This past weekend, I made my annual trek to Omaha for the Berkshire Hathaway shareholders meeting.  Once again, the wisdom imparted by Warren Buffett and Charlie Munger was well worth the trip, not to mention the spectacle of 40,000 doting stockholders enthusiastically appreciating every word from the Sages of Omaha.

Goldman Sachs

The first topic of discussion was Goldman Sachs and its SEC lawsuit over failure to reveal counterparty positions for the guarantee of a collateralized mortgage obligation by an insurance company.  The transaction was arranged by Goldman so that a hedge fund could bet against the underlying mortgage bonds by purchasing only the guarantee (a/k/a credit default swap) and collecting under it when the bonds went into default.

In defense of Goldman, Warren cited Berkshire Hathaway’s own guarantee of a multiple state bond obligation a couple of years ago at the request of Lehman Brothers.  Berkshire neither knew nor cared about the positions of counterparties in that transaction because counterparties are always taking different positions; rather it was concerned about making a good investment.  Warren said that the insurance company in the Goldman transaction was in the business of guaranteeing debt issues and should not have recourse claims just for making a bad investment decision.  He said that the allegation against Goldman in and of itself should not permanently damage its reputation.  Charlie said that were he at the SEC, he would have voted with the minority position against bringing the lawsuit.

Ironically, the SEC lawsuit against Goldman is to the financial benefit of Berkshire which holds $5 billion of Goldman’s 10% preferred stock.  In view of the lawsuit, federal regulators are unlikely to permit Goldman to retire its preferred stock any time soon, and meanwhile Berkshire will continue to enjoy its hefty 10% dividend which is far greater than other yields currently available in the marketplace for investments of similar quality.

Financial Institution Regulation

On the subject of financial institution regulation, Charlie was the most outspoken in calling for new regulations to provide for a simpler and safer conduct of business by major financial institutions.  His position is that the government regulatory system has been so permissive and the behavior of the financial institutions so excessive that regulations need to be changed.  He said that were he in charge, his regulatory changes would make Paul Volcker “look like a sissy.”  Charlie is similarly in favor of regulating the derivatives market.

Warren described Berkshire’s $63 billion derivative position as safe and at a level of only 1% of the derivative exposure of some other institutions.  He explained that language in pending legislation would not require Berkshire to post collateral unless Berkshire Hathaway was found to be dangerous to the financial system, a highly unlikely event.

Greece and Sovereign Debt

On the subject of Greece, Warren advocated always to distinguish between countries which borrow in their own currencies and countries like Greece and many others which do not.  Countries which borrow in their own currencies do not default; they run their money printing presses.  Generally, he has become bearish on the ability of currencies to maintain their value because of all the government deficit spending and increase in indebtedness.  He thinks that prospects for significant inflation have increased not only in the U.S., but around the world.  As for Greece, he said, “I don’t know how the movie is going to end, and I try not to go to movies like that.”

Succession

Warren has prepared for two yet to be named successors, a Chief Executive Office and a Chief Investment Officer.  Berkshire’s future CEO is widely regarded to be David Sokol, the highly regarded CEO of MidAmerican Energy Holdings Company, Berkshire’s utility subsidiary.  As for Berkshire’s future CIO, Warren said that his current four candidates are not all the same as last year, and that those under consideration performed well in 2009.  He pointed out that Berkshire’s investments are in outstanding, well-managed companies, and that the Berkshire Hathaway board of directors would have plenty of time to choose a good CIO should something happen to him.

Management

Berkshire Hathaway has only 21 employees at headquarters.  Subsidiary managers are held accountable, but they run their businesses with a minimum amount of direction from Omaha.  Warren does require a letter from his managers indicating who they feel should be their successor, and he requires them to call about anything questionable that comes up.  While other companies may engage in questionable activities, even if it is generally accepted practice such behavior is not acceptable at Berkshire Hathaway, and managers are required to report any such activity to Warren himself.

Stocks

Stocks continue to be Warren’s choice of investments as compared with cash which returns practically nothing and bonds for which interest rate risk has increased.  He believes that the next generation of Americans will live better than the current one, and he is generally optimistic about the future.  And if we do get into trouble, he says not to blame the Federal Reserve System, but to blame Congress.

Business as Usual

So for Berkshire Hathaway, it is business as usual, more difficult because Berkshire has such large amounts of cash to deploy, but the same in terms of seeking to purchase good companies with strong management and wide moats at discounts to intrinsic value.  Warren is still following the investment principles set forth by his Columbia University professor Benjamin Graham in The Intelligent Investor.  Sounds like a formula for continued success.

We contributed to an article in this week’s Barron’s that discusses the prospects for Lowe’s Companies, one of the giants in the home improvement industry and a stock we have been buying for our portfolios.  Following are a few highlights:

Obviously the major players like Lowe’s [(LOW)] and bigger rival Home Depot (HD) are in a much better position than small local or regional suppliers…. “We believe Lowe’s will continue to gain share and increase profits primarily at the expense of smaller competitors, who cannot match the company’s purchasing power,” says Jordan Smyth, a managing director at Edgemoor Investment Advisors in Bethesda, Md.  His firm, with $380 million in assets, has been buying Lowe’s….

Smyth contends Lowe’s has plenty of room to expand in the fragmented $695 billion retail hardware market where in 2009 it held only a 7% share, lagging behind Home Depot’s 10% share.  Edgemoor expects the overall market to grow at 5% a year up to 2013.

Click on this link to view the full article at Barron’s (subscription may be required), or you can watch some video highlights here.  We also reviewed Lowe’s in our last quarterly report, which you can access from our website by clicking here.

Berkshire Hathaway recently released its annual report, including Chairman Warren Buffett’s widely-read letter to shareholders.  As always, Buffett’s letter provides a combination of wise observations and witty remarks and, in the process, gives the reader insight into how one of the most remarkable investors of all time views current market opportunities.  Many followers of Berkshire Hathaway, including us, eagerly await this annual letter and pore over Buffett’s words to add to our investing knowledge.

This year, in light of Berkshire’s pending purchase of Burlington Northern Santa Fe and the recent addition of Berkshire’s stock to the S&P 500 index, Buffett uses the letter to “review some of the basics of our business, hoping to provide both a freshman orientation session for our BNSF newcomers and a refresher course for Berkshire veterans.”  As a result, this year’s letter is a particularly good place to get a thorough understanding of Berkshire’s investment philosophy and an overview of its businesses.

Morningstar provides some good highlights from the letter in Nine Nuggets from Berkshire’s Annual Report.  Go to this summary, and you will find such Buffett classics as, “Sing a country song in reverse, and you will quickly recover your car, house and wife.”  On more of a business note, you will also see that Buffett believes “within a year or so residential housing problems should largely be behind us.”  If you would like to read the entire shareholder letter, you can access it by clicking here.

As we commented in an earlier post, we view Berkshire’s addition to the S&P 500 as a positive for the stock over time, and we are encouraged by what we read in Buffett’s most recent letter.  We will once again attend the annual meeting in Omaha in early May and look forward to sharing some thoughts with you when we return.  Although we will be flying to the meeting, we had to chuckle at Buffett’s P.S. to the shareholder letter: “Come by rail.”