Berkshire Hathaway 2006 Annual Report Download - page 77

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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.
When we sold the Class B shares in 1996, we stated that Berkshire stock was not undervalued — and some people
found that shocking. That reaction was not well-founded. Shock should have registered instead had we issued shares
when our stock was undervalued. Managements that say or imply during a public offering that their stock is
undervalued are usually being economical with the truth or uneconomical with their existing shareholders’ money:
Owners unfairly lose if their managers deliberately sell assets for 80¢ that in fact are worth $1. We didn’ t commit that
kind of crime in our offering of Class B shares and we never will. (We did not, however, say at the time of the sale
that our stock was overvalued, though many media have reported that we did.)
11. You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of
price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell
sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their
managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par
businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory
profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end,
major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.)
Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We
would rather have our overall results penalized a bit than engage in that kind of behavior.
We continue to avoid gin rummy behavior. True, we closed our textile business in the mid-1980’ s after 20 years of
struggling with it, but only because we felt it was doomed to run never-ending operating losses. We have not, however,
given thought to selling operations that would command very fancy prices nor have we dumped our laggards, though
we focus hard on curing the problems that cause them to lag.
12. We will be candid in our reporting to you, emphasizing the pluses and minuses important in appraising business value.
Our guideline is to tell you the business facts that we would want to know if our positions were reversed. We owe you
no less. Moreover, as a company with a major communications business, it would be inexcusable for us to apply lesser
standards of accuracy, balance and incisiveness when reporting on ourselves than we would expect our news people to
apply when reporting on others. We also believe candor benefits us as managers: The CEO who misleads others in
public may eventually mislead himself in private.
At Berkshire you will find no “big bath” accounting maneuvers or restructurings nor any “smoothing” of quarterly or
annual results. We will always tell you how many strokes we have taken on each hole and never play around with the
scorecard. When the numbers are a very rough “guesstimate,” as they necessarily must be in insurance reserving, we
will try to be both consistent and conservative in our approach.