Buffett's methods ought to be as much of an inspiration to corporate boards as to investors
SINGAPORE (May 13): Billionaire investor Warren Buffett’s corporate vehicle Berkshire Hathaway hogged the headlines around the world this past week for doing nothing more than holding its annual shareholder meeting as scheduled on May 4.
The sometimes-styled “Woodstock for Capitalists” drew a reported attendance of some 40,000 people, and was live-streamed across the world. Buffett, 88, and his long-time business partner Charlie Munger, 95, spent hours fielding questions related to Berkshire’s corporate matters as well as the outlook for the US economy and the state of politics in the country. Some who attended the meeting simply wanted to test Buffett’s and Munger’s wisdom on everything from saving and investing to the importance of delayed gratification and understanding human nature.
To be sure, Berkshire’s huge following is largely a reflection of the stellar returns it has delivered over the last five decades. When Buffett took control of Berkshire in 1965, it was a waning textiles manufacturer. Buffett used the cash generated by the textiles operation to invest in more promising fields. This famously included the purchase of significant stakes in public-listed companies such as Coca-Cola, Bank of America, American Express and, recently, Apple.
Today, Berkshire has interests ranging from insurance and railways to logistics and energy, and boasts a market value topping US$513 billion ($700 billion). Buffett is said to be the third-richest person in the world, with a fortune of US$88 billion.
Yet, it is not just investors who ought to look to Buffett for inspiration. The boards and senior management of public-listed companies in Singapore could learn a thing or two from him too. In my view, investors are not drawn to Berkshire only because of Buffett’s enormously successful investment approach. Many of them simply like being treated as real owners of the businesses under the group. This is, in fact, the first of the “business principles” outlined in Berkshire’s so-called “Owner’s Manual” that Buffett created in 1996.
“Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as owner-partners, and of ourselves as managing partners,” Buffett says in the manual. “We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets.”
Candour, consistency, clarity
In keeping with that key principle, Buffett reports the company’s performance to his fellow shareholders in a manner unlike a professional CEO. While Berkshire publishes financial statements that comply with prevailing accounting standards, Buffett provides his own candid review of the company’s performance in its annual report, focusing on metrics that would matter to a business owner. And, he often does not confine himself to discussing the most recent financial year.
For instance, in Berkshire’s 2016 annual report, while discussing the company’s ongoing transition from obtaining most of its gains from investment activities to generating value by owning entire businesses, he brought up a “particularly egregious error” he made in 1993, when Berkshire acquired a company called Dexter Shoe for US$434 million. Buffett noted that the value of Dexter Shoe subsequently went to zero, while the value of Berkshire stock issued for the acquisition had appreciated to more than US$6 billion.
Besides candour, Buffett has also provided clarity and consistency in his reviews of Berkshire’s performance. For the past three decades, all his letters to shareholders have started with a comparison of the rise or fall in Berkshire’s book value per share over the past year with the performance of the Standard & Poor’s 500 Index (dividends included), followed by a discussion on the factors that contributed to the change in the company’s book value.
For instance, in Berkshire’s 2017 annual report, Buffett started by saying: “Berkshire’s gain in net worth during 2017 was US$65.3 billion, which increased the per-share book value of both our Class A and Class B stock by 23%.” He then added, “But only US$36 billion came from Berkshire’s operations. The remaining US$29 billion was delivered to us in December [2017] when Congress rewrote the US Tax Code.”
Yet, Buffett has not allowed the book value per share measure to become a target in and of itself. On the contrary, he informed Berkshire shareholders in the company’s 2018 annual report that this metric is losing its relevance, because of changing accounting rules as well as the company’s own shifting strategy to generate shareholder value. He noted that Berkshire’s major value now resides in its operating businesses, instead of its holdings of marketable stocks. But the company’s operating businesses are carried in its books at an amount far below their current intrinsic value. In short, Berkshire’s book value is likely to increasingly understate the company’s intrinsic value.
This could be exacerbated by Berkshire’s much-talked-about plans to increase its share buybacks. “It is likely that — over time — Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value,” Buffett notes in the 2018 annual report. “The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality.”
In the future, Buffett says the market price of Berkshire’s shares is likely to become a more useful indicator of its underlying performance. “Markets can be extremely capricious,” he concedes. And, as with the book value per share measure, he would need to ensure that driving up Berkshire’s market price does not become an end in itself. “Over time, however, Berkshire’s stock price will provide the best measure of business performance.”
‘We eat our own cooking’
Public-listed companies in Singapore do not come close to matching the candour, clarity and consistency with which Berkshire informs its shareholders of its performance. To be fair, many of the bigger companies do a reasonably good job of providing operational information for their key business units. But few ever admit to failing their shareholders in any way.
My colleagues at The Edge Singapore often joke about press releases put out by locally listed companies during earnings season. If an earnings or revenue figure is stated with no reference to whether it is up or down against the previous year, there is a very high chance that it is down. On the other hand, companies seize every opportunity to trumpet the extent to which their reported earnings came in higher than the previous year, even when the figures are distorted by non-recurring items.
Are these press releases supposed to inform investors about the real performance of their companies? Or, is their purpose primarily to stroke the egos of the board and management, and convince the world that they are doing a good job? What can be done to align the interests of the board more closely with those of investors?
Over the years, I have witnessed the introduction of many sensible rules and best practices to improve the integrity of the boards of public-listed companies. One notable example is the separation of the roles of chairman and CEO. Yet, when things go wrong, corporate governance experts often reflexively suggest that new rules and standards be introduced, or that changes be made to old ones.
Buffett, who is both chairman and CEO of Berkshire, has a different approach to ensuring his board acts and speaks out on behalf of the company’s shareholders. “In line with Berkshire’s owner-orientation, most of our directors have a significant portion of their net worth invested in the company,” he says in the owner’s manual. “We eat our own cooking.”
Buffett’s way is appealing
Of course, it is not feasible to insist that every director of a company has a certain proportion of his net worth invested in its shares. Yet, the general point that directors with a significant proportion of their net worth at stake are likely to behave differently from directors who are simply paid a fee for their services makes a lot of sense to me. A director who is an owner of the stock might be more inclined to ask tough questions about how the company’s excess cash is used, and whether the top managers are being appropriately incentivised.
One could even argue that the local market might have fewer stocks trading at depressingly low valuations if more locally listed companies had independent directors who are heavily invested in their own stock. As investors as well as independent directors, they would have the motive and means to ensure the value of any assets and retained earnings on the company’s books are fully reflected in the market price of the company’s shares. That, in turn, could reduce the risk of minority investors being squeezed out in delisting exercises on terms that are less than fair — something that has been happening in the local market all too frequently over the past year.
In the same vein, directors who are heavily invested in their companies might be less willing to pursue initiatives that are fashionable but do not clearly create value. Interestingly, Berkshire notes on the proxy statement distributed at its most recent shareholder meeting that the company does not have a policy regarding the consideration of diversity in identifying nominees for director. “In identifying director nominees, the governance committee does not seek diversity, however defined. Instead, as previously discussed, the governance committee looks for individuals who have very high integrity, business savvy, an owner-oriented attitude and a deep genuine interest in the company,” the statement reads.
Not everyone will agree with every aspect of the way Buffett runs Berkshire. And, many companies that are run quite differently have their own ardent followers. As an investor, however, Buffett’s philosophy and methods are particularly appealing to me.
This story appears in The Edge Singapore (Issue 881, week of May 13) which is on sale now. Subscribe here
