I attended my twelfth Berkshire Hathaway Annual Meeting this past weekend and found it to be as worthwhile as ever.  Chairman/CEO Warren Buffett, age 86, and Vice Chairman Charlie Munger, age 93, are still at the top of their game.  Their appreciative audience seemed to me larger than ever with approximately 40,000 stockholders in Omaha, NE for the meeting and related Berkshire Hathaway events.

Once again for five hours they responded to questions from financial journalists, research analysts and stockholders, many of which dealt with how the intrinsic value of Berkshire Hathaway is not reflected in its balance sheet and income statement.  Here are some of the stunning highlights:

• Berkshire Hathaway’s security holdings of public companies now have unrealized gains of $90 billion not recorded in net earnings.

• Berkshire Hathaway’s float, accumulated insurance premiums reserved for future claims, now exceeds $100 billion for the first time.  Carried as a liability on the balance sheet, Buffett regards these reserves as a revolving fund since premiums received for new insurance policies likely replenish insurance claims going forward.  Moreover, Berkshire Hathaway’s insurance operations, which have operated at an underwriting profit for the past fourteen years, are currently expected to continue that performance with the result that the investment earnings on its $100 billion float would fall to the bottom line.

• Berkshire Hathaway has $15 billion of intangible assets, representing the cost of acquired businesses exceeding their book value, which must be amortized as expenses over many years.  In 2016, the amortization of intangible expense for Berkshire Hathaway was $1.5 billion.  Buffett believes this expense is unwarranted because the acquired companies would not have incurred such an enormous intangible expense had they remained independent.  It is only because of Berkshire Hathaway’s ownership that the intangible expense must be deducted from profit.

Buffet believes that the intrinsic value of Berkshire Hathaway’s stock far exceeds its book value.

Positive News for the Future

• New Business in 2017
  • GEICO led by Tony Nicely has signed up 700,000 new policy holders.
  • Berkshire Reinsurance led by Ajit Jain received a $10 billion premium for a new reinsurance contract with AIG.

• Stock Investments
  • Warrants from the purchase of Bank of America Preferred Stock are now worth $10 billion in addition to the $5 billion originally invested.

• Tod Combs and Ted Weschler
  • Each of these investment managers brought into Berkshire Hathaway by Buffett are now managing $10 billion dollar portfolios and additionally have subsidiaries reporting to them.

• Stock Repurchases and Dividends
  • Buffett explained that if the size of Berkshire Hathaway’s cash available for investment makes it increasingly difficult to employ, dividends and stock repurchases would be considered.

• Taxes
  • Buffet said that reduction of corporate income taxes would increase profits of Berkshire Hathaway’s subsidiaries (with the exception of public utilities that have electric rate setting commissions which control profit levels).

• Management Succession
  • Buffett explained that when he retires or otherwise can no longer be CEO, his successor will come from within Berkshire Hathaway.  While he is not prepared to disclose the name of his successor as long as he plans to continue as CEO, he said that there is ample talent within the company from which to choose.

• Berkshire Hathaway Without Buffett
  • Buffett said of Berkshire Hathaway’s stock, “If I died tonight, I think the stock would go up tomorrow.”  He attributed the reason why to the market perception that the sum of Berkshire’s parts is worth more than their whole as a single company.  However, he has a loyal board and loyal managers who want his principles for Berkshire Hathaway to continue for the long term benefit of its shareholders.

Past performance is not indicative of future results. The information provided in this commentary should not be considered financial advice or a recommendation to buy or sell a particular security. You should not assume that any of the investment strategies or securities discussed herein are or will be profitable. The opinions expressed herein are those of Edgemoor Investment Advisers, Inc. (Edgemoor) and are subject to change without notice. You should always obtain current information and perform due diligence before investing.  All recommendations for the last 12 months are available upon request.

Edgemoor Investment Advisors, Inc. is a registered investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Edgemoor including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.

