Beyond creating a company that treats common shareholders with the utmost fairness and respect, one needs only to look at the long-term value created at Berkshire Hathaway to see why Buffett deserves the award. Since taking the helm of the sleepy textile business 44 years ago and turning it into arguably the strongest conglomerate on the planet, Buffett and his managers have grown the book value per A share from $19 to just over $77,500, as of Sept. 30. This translates to a 20.7% annualized increase in book value since 1965, versus a mere 9.6% annualized return in the S&P 500 (including dividends) over the same time period.
And while 2008 was an exceptionally difficult year for just about all investors, it was much less trying on Berkshire Hathaway and its shareholders. Berkshire's balance sheet equity should be roughly flat from a year ago once the books are closed on 2008. More importantly, the competitive positioning and cash-flow generating ability of Berkshire's businesses remain robust.
Ironically, for the first time in many years, giving the CEO of the Year award to Buffett may be a tad controversial. Among the perceived mistakes at Berkshire are the writing of large put option contracts on broad stock indexes last year, the company's $8 billion worth of investments in General Electric
and Goldman Sachs
in September and early October, as well as Buffett's editorial
in The New York Times
on Oct. 16 urging investors to "Buy American. I Am." With the market taking a sharp turn for the worse in late October and again in November, clearly the timing was not the best on these particular bullish actions.
Yet we do not view these as any reason to lose confidence in Buffett's abilities, either as an investor or corporate manager. Regarding the put options, my colleague Bill Bergman wrote an Analyst Note
that explains why there is more smoke than fire around the concerns here.
Furthermore, it is worth noting that Berkshire's investments in GE and Goldman were in perpetual preferred stock, which puts Berkshire ahead of common equityholders in the capital structure of these two firms. Although the GE and Goldman warrants Berkshire received are indeed out of the money at the moment, Berkshire will still receive a handsome 10% coupon on its investments, even if the stock values of GE and Goldman never recover to their former heights. These are just the type of sweetheart deals made possible only because of the reputation and financial strength built up over many decades by Buffett's value-creating decisions.
And if one still believes that Buffett has lost his edge, witness what value was recently created in Berkshire's dealings with Constellation Energy
. On Sept. 18, Berkshire agreed to buy Constellation for $4.7 billion and soon thereafter invested $1 billion into the firm. Without this lifeline of both cash and confidence, Constellation would have likely not survived the credit crisis. While Constellation ultimately elected to walk away from the merger with Berkshire to go with a rival restructuring plan, Berkshire's initial investment turned into a $1 billion note paying 14%, a $175 million termination fee, and a 10% equity stake in Constellation currently worth about $500 million. It takes quite the poker player to be able to successfully make such a low-risk, high-return bet, and have it play out inside of three months' time.
Avoiding the Wreck
Investors can learn a lot from studying Buffett's actions, but his decisions to stay on the sidelines are also notable. Indeed, he steered Berkshire Hathaway from many of the temptations that have caused competitors to crash and burn this past year. For instance, Buffett warned back in 2003 that derivatives were "financial weapons of mass destruction" that are "time bombs, both for the parties that deal in them and the economic system." Given all that has transpired in 2008, these statements--and Berkshire's actions--look especially prescient. While American International Group
, and other competitors now wallow in bankruptcy or near-bankruptcy, Berkshire is as financially healthy as ever.
Beyond derivatives, Berkshire also avoided excessive leverage back when credit was flowing a little too easy and asset prices were too high. In mid-2007, the opening salvos of the credit crisis were being shot across the subprime mortgage market, and many financial firms were levered to the hilt. Yet Berkshire had $47 billion--over one third of its equity at the time--in cash and cash equivalents, most of it unencumbered. By practicing prudence and patience earlier in the decade, Berkshire was in a position to put large amounts of capital to work in 2008. In other words, rather than blowing its ammunition hunting squirrels a few years ago, Berkshire has been able to shoot the proverbial elephants now walking by.
An Enviable Partner
Of course, we've always preferred managers who do not view the companies they run as their personal piggy banks. As a shareholder of Berkshire Hathaway (both personally as well as in Morningstar StockInvestor
's Tortoise Portfolio), I think we as owners are getting one heck of a deal by paying Buffett a $100,000 salary. (He earns less than $200,000 in total compensation annually.) Buffett allows his significant ownership stake in Berkshire to act as motivation enough to perform well as a manager, which nearly perfectly aligns his interests with those of common shareholders.
In 1996, Buffett scribed an "Owner's Manual" booklet for Berkshire shareholders where he spelled out some of the broad principles used to guide the management of the company. The very first principle said this:
"Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as owner-partners, and of ourselves as managing partners."
While many corporate managers may say they are positive and careful stewards of owner capital, few overtly view common shareholders for what they really are--partners. For being a successful managing partner, both in principle as well as in practice, Warren Buffett is our 2008 CEO of the Year.
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