Governance lessons from Buffett

With over 30,000 shareholders in attendance and a million viewers tuning into the live-streamed video, the annual shareholders meeting hosted by Warren Buffett and Charlie Munger, chairman and vice-chairman of Berkshire Hathaway Inc on May 6, has set off the usual media frenzy.

Media folk and the global investing community have been dissecting every word of investing wisdom dispensed by the duo in the hope of hitting a jackpot. But this is missing the woods for the trees.

It is doubtful if any ordinary investor can replicate the Buffett-Munger team’s stock-picking genius merely by copying their portfolio moves. Rather, it is the exemplary way in which they manage Berkshire Hathaway Inc that has enduring takeaways for investors. Indian companies, known to cut corners on governance, can learn a thing or four from Berkshire Hathaway.

Ill-timed and overpriced acquisitions have proved to be the downfall of many successful Indian companies. Tata Steel-Corus, Hindalco-Novelis, Jet Airways-Air Sahara — there’s a long list of acquisitions that have proved a millstone around shareholders’ necks.

Acquisitions are bread and butter for Berkshire Hathaway Inc, which has scaled up to a balance sheet size of $620 billion mainly through buyouts.

Starting out with two ailing textile mills in the 1960s, Berkshire began to prosper after it went on a shopping spree buying out a vast portfolio of unrelated businesses. Today, the listing of its subsidiaries reads like the Yellow Pages. By 2016, Berkshire’s business interests spanned insurance (GEICO, National Indemnity, General Re), railroads, utilities, manufacturing (Duracell, Lubrizol), retail (Fruit of the Loom, Vanity Fair) and food (International Dairy Queen, Kraft Heinz).

What is remarkable is Berkshire’s uncanny ability to make every acquisition dollar pay. Learning from past mistakes, it lays down a laundry list of criteria for every acquisition. To be on Berkshire’s shopping list, a company must have demonstrated earnings power (Buffett scoffs at projections and ‘turnarounds’). It must earn good return on equity with little or no debt. It must be simple and quote a fixed offer price.

Berkshire loathes bidding wars and frowns at paying any premium over market price. To top it all, its acquisitions are usually timed to crises situations. Thanks to these rules, between 1999 and 2016, Berkshire’s consolidated net profits galloped 25 times from $0.67 billion to $17.6 billion, while its equity base expanded by a mere 8 per cent. It hasn’t accumulated big debt.

Had Indian promoters followed these tenets, many a dubious acquisition could have been skipped.

Many Indian business groups that are giving banks a runaround for their money share a penchant for diversifying furiously into sectors that are the flavour of the season. In the early nineties, these groups had a yen for steel and textiles, in the late nineties they loved telecom and in 2006-07 they jumped into infrastructure and real estate. This has been value-decimating for every stakeholder.

Berkshire Hathaway is a sprawling conglomerate “with plans to sprawl further”. But its forays into new businesses are undertaken with a single-minded objective — improve the book value per share. Berkshire’s seemingly random portfolio of businesses fits together like a jigsaw, to ride out bumps in the economy.

So, the insurance business has a steady stream of premiums flowing in, providing Berkshire with $100 billion in ‘float’ to deploy in investments. The utilities business is slow-growing, but offers rock-steady earnings in times of adversity. In retail, manufacturing and consumer, Berkshire is invested in solid brands with prodigious free cash flows.

The widely-discussed stock portfolio is in fact just the icing on this cake. Even if the stock market tanks or a few bets go awry, Berkshire shareholders still have a big buffer to fall back on, in these subsidiaries.

Despite its tendency to ‘sprawl’, Berkshire’s book value has grown from $19 per share in 1965 to $1,72,108 in 2016. No wonder it has so many shareholder millionaires.

Indian tech giants and public sector majors are receiving flak from their shareholders over their large, unused cash piles. While shareholders are demanding dividends and buybacks, they’ve been waffling on their real reasons for holding cash.

Berkshire Hathaway Inc, with over $96 billion in cash, has no such qualms. Over the years, the company has frequently and plainly told its investors that it has no plans to declare dividends or announce stock buybacks. It has articulated good reasons for this.

One, Berkshire believes in snapping up companies in crisis, so it needs to keep powder dry to make acquisitions when market opportunities arise.

In September 2008, when the US credit crisis froze markets, Berkshire threw a $20 billion lifeline to its investee companies, thanks to this war chest.

Two, returning cash through dividends will make sense the day Berkshire believes that it cannot generate a decent return on equity by reinvesting its profits. While that day is yet to arrive,

Berkshire has a clear buyback policy — it will mop up its own shares if they trade at less than 120 per cent of book value. Buybacks at a premium, Buffett explains, give away undue benefits to shareholders who are quitting the company, at the cost of those who stay.

Three years ago, prompted by an activist shareholder, Berkshire Hathaway did put the dividend question to vote. Nearly 98 per cent of its shareholders voted for the company to continue with its zero dividend policy!

Corporate India is witness to unseemly boardroom battles with founder-promoters complaining about not being ‘consulted’ and reluctant to let professionals manage the show. Berkshire thrives on a culture of humility and autonomy.

It makes it clear that every acquired business is expected to fend for itself. In their meetings and newsletters, Buffett and Munger never fail to crack goofy jokes at their own expense, while dispensing many pats on the back for their ‘exceptionally talented’ professional managers.

Finally of course, there’s the distance that Buffett (86) and Munger (93) still go to engage with their shareholders.

The annual general meeting is an all-day affair, with a six-hour open house preceding the official meeting.

Shareholders and institutional investors get to grill the duo with impromptu questions.

This year’s meeting saw Buffett admitting that he had been “too dumb” to spot Amazon and ended up buying IBM instead. He stated that Ajit Jain, head of the insurance business, had “made more money for Berkshire than I have”.

Last year, he urged shareholders to trade him for Ajit Jain “without a second thought”, if offered the chance.

His best quip though was reserved for an investor who asked what would happen if Buffett were to move on: “If I were to die tonight, the stock would go up tomorrow.” What a contrast to Indian promoters who believe they are indispensable to their firms.

COMMENT NOW