At the Berkshire Hathaway Annual Meeting on April 30 with 40,000 in attendance and webcast available for the first time, Warren Buffett age 85 and Charlie Munger age 92 were at the top of their game.

Buy good companies, let their managers run them and invest the capital they generate has been their mantra from the outset, and we believe it is still working.  Berkshire’s annual percentage change in book value (its preferred measurement of performance) was up 6.4% for 2015 compared to the S&P 500 Index which was up 1.4% including the reinvestment of dividends.  Berkshire’s net earnings attributable to shareholders for the year were up 21.0% compared to 2014.  But that’s not to say that Berkshire only had smooth sailing during the year.  Berkshire’s stock was down 12.5% in 2015 but is up 11.3% so far this year, as of today, May 2, 2016.

In 2015, Berkshire’s reinsurance companies encountered increasing competition from others and continuing low interest rates which adversely impacted earnings on the fixed income investment portion of their reserves for claims.  GEICO suffered a significant decrease in profits as increased accidents caused by greater automobile mileage and higher accident rates resulted in rising claims.  BNSF encountered diminishing coal and oil railroad car shipments.  Even so, BNSF’s net earnings rose due to improved service and cost control, and we believe the overall performance of Berkshire for the year was laudatory.

To comprehend the intrinsic (true) value of Berkshire Hathaway, it is necessary to understand its three components.  First is the ownership of 78 non-insurance operating companies led by railroad BNSF and public utility Berkshire Hathaway Energy.  These operating companies account for 36% of Berkshire’s pre-tax net earnings.

Second is Berkshire’s insurance business consisting of 11 insurance companies with their $88 billion of reserve “float” funds available for investment pending future insurance claims.  $59 million of these funds are invested in stocks, the largest 4 of which are Wells Fargo, Coca-Cola, IBM and American Express.  Profits from Berkshire’s stock portfolio are understated since only dividends received by Berkshire are reported as income, not the share in earnings these stock holdings represent.  Moreover, the market value of Berkshire’s stock portfolio was $112 billion at year-end 2015 versus its cost of $59 billion, a 90% unrealized gain of $53 billion which under GAAP is reflected on Berkshire’s balance sheet but has not been recorded on Berkshire’s income statement.

The third value component is the future earnings potential of Berkshire’s retained earnings.  This has been the hallmark of Berkshire’s success and the reason it does not pay a dividend.  Warren and Charlie believe they can invest their stockholders share of Berkshire’s earnings better than their shareholders could invest their dividends if Berkshire paid them.

In Warren and Charlie’s view, Berkshire’s book value significantly understates the intrinsic value of the company.  Warren is so confident of this that Berkshire is committed to aggressively repurchase its shares if they ever fall to 120% of book value.  He also believes that Berkshire’s current market price of 144% of book value is well below its intrinsic value.

Here are some interesting take-aways from the meeting:

• Warren said Berkshire Hathaway will do just fine no matter who becomes our next president.  He is a supporter of Hilary Clinton, but is not worried if Donald Trump should win.

• According to Warren, an important reason why the managers of Berkshire Hathaway’s operating companies perform so well is that they can fully concentrate on their businesses and don’t have to be concerned about investor relations since Berkshire is their stockholder.

• A succession plan for Warren and Charlie is in place but not disclosed, because to announce it would be premature and cause undue attention.  Warren firmly believes that the culture and investment philosophy of Berkshire Hathaway will not change after he and Charlie are gone.  He thinks Berkshire’s board, management and stockholders are too committed to Berkshire’s way of doing things to allow that to happen.

• Warren views Amazon as a competitive force for change in the marketplace, and it is a company Berkshire follows closely.  On the subject of competition, Charlie said it is Berkshire’s culture to “Win fairly and use (spend) wisely.”  Warren stressed that treating all constituents fairly is important including both customers and vendors.  Pressing to win every aspect of a negotiation can be counter-productive.

All in all, it was another worthwhile Berkshire Hathaway annual meeting to attend in person or to view by webcast.

