Berkshire Hathaway 2016 Annual Meeting Recap by BRKRumors

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First, apologies for the large absence throughout April: this is a one man operation and I was away on vacation for most of April. I thought about doing daily updates, but then decided against it as it wouldn’t have been much of a vacation if I was working on this project. Anyways, vacation is over and we will be back to our regularly scheduled program around here.

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The 2016 Berkshire Hathaway Annual Meeting wrapped up yesterday. Here is a recap and analysis of the most important and compelling comments from the Q&A with Warren Buffett and Charlie Munger.

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Berkshire Hathaway 2016 Annual Meeting Recap - Why Capital Intensive Businesses?

Question: Why has there been a shift from buying companies that require little capital expenditures but throw off lots of cash to much more capital intensive businesses?

Answer: Buffett answered that it is a problem of Berkshire’s success and prosperity: there are not many businesses that would sufficiently move the needle at Berkshire at it’s current size that fits the bill of an excellent businesses with low capital requirements that throws off lots of cash.

Analysis: While the holy grail is an excellent business possessing a durable competitive advantage that requires little to no additional capital expenditures to generate free cash flow, those types of business are rare. Additionally, those types of business do not exist at a sufficient size for Buffett to buy that would have any meaningful effect on revenue and profits. It’s like gravity: the larger you get, the harder it is to escape its grasps. Berkshire’s move into capital intensive businesses in regulated industries like utilities and railroads sacrifices growth and higher returns for consistent and stable returns. Warren Buffett has been buying companies such as BNSF, MidAmerican Energy, and Precision Castparts because he understands that this is the compromise of yielding satisfactory returns over long periods of time at the size Berkshire Hathaway is today.

Berkshire Hathaway 2016 Annual Meeting Recap - On the Divestment in Reinsurance

Question: Why Berkshire has divested completely from its stakes in some of Europe’s largest publicly traded reinsurance companies?

Answer: Buffett stated that he sees the reinsurance business over the next 10 years as not being as attractive as it was the past 10 years.

Analysis: Because of low interest rates around the world, it makes for investing premiums for a reasonable profit more difficult. Munger added that more competition from the financial sector is moving into the area of reinsurance, taking supply up and making the environment more competitive, which in turn means lower margins.

Berkshire Hathaway 2016 Annual Meeting Recap - The Threat of Amazon

Question: How will new companies like Amazon disrupt Berkshire’s companies?

Answer: Buffett says that internet companies, like Amazon, have turned traditional sales business models on its head. He praises Jeff Bezos.

Analysis: Buffett believes that the advent of internet marketing and sales is a huge economic trend that was on no ones radar decades ago. He doesn’t believe that Berkshire’s business at the moment have too much to worry about as they do not try to compete with Amazon on online retail. But there is a major shift occurring in how sales are made in society.

Berkshire Hathaway 2016 Annual Meeting Recap - On Coke

Question: How can Berkshire be proud of its holdings in Coke when sugary soft drinks cause immense society health issues? The question further asks how it is not a contradiction if Berkshire is not willing to invest in tobacco on moral grounds, why it would invest in Coke?

Answer: Buffett provides his typical answer by joking about how much Coke he consumes and his distaste for broccoli. Munger provides an interesting comment by stating that when looking at an issue, it is silly not to look at the positive benefits as well as the negatives. He uses the airline industry as an example: just because it causes some deaths every year does not mean that there are not tremendous benefits to air travel.

Analysis: This is a tough one to analyze. I personally don’t believe there is anything inherently negative about sugary soft drinks. My personal bias tends to lean towards people being responsible for their own actions and the consequences that spring from those actions. On the other hand, their most definitely are factors such as education, income levels, and other factors that influence how likely one is to over-consume products such as Coke. I chalk this one up to the “too hard” pile.

Berkshire Hathaway 2016 Annual Meeting Recap - On Nevada Rooftop Solar

Question: Why is NV Energy fighting rooftop solar in Nevada?

Answer: This is an issue that as been highlighted here. Buffett answers that the small number of the population in Nevada that has rooftop solar installed and feeds back excess capacity to the grid are getting heavily subsidized to do so and doesn’t believe it makes sense for the majority of the population in Nevada.

Analysis: It was interesting that Buffett invoked the concept of the 1% and 99%. He referred to the population with rooftop solar as the 1%. He said that this 1% were able to sell back excess power to the grid at below market rates, which meant that the 99% of electricity consumers in Nevada had to subsidize and it turn pay higher rates than market rates. Buffett is saying that it is not fair that a small number of people are being heavily subsidized, and in turn are able to sell electricity back to the grid at inflated prices while NV Energy does not do this nor are allowed to.

Berkshire Hathaway 2016 Annual Meeting Recap - The Sin of Valeant

Question: Any comments on Sequoia Fund and their massive losses linked to Valeant?

Answer: Buffett states that the unusually large position that Sequoia took in Valeant was a mistake and says that the business model of Valeant was enormously flawed. Both Buffett and Munger stated that from their long experience in business, they can spot patterns that frequently lead to bad outcomes, and Valeant displayed those patterns and trends. Munger concludes by saying that Valeant was sewer and those who created it deserve all the opprobrium that they got.

Analysis: Not much to say on this one.

Berkshire Hathaway 2016 Annual Meeting Recap - The Prospects for Investment Banks

Question: What are the prospects of investment banks going forward?

Answer: Buffett says that higher capital requirements have turned banks into less attractive businesses. States that he likes Wells Fargo a lot because of the limited downside risk relative to its potential upside.

Analysis: The financial sector used to be much more attractive when capital requirements were lower and interest rates higher.

Berkshire Hathaway 2016 Annual Meeting Recap - On Berkshire’s (lack of) Due Diligence

Question: How safe is the way Berkshire operates when it comes to making deals?

Answer: The unique way in which Buffett conducts due diligence when purchasing companies involves very little of what the rest of Corporate America does when companies make big purchases. Buffett and Munger state that the quality of the management is the most important factor.

Analysis: Buffett and Munger believe that as long as they can correctly gauge the competence, integrity, and quality of the management team they are buying from, that will ultimately lead to success or failure of the business. While there have been mistakes made in the long history of Berkshire, the success in aggregate should demonstrate that, at least in this case, they have been correct in their assessment of what is important when conducting due diligence.

Berkshire Hathaway 2016 Annual Meeting Recap - The Future of the Package Goods Industry

Question: How does 3G’s operations compares to Berkshire?

Answer: The most interesting part of the answer was not specifically about how 3G operates, but Buffett’s quip that the volume trends in the package goods industry are not looking particularly strong.

Analysis: Combined with the comment on the outlook of the package goods industry, it is interesting to compare that to the current industry as a whole and their elevated valuations. Could low interest rates be pushing investors into perceived safe havens in the package goods industry, leading to elevated valuations that are out of sync with historic norms? It’s not like the industry is some giant growth industry, so the elevated valuation levels make little sense outside of yield starved investors piling in. Your opinion?