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.

At the largest ever Berkshire Hathaway Annual Meeting on May 3, with approximately 40,000 stockholders in attendance, Warren Buffett and Charlie Munger rose to the occasion and 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 it is still working.

Net income of $19 billion for Berkshire Hathaway in 2013 was an all-time record.  But net income is not a good measure of Berkshire Hathaway’s real value, whether it be the 31% increase in 2013 over the prior year or the 4% decrease in the first quarter of 2014 from the same period a year earlier (due to a drop in insurance underwriting profits which were unusually high a year earlier).

To comprehend the intrinsic or true value of Berkshire Hathaway, it is necessary to understand its three components.  First is the ownership of 68 non-insurance operating companies led by railroad BNSF and public utility Berkshire Hathaway Energy.  These operating subsidiaries now account for more than two-thirds of Berkshire’s annual net profit.

Second is Berkshire’s insurance company business and its rapidly growing $77 billion of reserve “float” invested in stocks, the largest four of which are Wells Fargo, Coca-Cola, American Express and IBM.  Profits from Berkshire’s stock portfolio are vastly understated since only dividends received by Berkshire are reported as net income, not the share in earnings these stock holdings represent nor their gain in market value.  The unrealized gain in Berkshire’s stock portfolio increased $11 billion in 2013, but none of it reported as income.

The third component is the value of future earnings which Berkshire will make from investment of its growing retained earnings.  Berkshire retains all its earnings for reinvestment with enormous stockholder approval.  Ninety-seven percent of Berkshire’s shareholders rejected a proposal that the company pay a dividend.

For the past 49 years, Berkshire has compared the book value of its shares to the S&P 500 Index.  During that period of time, Berkshire’s book value per common share has compounded at an annual gain of 19.7% compared to 9.8% for the S&P including dividends.  The recent criticism of Berkshire for the underperformance of its book value per share compared to the S&P over the last five years represents a misunderstanding of what the company is all about.  Berkshire is a value oriented investor which outperforms the S&P in years when the market is down or marginally up, underperforms the S&P when the market is unusually strong, but outperforms the S&P over the course of full business cycles.  Going back to 2007 before the Great Recession began, Berkshire’s increase in book value has outperformed the S&P.

It should be noted that Berkshire’s book value significantly understates the intrinsic value of the company.  Taking all aspects of Berkshire’s intrinsic value into account, Warren and Charlie make a strong case that Berkshire’s shares are worth much, much more.  Warren is so confident of this that Berkshire is committed to aggressively repurchase its shares if they ever fall below 120% of book value.  At just 139% of current book value today, investment in Berkshire’s stock looks very attractive.

Here are some other interesting take–aways from Berkshire’s Annual Meeting.

• Warren’s $1 million bet with New York asset manager Protégé Partners that the performance of a low cost S&P 500 Index fund would beat that of five Protégé selected hedge funds over ten years is working overwhelming in his favor.  Six years into the bet, the total return of the S&P fund is up 43.8% compared to 12.5% for the hedge funds.
• Both Warren and Charlie think that Federal Reserve Chairman Ben Bernanke did a heroic job during and after the market crash of 2008-2009, and they like what his successor, Janet Yellen, is doing now.  On a cautionary note, they point out that we are in uncharted waters with the Fed holding short term interest rates near zero and purchasing billions upon billions of US government debt securities for over five years.  Warren describes it as a movie we have not seen before and don’t know how it ends.
• Both think that the federal government should continue to provide guarantees of properly underwritten home mortgages to keep their interest rates low, but not through any form of public/private vehicle such as Fannie Mae or Freddie Mac.
• Both concur that the Canadian oil tar sands are a significant long term energy asset for the future, but neither has an opinion as to whether they are a good investment opportunity at this present time.
• Both feel that after they are no longer around, the management of Berkshire will remain excellent.  Warren has recommended a successor CEO to the board; Warren’s investment protégées Todd Combs and Ted Weschler are each managing portfolios in excess of $7 billion which are outperforming the S&P 500 Index; and Warren’s son, Howard Buffett, has been designated future non-executive chairman to preside over a future CEO change should it become necessary.

