Berkshire Hathaway 2003 Annual Report Download - page 72

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We have found over time that the undistributed earnings of our investees, in aggregate, have been fully as
beneficial to Berkshire as if they had been distributed to us (and therefore had been included in the
earnings we officially report). This pleasant result has occurred because most of our investees are engaged
in truly outstanding businesses that can often employ incremental capital to great advantage, either by
putting it to work in their businesses or by repurchasing their shares. Obviously, every capital decision that
our investees have made has not benefitted us as shareholders, but overall we have garnered far more than
a dollar of value for each dollar they have retained. We consequently regard look-through earnings as
realistically portraying our yearly gain from operations.
7. We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long-term fixed-
rate basis. We will reject interesting opportunities rather than over-leverage our balance sheet. This
conservatism has penalized our results but it is the only behavior that leaves us comfortable, considering
our fiduciary obligations to policyholders, lenders and the many equity holders who have committed
unusually large portions of their net worth to our care. (As one of the Indianapolis “500” winners said:
“To finish first, you must first finish.”)
The financial calculus that Charlie and I employ would never permit our trading a good night’ s sleep for a
shot at a few extra percentage points of return. I’ ve never believed in risking what my family and friends
have and need in order to pursue what they don’ t have and don’ t need.
Besides, Berkshire has access to two low-cost, non-perilous sources of leverage that allow us to safely own
far more assets than our equity capital alone would permit: deferred taxes and “float,” the funds of others
that our insurance business holds because it receives premiums before needing to pay out losses. Both of
these funding sources have grown rapidly and now total about $45 billion.
Better yet, this funding to date has often been cost-free. Deferred tax liabilities bear no interest. And as
long as we can break even in our insurance underwriting the cost of the float developed from that operation
is zero. Neither item, of course, is equity; these are real liabilities. But they are liabilities without
covenants or due dates attached to them. In effect, they give us the benefit of debt — an ability to have
more assets working for us — but saddle us with none of its drawbacks.
Of course, there is no guarantee that we can obtain our float in the future at no cost. But we feel our
chances of attaining that goal are as good as those of anyone in the insurance business. Not only have we
reached the goal in the past (despite a number of important mistakes by your Chairman), our 1996
acquisition of GEICO, materially improved our prospects for getting there in the future.
8. A managerial “wish list” will not be filled at shareholder expense. We will not diversify by purchasing
entire businesses at control prices that ignore long-term economic consequences to our shareholders. We
will only do with your money what we would do with our own, weighing fully the values you can obtain by
diversifying your own portfolios through direct purchases in the stock market.
Charlie and I are interested only in acquisitions that we believe will raise the per-share intrinsic value of
Berkshire’ s stock. The size of our paychecks or our offices will never be related to the size of Berkshire’ s
balance sheet.
9. We feel noble intentions should be checked periodically against results. We test the wisdom of retaining
earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for
each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis.
As our net worth grows, it is more difficult to use retained earnings wisely.
We continue to pass the test, but the challenges of doing so have grown more difficult. If we reach the
point that we can’ t create extra value by retaining earnings, we will pay them out and let our shareholders
deploy the funds.
10. We will issue common stock only when we receive as much in business value as we give. This rule applies
to all forms of issuance — not only mergers or public stock offerings, but stock-for-debt swaps, stock
options, and convertible securities as well. We will not sell small portions of your company — and that is
what the issuance of shares amounts to — on a basis inconsistent with the value of the entire enterprise.