Hi all,
Last night I attended a celebration for our next door neighbour, a great man who recently received one of the highest honours in the country in the January Australia Day awards and was also a recent recipient of the 2015 Citizen of the Year award for his contribution to the local community.
Whilst we are all aware of how lucky we are to live in this great city and country, on a perfect summer’s eve and in a very happy and relaxed environment, I found an underlying theme of concern in some of the back yard talk amongst the predominantly retiree crowd. Inter alia, the areas of real worry (for some) centred on Middle East unrest, global refugee issues, global debt levels, and in general Australian and US political mediocrity.
Warren Buffett & Charlie Munger (now 85 and 92 years old respectively), are for mine the greatest of optimists (and realists). Not blind optimism, but clear, intelligent and logical optimism supported by indisputable facts and rational thinking.
Below are some extracts from Warren’s much heralded and anticipated annual letter to Berkshire Hathaway shareholders released just over the weekend. “How exciting!” I rightfully hear you say!!!! The full 30 page piece is attached for those who want the lot (highlighted bits on the link are my highlights).
Feel free to use at your next BBQ.
Three “worrying” topics where some Warren logic below should be of use;
TOPIC 1: “I pity and worry for the kids of today”
TOPIC 2: “I worry for Australia’s unemployed and for our economy with the mining boom now over”
TOPIC 3: “I worry about how technology, new competition and disruption (the inevitability of change) will impact my investments”
ON TOPIC 1
It’s an election year, and candidates can’t stop speaking about our country’s problems (which, of course, only they can solve). As a result of this negative drumbeat, many Americans now believe that their children will not live as well as they themselves do.
That view is dead wrong: The babies being born in America today are the luckiest crop in history.
American GDP per capita is now about $56,000. As I mentioned last year that – in real terms – is a staggering six times the amount in 1930, the year I was born, a leap far beyond the wildest dreams of my parents or their contemporaries. U.S. citizens are not intrinsically more intelligent today, nor do they work harder than did Americans in 1930. Rather, they work far more efficiently and thereby produce far more. This all-powerful trend is certain to continue: America’s economic magic remains alive and well.
Some commentators bemoan our current 2% per year growth in real GDP – and, yes, we would all like to
see a higher rate. But let’s do some simple math using the much-lamented 2% figure. That rate, we will see, delivers
astounding gains.
America’s population is growing about .8% per year (.5% from births minus deaths and .3% from net
migration). Thus 2% of overall growth produces about 1.2% of per capita growth. That may not sound impressive.
But in a single generation of, say, 25 years, that rate of growth leads to a gain of 34.4% in real GDP per capita.
(Compounding’s effects produce the excess over the percentage that would result by simply multiplying 25 x 1.2%.)
In turn, that 34.4% gain will produce a staggering $19,000 increase in real GDP per capita for the next generation.
Were that to be distributed equally, the gain would be $76,000 annually for a family of four. Today’s politicians
need not shed tears for tomorrow’s children.
Indeed, most of today’s children are doing well. All families in my upper middle-class neighbourhood (in Omaha, Nebraska)
regularly enjoy a living standard better than that achieved by John D. Rockefeller Sr. at the time of my birth. His
unparalleled fortune couldn’t buy what we now take for granted, whether the field is – to name just a few –
transportation, entertainment, communication or medical services. Rockefeller certainly had power and fame; he
could not, however, live as well as my neighbors now do.
Though the pie to be shared by the next generation will be far larger than today’s, how it will be divided
will remain fiercely contentious. Just as is now the case, there will be struggles for the increased output of goods
and services between those people in their productive years and retirees, between the healthy and the infirm,
between the inheritors and the Horatio Algers, between investors and workers and, in particular, between those with
talents that are valued highly by the marketplace and the equally decent hard-working Americans who lack the skills
the market prizes. Clashes of that sort have forever been with us – and will forever continue. Congress will be the
battlefield; money and votes will be the weapons. Lobbying will remain a growth industry.
The good news, however, is that even members of the “losing” sides will almost certainly enjoy – as they
should – far more goods and services in the future than they have in the past. The quality of their increased bounty
will also dramatically improve. Nothing rivals the market system in producing what people want – nor, even more
so, in delivering what people don’t yet know they want. My parents, when young, could not envision a television
set, nor did I, in my 50s, think I needed a personal computer. Both products, once people saw what they could do,
quickly revolutionized their lives. I now spend ten hours a week playing bridge online. And, as I write this letter,
“search” is invaluable to me. (I’m not ready for Tinder, however.)