At Edgemoor Investment Advisors, Berkshire’s stock is still on our buy list, for many good reasons.

The “Fasten Your Seatbelts” public announcement that the Berkshire Hathaway Annual Meeting was about to begin in Omaha’s packed convention center this past Saturday was like a plane steward’s admonition before a perfectly smooth flight.  It’s difficult to imagine how anything could be going better for Berkshire Hathaway.

Warren Buffett reported that his company’s operating earnings during the first three months of 2013, $4.9 billion, 51% above the first three months of 2012, were the highest for any quarter ever reported.  Berkshire’s four major industry operating sectors all performed well including their largest components:  insurance companies Berkshire Hathaway Insurance Groups and GEICO; regulated companies BNSF (railroad) and MidAmerica (public utility); manufacturing/service/retailing companies Marmon (150 different businesses); and financial companies Clayton Homes (manufactured housing/finance) and CORT (leasing).

But Berkshire’s operating company earnings were only part of the story.  In addition to its $4.9 billion of reported net income was another $5.5 billion of net appreciation of investments representing the increase in book value of Berkshire’s fixed income and equity marketable securities in its investment portfolio.  The largest of these investments were Wells Fargo, Coca-Cola, IBM and American Express aggregating $52 billion at year-end 2012.

On the acquisition front, Buffet is still looking for a couple of “elephants” to purchase with readily available proceeds from Berkshire’s $48 billion in short term Treasuries.  He expressed his satisfaction with Berkshire’s $12 billion investment in Heinz during the first quarter, and he believes that there are other good large investment opportunities to pursue for the benefit of Berkshire shareholders in the future.

Finally in terms of valuation, there is the unrecorded intrinsic value of Berkshire’s operating subsidiaries.  Buffett used the example of GEICO’s first quarter insurance underwriting operations to explain.  Based on its first quarter new insurance policies, GEICO is positioned to write $1 billion of new US auto insurance in 2013 out of $1.5 billion industry-wide.  The intrinsic value of GEICO’s growing insurance business is worth far more than the company’s book value carried on Berkshire’s financial statements, and the same is true for most of Berkshire’s other operating businesses.

Buffett said that Berkshire will acquire its own stock whenever its market value falls below 120% of book value (currently at 140%).  Don’t hold your breath.  The market has responded positively to all the good news from Berkshire Hathaway, and it is now the fifth largest company in total market value after Apple, Exxon Mobil, Microsoft and Google.

As always in recent years, questions were raised about what happens to Berkshire after Buffett is no longer around, and a particular question was raised about the future role of Buffett’s son, Howard.  Warren explained that his recommendation for Berkshire’s future Chief Executive Officer and Chief Investment Officer(s) were confidential, but well known to Berkshire’s Board of Directors.  However, as assurance that Berkshire continue to operate the same, he has recommended to his Board of Directors that after his departure, his son Howard become the non-paid, non-executive Chairman of the Board.  As a Berkshire director and major shareholder, Howard is immersed in Berkshire’s principles and culture.  He would assure that Berkshire’s management would either continue successfully on the same path as before, or if not, request the board make appropriate management changes.

While questions about Berkshire were answered confidently and completely, questions about the ultimate impact of the Federal Reserve Bank’s quantitative easing were not.  Both Buffett and his longtime investment partner, Charlie Munger, agreed that the Fed, led by Chairman Ben Bernanke, responded correctly to the financial market crisis of 2008 and subsequent slow economic recovery, but neither could offer an opinion of its aftermath results.  Munger simply said, “I don’t know,” and Buffett agreed, comparing it to an interesting movie where you don’t know the ending. However, Buffett did comment that that the Fed’s quantitative easing has the potential to be very inflationary and that “bonds are a terrible buy right now,” with which we at Edgemoor concur.  He said that the Fed’s balance sheet, which has swollen to $3.4 trillion, is in unchartered territory, and he observed that when the market gets the signal that the Fed is going to stop purchasing $85 billion of mortgage backed securities per month, it could be a “shot heard around the world.”

Be that as it may, it is this author’s opinion that Berkshire Hathaway’s stock is a good value in today’s market.