Berkshire Hathaway 1999 Annual Report Download - page 59

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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 $32 billion.
Better yet, this funding to date has been cost-free. Deferred tax liabilities bear no interest. And as long as we
can break even in our insurance underwriting — which we have done, on the average, during our 32 years in
the business — 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.)