Two investors I admire, Bill Ackman (Trades, Portfolio) and Whitney Tilson (Trades, Portfolio), have recommended that to learn about investing, investors should read Berkshire Hathaway Inc's (BRK.A, Financial) (BRK.B, Financial) annual letters to shareholders. This series focuses on the main points Warren Buffett (Trades, Portfolio) makes in these letters and my analysis of the lessons learned from them. In this discussion, I cover the 2003 letter.
Buffett on Taxes
In the 2003 Berkshire letter, Buffett noted that following an op-ed piece he wrote in the Washington Post on May 20, 2003 that was critical of the Bush administration’s tax proposals, two weeks later the Assistant Secretary for Tax Policy at the U.S. Treasury delivered a speech which included a sly dig at “a certain midwestern oracle.”
Buffett highlighted the fact that Berkshire Hathaway Inc (BRK.A, Financial) (BRK.B, Financial) would be sending the Treasury $3.3 billion for tax on its 2003 income, a sum equalling 2.5% of the total income tax paid by all U.S. corporations in fiscal 2003. In contrast, Berkshire’s market valuation was about 1% of the value of all American corporations at the time.
He also stated that Berkshire’s federal tax return for 2002, when they paid $1.75 billion, covered 8,905 pages. Buffett said that Berkshire’s team were proud to be making this contribution as they felt the company was surely pulling its share of America’s fiscal load.
However, Buffett said he understood why the Treasury was frustrated with Corporate America and prone to outbursts. He went on to say, “But it should look to Congress and the Administration for redress, not to Berkshire.”
Tax breaks for corporations (and their investors, particularly large ones) were a major part of the administration’s 2002 and 2003 initiatives. Buffett reminded his readers that many large corporations “pay nothing close to the stated federal tax rate of 35%.” Buffett went on to give some more statistics on how much tax Berkshire Hathaway Inc (BRK.A, Financial) (BRK.B, Financial) has paid over the years, noting, “We hope our taxes continue to rise in the future – it will mean we are prospering – but we also hope that the rest of Corporate America antes up along with us.”
What this shows us that Buffett’s folksy image is sometimes misleading. He is prepared to defend himself when unfairly attacked, and while Buffett is happy to pay taxes, as it is a sign of success, he is also happy to call out those talking rubbish and educate them on the facts.
Buffett on Corporate Governance
Buffett wrote about CEO pay, stating, “In judging whether Corporate America is serious about reforming itself, CEO pay remains the acid test.” He was not encouraged with what he saw and said consultants and human resources departments have facilitated this situation. He added:
"It’s understandable how pay got out of hand. When management hires employees, or when companies bargain with a vendor, the intensity of interest is equal on both sides of the table. One party’s gain is the other party’s loss, and the money involved has real meaning to both. The result is an honest-to-God negotiation. But when CEOs (or their representatives) have met with compensation committees, too often one side – the CEO’s – has cared far more than the other about what bargain is struck. A CEO, for example, will always regard the difference between receiving options for 100,000 shares or for 500,000 as monumental. To a comp committee, however, the difference may seem unimportant – particularly if, as has been the case at most companies, neither grant will have any effect on reported earnings. Under these conditions, the negotiation often has a 'play-money' quality."
Buffett also blamed directors, saying they and other fiduciaries throughout Corporate America “must now decide whether their job is to work for owners or for managers.”
He wrote that truly independent directors are the solution, and they should own stock in the company.
"True independence – meaning the willingness to challenge a forceful CEO when something is wrong or foolish – is an enormously valuable trait in a director. It is also rare. The place to look for it is among high-grade people whose interests are in line with those of rank-and-file shareholders – and are in line in a very big way."
Buffett on Free Enterprise
Buffett spent a section commenting on MidAmerican Energy Holdings, which was subject to the Public Utility Holding Company Act. MidAmerican had a large investment in the United Kingdom. Buffett shares the following interest fact:
"On March 31, 1990, the day electric utilities in the U.K. were denationalized, Northern and Yorkshire had 6,800 employees in functions these companies continue today to perform. Now they employ 2,539. Yet the companies are serving about the same number of customers as when they were government owned and are distributing more electricity. This is not, it should be noted, a triumph of deregulation. Prices and earnings continue to be regulated in a fair manner by the government, just as they should be. It is a victory, however, for those who believe that profit-motivated managers, even though they recognize that the benefits will largely flow to customers, will find efficiencies that government never will."
Berkshire and Leucadia Partnership
Berkadia, the partnership between Berkshire Hathaway Inc (BRK.A, Financial) (BRK.B, Financial) and Leucadia to finance and manage the wind-down of Finova, a bankrupt lending operation, had been going so well that Berkshire’s $5.6 billion guarantee was extinguished. Buffett noted, “The plan was that we would supply most of the capital and Leucadia would supply most of the brains.”
The lesson here is that even an entity as strong as Berkshire Hathaway Inc (BRK.A, Financial) (BRK.B, Financial) is not afraid to partner with other experts to act on opportunities.
Buffett on Foreign Exchange Contracts
In 2002, Berkshire Hathaway Inc (BRK.A, Financial) (BRK.B, Financial) entered the foreign currency market for the first time in Buffett’s life, and in 2003 Berkshire enlarged its position as he became increasingly bearish on the dollar. He noted “that the cemetery for seers has a huge section set aside for macro forecasters.” Berkshire had, in fact, made few macro forecasts as Buffett and Munger believe sustained success in this area is extremely rare. He wrote:
"We have – and will continue to have – the bulk of Berkshire’s net worth in U.S. assets. But in recent years our country’s trade deficit has been force-feeding huge amounts of claims on, and ownership in, America to the rest of the world. For a time, foreign appetite for these assets readily absorbed the supply. Late in 2002, however, the world started choking on this diet, and the dollar’s value began to slide against major currencies. Even so, prevailing exchange rates will not lead to a material letup in our trade deficit. So whether foreign investors like it or not, they will continue to be flooded with dollars. The consequences of this are anybody’s guess. They could, however, be troublesome – and reach, in fact, well beyond currency markets."
The lesson I take from this is a little international diversification is wise, especially when your country’s trade deficit is getting worse.
Buffett's Book Recommendations
Buffett recommended three books in the 2003 shareholder letter: "Bull!" by Maggie Mahar, "The Smartest Guys in the Room" by Bethany McLean and Peter Elkind and "In an Uncertain World" by Bob Rubin, saying all three are well-reported and well-written. Additionally, Buffett noted, “Jason Zweig last year did a first-class job in revising 'The Intelligent Investor,' my favorite book on investing.”