For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s
golden goose of commerce and innovation will continue to lay more and larger eggs. America’s social security
promises will be honored and perhaps made more generous. And, yes, America’s kids will live far better than their
parents did.
ON TOPIC 2
Productivity is the all-important factor in America’s economic growth over the past 240 years. Without more output of desired goods and services per working
hour – that’s the measure of productivity gains – an economy inevitably stagnates. At much of corporate
America, truly major gains in productivity are possible.
At Berkshire, we, too, crave efficiency and detest bureaucracy.
Our role is simply to create an environment in which our CEOs – and their eventual successors, who typically are like-minded – can maximize both
their managerial effectiveness and the pleasure they derive from their jobs.
(With this hands-off style, I am heeding a well-known Mungerism: “If you want to guarantee yourself a lifetime of misery, be sure to
marry someone with the intent of changing their behavior.”)
We will continue to operate with extreme – indeed, almost unheard of – decentralization at Berkshire.
Productivity and Prosperity
Earlier, I told you how our partners at Kraft Heinz root out inefficiencies, thereby increasing output per
hour of employment. That kind of improvement has been the secret sauce of America’s remarkable gains in living
standards since the nation’s founding in 1776. Unfortunately, the label of “secret” is appropriate: Too few
Americans fully grasp the linkage between productivity and prosperity.
To see that connection, let’s look first at the country’s most dramatic example – farming – and later examine three Berkshire-specific areas.
In 1900, America’s civilian work force numbered 28 million. Of these, 11 million, a staggering 40% of the
total, worked in farming. The leading crop then, as now, was corn. About 90 million acres were devoted to its
production and the yield per acre was 30 bushels, for a total output of 2.7 billion bushels annually.
Then came the tractor and one innovation after another that revolutionized such keys to farm productivity
as planting, harvesting, irrigation, fertilization and seed quality.
Today, we devote about 85 million acres to corn.
Productivity, however, has improved yields to more than 150 bushels per acre, for an annual output of 13-14 billion
bushels. Farmers have made similar gains with other products.
Increased yields, though, are only half the story: The huge increases in physical output have been
accompanied by a dramatic reduction in the number of farm laborers (“human input”). Today about three million
people work on farms, a tiny 2% of our 158-million-person work force.
Thus, improved farming methods have allowed tens of millions of present-day workers to utilize their time and talents in other endeavors, a reallocation of
human resources that enables Americans of today to enjoy huge quantities of non-farm goods and services they would otherwise lack.
It’s easy to look back over the 115-year span and realize how extraordinarily beneficial agricultural
innovations have been – not just for farmers but, more broadly, for our entire society. We would not have anything
close to the America we now know had we stifled those improvements in productivity. (It was fortunate that horses
couldn’t vote.)
On a day-to-day basis, however, talk of the “greater good” must have rung hollow to farm hands who
lost their jobs to machines that performed routine tasks far more efficiently than humans ever could. We will
examine this flip-side to productivity gains later in this section.
For the moment, however, let’s move on to three stories of efficiencies that have had major consequences
for Berkshire subsidiaries. Similar transformations have been commonplace throughout American business.
In 1947, shortly after the end of World War II, the American workforce totaled 44 million. About
1.35 million workers were employed in the railroad industry. The revenue ton-miles of freight moved by
Class I railroads that year totaled 655 billion.
By 2014, Class I railroads carried 1.85 trillion ton-miles, an increase of 182%, while employing only
187,000 workers, a reduction of 86% since 1947. (Some of this change involved passenger-related
employees, but most of the workforce reduction came on the freight side.)
As a result of this staggering
improvement in productivity, the inflation-adjusted price for moving a ton-mile of freight has fallen by
55% since 1947, a drop saving shippers about $90 billion annually in current dollars.
Another startling statistic: If it took as many people now to move freight as it did in 1947, we would need
well over three million railroad workers to handle present volumes. (Of course, that level of employment
would raise freight charges by a lot; consequently, nothing close to today’s volume would actually move.)
The productivity gains that I’ve just spelled out – and countless others that have been achieved in America
– have delivered awesome benefits to society. That’s the reason our citizens, as a whole, have enjoyed – and will
continue to enjoy – major gains in the goods and services they receive.
To this thought there are offsets. First, the productivity gains achieved in recent years have largely
benefitted the wealthy. Second, productivity gains frequently cause upheaval: Both capital and labor can pay a
terrible price when innovation or new efficiencies upend their worlds.
