Questions We'd Like to Hear at Berkshire's Annual Meeting
Buffett's succession plans will likely garner heavy attention once again during the Berkshire annual meeting's question-and-answer session.
The main focus of Berkshire Hathaway's (BRK.A) (BRK.B) annual meeting is the question-and-answer segment that Warren Buffett and Charlie Munger hold, where the two men have, for a number of years, fielded questions from shareholders.
That format was changed in 2009, when several journalists were selected to participate in the question-and-answer period. Further changes were made this year, with Buffett and Munger agreeing to take questions from analysts who cover Berkshire's shares. The new format means that this year one third of the questions will be coming from shareholders, one third from the three journalists, and one third from three industry analysts. This is presumably to help focus the discussion toward more company-specific topics, which we believe better serves all shareholders.
Although the topics up for discussion this weekend are likely to run the full gamut, we've laid out some of the key issues we expect to be broached during the meeting, as well as some specific questions we'd like to have answered over the course of the weekend.
Future Acquisitions and Investments
Historically, acquisitions have been a major part of Berkshire's business and value creation, a trend we expect to continue. Given that the company has a significant amount of cash on its balance sheet, which is currently generating a near-zero return, we believe it is imperative that Berkshire put capital to work in profitable investment opportunities. Furthermore, as the firm continues to expand, future acquisitions will need to be large enough to move the needle in terms of cash position and profitability.
Excess Cash on the Balance Sheet
With many of the lucrative investments that Berkshire made during the financial crisis--such as Swiss Re, Goldman Sachs (GS), and General Electric (GE)--having been called away by their issuers last year, the firm had to rely on substantial investments in Bank of America (BAC), Lubrizol, and International Business Machines (IBM) to keep its cash balance from getting too high. Berkshire's sizable cash position (which was north of $37 billion at the end of 2011) is likely to grow even larger this year through the typical course of business. With yields at historically low levels, this cash is earning very little for shareholders.
The issue of succession has again been placed in the front of investors' minds with Buffett's recent announcement that he has stage-1 prostate cancer. Although the cancer (at this point) appears to be manageable and is assumed to not be life-threatening, it serves as yet another reminder to shareholders that Buffett is, in fact, mortal and will not lead Berkshire forever. As we have noted on countless occasions, both Buffett (at age 81) and Munger (88 years old) are octogenarians, raising the importance of succession for long-term investors in the firm.
As many investors may recall, succession was not formally addressed by Buffett until his 2005 annual letter to shareholders, where he noted that his three main jobs--chairman, chief executive, and chief investment officer--would likely be handled by one chairman, one CEO, and three or more external hires (reporting to directly to the CEO) that would manage the investment portfolio, once he retired. Although the Oracle of Omaha's son, Howard Buffett, has been identified by Buffett as his choice for nonexecutive chairman, ultimately serving as a guardian of the company's values, and adding "one extra layer of protection" for shareholders, the decision ultimately rests with the board of directors.
Looking more closely at the efforts aimed at filling the role of chief investment officer, Berkshire continues to make strides toward hiring three or more external managers to oversee the firm's investment portfolio. Following up on the hiring of Todd Combs in late 2010, Berkshire announced in the third quarter of last year that it had hired Ted Weschler, bringing the total number of outside managers up to two, which means we could still see one or more additional hire(s) at the firm as we move forward.
With all of Berkshire's operating businesses managed on a decentralized basis, eliminating the need for layers of management control and pushing responsibility for each business down to the subsidiary level, Buffett has had the freedom to focus on managing the investments in the firm's portfolio and making capital-allocation decisions. By insisting that the outside managers Berkshire hires to run the investment portfolio report directly to the CEO, he is signaling, in our view, that the primary job of any incoming CEO will be one of capital-allocator-in-chief.
Despite announcing in his annual letter to shareholders that Berkshire's board of directors has a candidate in mind to replace him as chief executive, and that this person is "an individual to whom they have had a great deal of exposure and whose managerial and human qualities they admire," Buffett has been far from transparent about the details of the firm's succession plan. We don't believe that Berkshire has handled the question of succession in a forthright manner and think that the firm needs to be much more transparent about its plans for Buffett's eventual succession, especially given the age of Berkshire's two top managers.
Thoughts on the Economy
Although not an economic prognosticator in the traditional sense, many people often ask Warren Buffett for his opinion on the state of the economy. After his well-publicized bullish stance at the depths of the financial crisis--including an article about "buying American" in the New York Times in October 2008--and his articles since (most notably the excerpt from this year's annual letter to shareholders that was published in Fortune magazine in early February), we'd like to see if his thesis has evolved.
Berkshire's Operating Subsidiaries
Berkshire's noninsurance subsidiaries run the gamut from brick manufacturing and railroads to energy companies and diamond stores. The operations represent a wide sample of the domestic economy and, to different extents, are affected by cyclical ebbs and flows.
There is no common theme running across the subsidiaries except the fact that Buffett believes he acquired them for a reasonable price and that their businesses benefit from long-term competitive advantages. That said, questions about Berkshire's subsidiaries can reveal further details about Buffett's opinion of the markets, possible future acquisition targets, and the economy more generally.
The Insurance Market
Although its contribution to pretax earnings has shrunk on a percentage basis as Berkshire has moved into other businesses, the firm's insurance operations are not only a big generator of cash for Berkshire but account for more than half of the company's aggregate intrinsic value, in our view.
Insurance is inherently cyclical, though the cycles are largely unrelated to the economy as a whole. Given the abundance of capital that has existed in the industry for a number of years, which has led to soft pricing, some prognosticators have been calling for a turn in the cycle, which has been exemplified by low investment yields and artificially inflated profitability figures. Others, ourselves included, believe it may take a large industry loss or some other catalyst to drive a meaningful change in pricing behavior. Given Berkshire's size and influence in the insurance market, as well as the long-term perspective that is taken by Buffett, it is always interesting to hear his comments on the insurance market.
A version of this article appeared April 29, 2011.
Drew Woodbury does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.