An Oracle Who… Owns Up… And Oversees

Friday, March 1st, was a banner day in the financial world. No, the Dow Jones Industrials didn’t set a new record high.  Instead, something much more enlightening occurred!  On that day, an “Oracle” spoke from Omaha!

Yes, I realize that the “Oracle” of whom I speak, investment icon Warren Buffett, is heard from quite regularly.  But when Buffett issues his annual Berkshire Hathaway (BRK.B) shareholder report, the nature of the report is so different from most other such reports that it adds credence to the use of the term “Oracle” to describe him. First, this term has its origins in the 15th century – borrowing from the Latin oraculum to refer to someone who speaks with such special authority and wisdom that countless others regard her/his words very highly, as though they have other worldly significance.

Why are Buffett’s reports different? It is simple. Most shareholder reports are excessively glossy and inadequately informative – since they are so often used more as a public relations tool than as a truly open, transparent, honest assessment of company performance.  As a case in point, if I had the time and access required, I would spend a weekend reviewing the annual reports issued by Lehman Brothers, Enron, and WorldCom just before the scandals broke that undid each one of those former corporate giants.  The history of such companies speaks volumes regarding the extremely limited value of annual reports.

A perfect illustration of this truth was revealed in dramatic fashion within the detailed (2,200 pages) bank examiner’s report following the failure of Lehman Brothers – a seminally catastrophic financial event that was a key trigger point for the economic crisis from which we still suffer. The bank examiner, Anton Valukas (a former federal prosecutor) uncovered an elaborate scheme to (figuratively) sweep $50 billion of assets “under the rug” (off its corporate books) in order to conceal Lehman’s dependence upon immense leverage.  Valukas confirmed that senior executives and the bank’s accountants were aware of the scheme, leading him to write: “Unbeknownst to the investing public, rating agencies, government regulators, and Lehman’s board of directors, Lehman reverse engineered the firm’s net leverage ratio for public consumption…”.

You won’t find excessive gloss or fluff in Buffett’s report; far from it!  In fact, the twenty-one page report (plus one page summary of corporate performance versus the S&P 500 Index) weaves a startling and refreshing mixture of confession, primer on business management, mini-course on investment principles (eg. the calculus of dividends), and a call to vision that looks beyond the economic clouds with which we currently wrestle. (Find the report at http://www.berkshirehathaway.com/letters/2012ltr.pdf .)

There aren’t many major U.S. corporate leaders who have the humility to admit shortcomings and even “failure”. Buffett not only has that humility – he actually starts his report with it!  After an introductory paragraph, Buffett writes:

“A number of good things happened at Berkshire last year, but let’s first get the bad news out of the way.

“When the partnership I ran took control of Berkshire in 1965, I could never have dreamed that a year in which we had a gain of $24.1 billion would be subpar, in terms of the comparison we present on the facing page.”

Yes, unlike Lehman (that tried to hide less than flattering numbers) and too many other companies, Berkshire put the “numbers” right up front!  A look at those numbers shows that, during the past 14 years, Berkshire underperformed the S&P 500 in six of those years!

Continuing on the theme of “subpar”, Buffett wrote: “But subpar it was. For the ninth time in 48 years, Berkshire’s percentage increase in book value was less than the S&P’s percentage gain (a calculation that includes dividends as well as price appreciation)….

“To date, we’ve never had a five-year period of underperformance, having managed 43 times to surpass the S&P over such a stretch… But the S&P has now had gains in each of the last four years, outpacing us over that period. If the market continues to advance in 2013, our streak of five-year wins will end….  It’s our job to increase intrinsic business value… If we fail, however, our management will bring no value to our investors, who themselves can earn S&P returns by buying a low-cost index fund.”

Now that is some Oracle— a different breed of oracle, to be sure! An oracle who admits falling short of his own objectives, and then holds himself accountable!  That is an oracle to emulate.

Continuing with his “bad news”, Buffett uses an interesting image to convey his “second disappointment”: “my failure to make a major acquisition. I pursued a couple of elephants, but came up empty-handed.” Obviously, Buffett is not referring here to a safari – but rather to his desire to purchase a promising company. Obviously, “elephant” is Buffett’s way of emphasizing that any company he buys must be big enough to make a difference within a corporation that can grow $23 billion in one year!

Finally, on the letter’s next page, Buffett begins his detailed evaluation of developments within various components of the immense Berkshire corporate family.  But lest you think that Buffett spends the remainder of the letter trumpeting himself and his company, I can assure you that is not the case. For example, on page 19 he confesses to his own foolish sin in 1986 of “wishing his way into a series of bad decisions.”  Then, much like a grandfather might do in an attempt to gently help shape the mind of a beloved grandchild, he writes: “But wishing makes dreams come true only in Disney movies; it is poison in business.”

Soon, we will pick up with more from Buffett’s gem of a shareholder letter!

Submitted by Thomas Petty

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