We need shed no tears for the capitalists (whether they be private owners or an army of public
shareholders). It’s their job to take care of themselves. When large rewards can flow to investors from good
decisions, these parties should not be spared the losses produced by wrong choices.
Moreover, investors who diversify widely and simply sit tight with their holdings are certain to prosper: In America, gains from winning
investments have always far more than offset the losses from clunkers. (During the 20th Century, the Dow Jones
Industrial Average – an index fund of sorts – soared from 66 to 11,497, with its component companies all the while
paying ever-increasing dividends.)
A long-employed worker faces a different equation. When innovation and the market system interact to
produce efficiencies, many workers may be rendered unnecessary, their talents obsolete. Some can find decent
employment elsewhere; for others, that is not an option.
When low-cost competition drove shoe production to Asia, our once-prosperous Dexter operation folded,
putting 1,600 employees in a small Maine town out of work. Many were past the point in life at which they could
learn another trade. We lost our entire investment, which we could afford, but many workers lost a livelihood they
could not replace.
The same scenario unfolded in slow-motion at our original New England textile operation, which
struggled for 20 years before expiring. Many older workers at our New Bedford plant, as a poignant example, spoke
Portuguese and knew little, if any, English. They had no Plan B.
The answer in such disruptions is not the restraining or outlawing of actions that increase productivity.
Americans would not be living nearly as well as we do if we had mandated that 11 million people should forever be
employed in farming.
The solution, rather, is a variety of safety nets aimed at providing a decent life for those who are willing to
work but find their specific talents judged of small value because of market forces. (I personally favor a reformed
and expanded Earned Income Tax Credit that would try to make sure America works for those willing to work.) The
price of achieving ever-increasing prosperity for the great majority of Americans should not be penury for the
unfortunate.
ON TOPIC 3
Important Risks
We, like all public companies, are required by the SEC to annually catalog “risk factors” in our 10-K. I
can’t remember, however, an instance when reading a 10-K’s “risk” section has helped me in evaluating a business.
That’s not because the identified risks aren’t real. The truly important risks, however, are usually well known.
Beyond that, a 10-K’s catalog of risks is seldom of aid in assessing: (1) the probability of the threatening event
actually occurring; (2) the range of costs if it does occur; and (3) the timing of the possible loss.
A threat that will only surface 50 years from now may be a problem for society, but it is not a financial problem for today’s investor.
Berkshire operates in more industries than any company I know of. Each of our pursuits has its own array
of possible problems and opportunities. Those are easy to list but hard to evaluate: Charlie, I and our various CEOs
often differ in a very major way in our calculation of the likelihood, the timing and the cost (or benefit) that may
result from these possibilities.
Let me mention just a few examples.
To begin with an obvious threat, BNSF, along with other railroads, is certain to lose significant coal volume over the next decade.
At some point in the future – though not, in my view, for a long time – GEICO’s premium volume may shrink because of driverless cars.
This development could hurt our auto dealerships as well.
Circulation of our print newspapers will continue to fall, a certainty we allowed for when purchasing them.
To date, renewables have helped our utility operation but that could change, particularly if storage
capabilities for electricity materially improve.
Online retailing threatens the business model of our retailers and certain of our consumer brands.
These potentialities are just a few of the negative possibilities facing us – but even the most casual follower of business news has long been aware of them.
None of these problems, however, is crucial to Berkshire’s long-term well-being. When we took over the
company in 1965, its risks could have been encapsulated in a single sentence: “The northern textile business in
which all of our capital resides is destined for recurring losses and will eventually disappear.”
That development, however, was no death knell. We simply adapted. And we will continue to do so.
Every day Berkshire managers are thinking about how they can better compete in an always-changing
world. Just as vigorously, Charlie and I focus on where a steady stream of funds should be deployed. In that respect,
we possess a major advantage over one-industry companies, whose options are far more limited. I firmly believe
that Berkshire has the money, talent and culture to plow through the sort of adversities I’ve itemized above – and
many more – and to emerge with ever-greater earning power.
(worth repeating this paragraph)
Moreover, investors who diversify widely and simply sit tight with their holdings are certain to prosper: In America, gains from winning
investments have always far more than offset the losses from clunkers. (During the 20th Century, the Dow Jones
Industrial Average – an index fund of sorts – soared from 66 to 11,497, with its component companies all the while
paying ever-increasing dividends.)