The Many Audiences of Buffett’s Letters
In part I of this post, I talked at a basic level about the factors that seem to me to have enabled the financial success of Warren Buffett and Berkshire Hathaway, and the value of his annual letters to stockholders, and their amalgamation in Larry Cunningham’s The Essays of Warren Buffett, now in its third edition. In examining Buffettonian business principles through those letters, however, it is good to remember that among his many talents has always been an uncanny ability to recognize how his comments will be perceived by different audiences, combined with an acute sensitivity to those audiences (in this regard, he has sometimes been regarded as differing somewhat from his partner, Charlie Munger).
The audience for the letters of Warren Buffett (as he is well aware) is not limited to the stockholders of Berkshire Hathaway. The audience also includes other investors and market participants, the managers and other employees of Berkshire and its many subsidiaries, the owners of businesses who might one day want to sell to Berkshire, the regulators and other government officials who can affect the business, its competitors, the news media and others. Inevitably, then, some part of the content of the letters is intended for those non-stockholder audiences.
To take a simple example, the letters have at times referred to a given operation’s return on book value, in the process of praising the operation’s management for above-market returns. (Always naming the managers involved: “Praise by name, criticize by category.” A maxim breached only, to my recollection, by a reference to Ivan Boesky.) It is fairly apparent that Warren Buffett would not seriously suggest that an appropriate measure of an entity’s worth is book value. There are simply too many ways and too many circumstances in which book value will understate, and often substantially understate, actual worth. (Where is the value of the moat to be found on a balance sheet, except in the case of goodwill for a recently-acquired enterprise? Warren himself notes this—see page 224 in the Essays, for example—whenever he talks about the more rational, if less precise, intrinsic value of an enterprise.) And by virtue of the necessity of recognizing impairment charges book value should be far more likely to understate than to overstate intrinsic value. In consequence, an organization’s return, as measured by return on book value, will often overstate the performance of its managers, but in the pattern of Berkshire Hathaway, to overstate the contribution of managers does little or no harm to stockholders, and may provide a little more job satisfaction, a little more incentive, etc., to the managers involved.
I do not mean to suggest that Warren Buffett would mislead his partner-stockholders—far from it. That he would avoid like the plague. In the first place, it’s simply not in his nature. In the second place (as if a second place were needed) he would immediately realize that misrepresentations would likely be discovered and the reputation he has worked so assiduously to maintain and enhance would be undermined. But he would, and does, introduce relatively harmless error from time to time when doing so is in one way or another to the longer term benefit of Berkshire Hathaway. I rather think he expects his stockholders to be able to recognize such excursions and treat them accordingly. It’s worth recognizing, though, that if in the course of reading the letters, or the Essays, there comes a point when one finds oneself scratching one’s head and saying “that can’t be right,” there is at least a possibility that it isn’t quite right, and was written for a different audience. Of course, it’s also possible that it is right, and that one just didn’t understand. It is quite unlikely to be the case that Warren didn’t understand.
It’s an interesting question whether the change in Berkshire’s stockholder body over the last several years has changed the nature of the annual letters (I would guess not—they have always been written to be understood by everyman). If there have been such changes, that is the kind of nuance that is necessarily lost in the deconstruct-and-reconstruct process of putting together the Essays.
In 1983 [Page 188 in this edition of the Essays], Warren explained why he was opposed to stock splits, including his desire to maintain a stockholder base of long-term, dedicated holders for whom BRK was typically their largest holding. In 1996, forced by circumstances, he issued the Class B shares, each share with a value equal to 1/30 the value of the former (then renamed “Class A”) shares. (The circumstance was the emergence of “clone” funds that would purchase only Berkshire shares, effectively creating a lower-priced equivalent (but for the management fee) share. If someone was going to open the door to holders of lower-priced shares, he, properly, wanted to maintain control of the company-stockholder relationship, and to avoid a third-party management fee charge.)
In 2010, those lower-priced Class B shares, were split 50-for-1, this time in order to facilitate a tax-free merger for the acquisition of Burlington Northern Santa Fe (although the Board announced that it thought the split advisable without regard to the BNSF transaction). Certainly, the creation of the lower-priced shares has changed the nature of the Annual Meeting—the Woodstock for Capitalists that is now said to be the largest single event in the annual life of Omaha, Nebraska. The original issuance of the Class B shares was the far more significant of the two events for this purpose, but between them, they have necessarily changed the complexion of the Berkshire stockholder body. The B shares have considerably more liquidity than the A shares—as I write this, I note that in today’s trading, so far, 345 shares of A stock have traded, with a value of almost $60 million while a little over 2 million B shares have traded, with a value of over $225 million. In that environment, it’s rational for a holder to prefer the B shares even if she holds shares with a value in excess of that of a round lot of the A (10 shares).
So it is reasonably clear, by now, that the virtues that were once being preserved by not splitting the stock are gone. Holders of A shares and holders of B shares are treated virtually identically, and differences in treatment are not likely to be introduced at this stage. Should the classes now be combined? Possibly, but there’s not much to be gained by doing so, and there may be a minor point of pride in having—by a very large measure—the most expensive per-share price of any publicly traded company. Should the relevant chapters (there are a few of them) be dropped from the next edition of the Essays? I think not, for the same reason that they were not dropped from this edition. Even if they’re outdated vis-à-vis Berkshire, they still contain valuable thoughts about the general irrationality of splits and the like—a topic on which managements often exhibit signs of confusion.
I’ve meandered further afield than I’d intended in responding to Larry’s invitation to comment on the third edition of The Essays of Warren Buffett—but then, that’s only to be expected. The letters themselves proceed in what appears a meandering sort of way, and I am too used to the letters by now to write about them in a different way. I suspect that for those uninitiated in the ways of Buffett and Munger, the Essays are a marvelous way to approach their thinking in a more ordered way than might otherwise be possible. (Another approach is Carol Loomis’ superb collection of articles by and about Buffett and Berkshire, Tap Dancing to Work: Warren Buffett on Practically Everything, 1966-2012, a Fortune Magazine Book, 2012. A different approach and perspective, but equally enlightening.) The letters themselves, written as they are to accompany the annual financial statements, are wonderful, but viewed as a single compilation they would appear disorganized. By cutting, sorting and pasting, this volume provides order and cohesiveness, without losing the master’s touch. It is a collection that belongs on one’s shelf.
Simon M. Lorne is vice chairman and chief legal officer of Millennium Management, co-director of Stanford Law School’s Directors’ College, Adjunct Professor at NYU’s Law and Business Schools and Visiting Scholar at Oxford University’s Said School of Business. He was a partner of Munger, Tolles & Olson (1972-1993 & 1999-2004); general counsel of the U.S. Securities and Exchange Commission (1993-1996); the global head of internal audit at Salomon Brothers (now a unit of Citigroup) (1996-1998); and the global head of Compliance at Citigroup (1998-1999). He previously served on the faculties at Penn and USC Law Schools and has published extensively. He is a director of Teledyne Technologies, Inc., and a member of the Advisory Counsel of the Public Company Accounting Oversight Board.