Past performance is not indicative of future results. The information provided in this commentary should not be considered financial advice or a recommendation to buy or sell a particular security. You should not assume that any of the investment strategies or securities discussed herein are or will be profitable. The opinions expressed herein are those of Edgemoor Investment Advisers, Inc. (Edgemoor) and are subject to change without notice. You should always obtain current information and perform due diligence before investing.

Edgemoor Investment Advisors, Inc. is a registered investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Edgemoor including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.

Here is another great summary of some of the comments from Warren Buffett and Charlie Munger at the Berkshire Hathaway annual meeting: The Warren Buffett & Charlie Munger Show.

2015 marks 50 years since Warren Buffett took the helm at Berkshire Hathaway and the roughly 40,000 attendees at this year’s annual meeting were in a celebratory mood.  The morning began, as usual, with a video.  The highlight of this year’s production was a hilarious bit featuring Warren Buffett as the Berkshire Bomber facing off in a grudge match against welterweight boxing champion Floyd Mayweather.

With the video feature concluded Warren Buffett and Charlie Munger took the stage for the main event, their annual question and answer session.  The Q&A was, as always, wide ranging and included audience questions from natives of Germany, Taiwan, China, Korea, and a seventh grader from Florida.

There was much well deserved praise for Mr. Buffett and Mr. Munger on their remarkable longevity and success running Berkshire, and the role of Berkshire’s corporate culture in creating and maintaining its success was a thread that ran throughout the Q&A session.  Choosing carefully those you associate with, nurturing your reputation and setting the proper tone at the top were all offered as key components for anyone seeking to create and sustain an enduring corporate culture.  They emphasized that Berkshire’s culture was not created overnight and that good fortune and being ready and open to opportunities when they were presented were also important parts of their success at Berkshire.

Not every questioner heaped praise on Berkshire.  The morning’s first question was probably the most pointed.  A shareholder asked Mr. Buffett to defend mortgage lending practices at Berkshire’s manufactured home subsidiary Clayton Homes.  Mr. Buffett, clearly anticipating a question on Clayton, offered a well-documented and persuasive defense of Clayton and its lending practices, pointing out that 97% of Clayton’s borrowers successfully pay off their mortgages and concluding that “Clayton has behaved very well.”

The same shareholder also questioned Berkshire’s association with buyout firm 3G Capital which has a reputation for cutting jobs at the companies it acquires.  With respect to 3G, Mr. Buffett remarked, and Mr. Munger seconded, that some of the companies it acquired had too many employees to work efficiently and that no one is required or expected to retain more people than needed to run a business.  He added that after being acquired by 3G, performance at those companies improved considerably.

Succession, which has been a frequent topic at Berkshire meetings in recent years, was discussed only briefly this year with Mr. Buffett stating his belief the person at the top must have extensive operational experience, not simply investing prowess.

On stock valuations Mr. Buffett was asked whether he felt that the ratio of total market capitalization to GDP, one of his favored market valuation metrics, was now too high.  He responded that in the current environment of exceptionally low interest rates current valuations were very reasonable.

They also remarked that the reinsurance business, where Berkshire is a major player, is not the attractive business it once was as competition has grown and made pricing unattractive.

Responding to a question about China and whether the principles of value investing have applicability there, Mr. Buffett and Mr. Munger agreed that the principles of value investing know no borders.  They added that China could benefit from shifting toward a more value-oriented approach to investing and away from the speculative fevers that tend to dominate markets in China today.

Turning to China again, both Mr. Buffett and Mr. Munger expressed admiration for the speed with which China has transformed itself over the past four decades and agreed that China and the U.S. must find a way to cooperate over the long term for their mutual benefit and for the benefit of world.

On the acquisition front, both expressed interest in doing more deals in Europe, having recently closed on the acquisition of a German motorcycle equipment retailer.

As the Q&A wound to a close Mr. Munger offered a fitting conclusion, saying that simply being a shrewd investor, passively holding stocks, is not enough to make a life satisfying and that we all should strive to contribute more.