Summary of 2005 Berkshire Hathaway (BRK) Chairman Letter

What were the details of the letter:

· Completed five acquisitions (two insurers, a RV manufacturer, Business Wire, and an utility) during the year and now have a portfolio of 68 distinctive businesses.

· Capital allocation has shifted to business acquisitions.

· GEICO increased its market share of U.S. private passenger auto business from 5.6% to 6.1%. One percent of market share equates to $1.6 billion in sales.

· Pricing adjustment in reinsurance business to account for factors that have dramatically increase the intensity or frequency of hurricanes.

· Clayton Homes’ loans portfolio has increased significantly since Berkshire’s acquisitions ($9.6 billion).

· Derivatives have continued to mushroom in the industry; while, Berkshire’s positions from Gen Re securities are soon to be closed.

· Widening “moat” (long-term competitiveness) must take precedence of short-term financial results.

· The abuse of option compensation.

· Gotrocks and Helpers: frictional costs of owning securities have increased significantly and greatly reduced investors’ potential returns.

· Excessive debt is a double-edged sword. A string of success can be washed away with one loss.

Practical application:

· Act on your problem as soon as possible.

· Beware of exotic financial instruments.

· Personal gain/loss dictates someone’s action accordingly.

Quotes from the letter:

· “Unlike many business buyers, Berkshire has no “exit strategy.” We buy to keep. We do, though, have an entrance strategy, looking for businesses in this country or abroad that meet our six criteria and are available at a price that will produce a reasonable return. If you have a business that fits, give me a call. Like a hopeful teenage girl, I’ll be waiting by the phone.”

· “Joe, Ajit and I don’t know the answer to these all-important questions [to the factors that caused hurricanes in 2004-2005]. What we do know is that our ignorance means we must follow the course prescribed by Pascal in his famous wager about the existence of God. As you may recall, he concluded that since he didn’t know the answer, his personal gain/loss ratio dictated an affirmative conclusion.”

· “Long contracts, or alternatively those with multiple variables, are the most difficult to mark to market (the standard procedure used in accounting for derivatives) and provide the most opportunity for “imagination” when traders are estimating their value. Small wonder that traders promote them.”

· “So I failed in my attempt to exit painlessly, and in the meantime more trades were put on the books. Fault me for dithering. (Charlie calls it thumb-sucking.) When a problem exists, whether in personnel or in business operations, the time to act is now.”

· “When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as “widening the moat.” And doing that is essential if we are to have the kind of business we want a decade or two from now. We always, of course, hope to earn more money in the short-term. But when short-term and long-term conflict, widening the moat must take precedence. If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted.”

· “Indeed, the very thought of options with strike prices that are adjusted for retained earnings seems foreign to compensation “experts,” who are nevertheless encyclopedic about every management-friendly plan that exists. (‘Whose bread I eat, his song I sing.’)”

· “Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, ‘I can calculate the movement of the stars, but not the madness of men.’”

· “Dow increased from 65.73 to 11,497.12 in the 20th century, and that amounts to a gain of 5.3% compounded annually. (Investors would also have received dividends, of course.) To achieve an equal rate of gain in the 21st century, the Dow will have to rise by December 31, 2099 to – brace yourself – precisely 2,011,011.23.”

· “Any other approach is dangerous. Over the years, a number of very smart people have learned the hard way that a long string of impressive numbers multiplied by a single zero always equals zero. That is not an equation whose effects I would like to experience personally, and I would like even less to be responsible for imposing its penalties upon others.”

3+ questions to the group & group discussion:

· How active should we be with our portfolio?

· What would be an “exit strategy” for our investment?

· Should we account macro factors into investment decision?