Berkshire Hathaway Inc. (NYSE:BRKA)(NYSE:BRKB), the conglomerate holding company run by Warren Buffett, spent $18 billion on two large acquisitions in 2013. First, Buffett purchased a major interest in H.J. Heinz, a food processing company with deep roots in the United States. Berkshire was the financing partner in the deal, working with 3G Capital, a multinational long-term value creation investment firm run by Jorge Paulo Lemann, who, like many of his business partners, Buffett considers a friend. “With the Heinz purchase, moreover,” Buffett said in his shareholder letter, “we created a partnership template that may be used by Berkshire in future acquisitions of size.”
Second, through its utility subsidiary MidAmerican Energy, Berkshire purchased NV Energy, a public electric utility company in southern Nevada that services the Las Vegas Valley. NV Energy supplies electricity to “about 88% of Nevada’s population,” according to Buffett, which makes the business effectively inseparable from the economy of the region. As long as Nevada consumes power, NV Energy will be there to supply it. Buffett emphasized that “NV Energy will not be MidAmerican’s last major purchase.”
Said Buffett in the shareholder letter: “Both companies fit us well and will be prospering a century from now.” This idea of long-term prosperity is tied to both the productivity and the size of the businesses. Musing on investment strategy toward the end of his letter to shareholders, Buffett reiterated his belief that investors should focus on the long-term productivity of assets. After all, productivity is what drives earnings, and earnings are what drive the entire business machine. The example Buffett brings to light is a 400-acre farm he purchased in 1986 for $280,000. “Now, 28 years later,” Buffett wrote, “the farm has tripled its earnings and is worth five times or more what I paid.”
With this and another real estate investment Buffett used as an example, he “thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field — not by those whose eyes are glued to the scoreboard.”
The comment carries particular weight because by most measures, Berkshire tops the scoreboard. At least, it tops the scoreboard over the long run. Berkshire reported an 18.2 percent increase in book value per share in 2013, ostensibly a huge defeat compared to a 32.4 percent gain for the S&P 500 index including dividends. Berkshire’s book value growth trailed the S&P 500 by 1.6 percent in 2012, beat it by 2.5 percent in 2011, and trailed by 2.1 percent in 2010 and by 6.7 percent in 2009. Taking just these last five years, Berkshire’s performance has been underwhelming.
However, stepping back to a longer time frame reveals a different picture. “Over the last 49 years (that is, since present management took over), book value has grown from $19 to $134,973, a rate of 19.7% compounded annually,” said Buffett. This compares against a compounded annual gain of 9.8 percent for the S&P 500 with dividends. This is pretty much as good a record as exists in the world of business, and Buffett is conscious of the reputation it fosters and how it sets expectations. The last five years demonstrate that Berkshire can’t beat the market every year — and, in fact, it would be foolish to expect that it could or should.
“Charlie Munger, Berkshire’s vice chairman and my partner, and I believe both Berkshire’s book value and intrinsic value will outperform the S&P in years when the market is down or moderately up,” Buffett wrote. “We expect to fall short, though, in years when the market is strong — as we did in 2013. We have underperformed in ten of our 49 years, with all but one of our shortfalls occurring when the S&P gain exceeded 15%.”
If, however, over the long run, Berkshire fails to outperform the S&P 500, “we will have not earned our pay,” Buffett said. “After all, you could always own an index fund and be assured of S&P results.”
The big, interesting question on the table is how does Buffett intend to go about continuing to earn his pay? The short answer is by continuing to do what he has been doing over the past few years: making big purchases of well-priced highly productive companies, either in part or in whole, such as Heinz and NV Energy. In an interview with CNBC on Monday, Buffett confirmed this, saying: “Our preference at Berkshire is to keep buying big operating businesses. In terms of building Berkshire for the long term, we just like adding earning power, big chunks of earning power.”