that held at our regulated utility and railroad businesses. Because of that commitment, we customarily keep at least $20 billion on hand so that we can both withstand unprecedented insurance losses (our largest to date having been about $3 billion from Katrina, the insurance industry’s most expensive catastrophe) and quickly seize acquisition or investment opportunities, even during times of financial turmoil.

Berkshire Hathaway operates with more than just an adequate bankroll – it has a fortress balance sheet. Having such an “investing bankroll” means that Berkshire Hathaway can survive severe negative downturns and can also bet big when an opportunity arises where the odds are favourable. That is the type of bankroll that poker players and investors need to target whereas in reality they typically operate with insufficient funding.

Odds – Do not Bet when the Returns do not Match the Odds

The willingness to walk away if the appropriate premium can’t be obtained.

When you have evaluated a poker hand situation, if the pot and implied odds show that the money you have to risk to stay in the game is too high relative to the potential rewards then you should set down your cards.

Similarly, if you have analysed an investment opportunity and the returns do not compensate for the potential downside then you should not participate.

Game Rules Do Not Change

Money will always flow toward opportunity, and there is an abundance of that in America. Commentators today often talk of “great uncertainty.” But think back, for example, to December 6, 1941, October 18, 1987 and September 10, 2001. No matter how serene today may be, tomorrow is always uncertain.

This quote from Mr. Buffett is an optimistic version of an oft-quoted theme in investing i.e. “this time it’s different, but it never is.”

The oft-quoted theme is generally a warning against getting caught up in the positive mania surrounding a bubble when it is inevitable that gravity will eventually take hold. Mr. Buffett in this case is arguing that when the market is crashed out it is inevitable that unless society is collapsing that valuations will swing upwards.

Texas Holdem Poker teaches this theme well, since it is a game where the rules never change nor does the method for ongoing success. Texas Holdem teaches the value of sticking with a core set of principals even in the face of evidence that they are not working over a period of time.  Just like Mr. Buffett sticks to his methods no matter what the mood or (lack of) logic of the market.

Public Relations Points

This section sets out some points about Mr. Buffett’s PR capabilities, which are legendary.  Having said that even his skills in this area have not managed to avert continued public scrutiny about David Sokol’s recent Lubrizol share trades.

Table Image

In many cases, these are people who have sought out Berkshire as an acquirer for a business that they and their families have long owned. They came to us with an owner’s mindset, and we provide an environment that encourages them to retain it.

There is no doubt that Mr. Buffett’s “folksy” image has enabled Berkshire Hathaway to get proprietary dealflow and hence acquire businesses which were not available to the ordinary corporate or private equity acquiror.  Despite this image Mr. Buffett has often demonstrated ruthless streaks with Berkshire Hathaway when it comes to depriving businesses of capital that are not sufficiently successful in his view.

Therefore, his table image in the investment world has allowed him to access unique opportunities with risk-reward profiles that are often better than would be otherwise available.  Furthermore, this table image is likely to have enabled him to pay lower prices for such investment opportunities, since his reputation as an attractive buyer has helped Berkshire to avoid auction situations which would otherwise drive up acquisition costs.

Borrowing

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.

This aspect of Berkshire Hathaway and how it is portrayed continues to astound the Masked Financier and once again is testament to Mr. Buffett’s “table image” in the investment world.  The above description of this aspect of Berkshire’s business model shows that it is effectively one of the biggest leveraged buyout firms in the world, yet Mr. Buffett often criticizes the private equity industry for the use of leveraged buyouts.  And even more amazing is the comparative sources of borrowing for Berkshire and the rest of the corporate world’s acquirors.  Other firms borrow money from banks, who are set up to make risky loans (sometimes not so well) for the purpose of acquiring companies.   Yet Berkshire borrows money from insurance policyholders, who themselves expect that their insurance premiums are being invested in cash and bonds.  If the balance sheet of the Zurich or Progressive insurance companies were analysed and showed large long term put option derivatives and other such esoteric securities the investment community, the press, and likely the financial regulators would be aghast, but when Berkshire Hathaway does it barely an eyebrow is raised.

Time Horizon – Forever

The largest earner in our manufacturing, service and retailing sector is Marmon, a collection of 130 businesses. We will soon increase our ownership in this company to 80% by carrying out our scheduled purchase of 17% of its stock from the Pritzker family. The cost will be about $1.5 billion. We will then purchase the remaining Pritzker holdings in 2013 or 2014, whichever date is selected by the family. Frank Ptak runs Marmon wonderfully, and we look forward to 100% ownership.

Warren Buffett often represents that one of the benefits of the Berkshire Hathaway worldview is that the investment horizon is forever and that investors can benefit from this approach compared with the more short term buy-and-flip perspectives of private equity investors and the constant portfolio churn of corporate acquirors.  As per above Mr. Buffett’s publicising of this approach has also helped in getting access to proprietary deals not available to the rest of the market.

However, the Masked Financier thinks that Mr. Buffett is being a little disingenuous when he states that Berkshire Hathway’s holding period is forever when its CEO is 80.  Who knows what will happen to Berkshire Hathaway when Mr. Buffett moves on?  Particularly since the investment bankers of Wall Street seem to have started to get involved in Berkshire Hathaway’s investment process based on Citi’s advice to David Sokol which let to the Lubrizol acquisition.  It is ironic that the reason for Berkshire’s takeover of the Marmon-Pritzker companies, which themselves had been in existence since 1953, was because of a family feud which I’m sure the founders could never have foreseen.

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I hope readers find this update on the Masked Financier’s thinking about Warren Buffett and would appreciate any comments or feedback.  I look forward with interest to hearing Mr. Buffett’s thoughts at the Shareholder Meeting.