On Feb. 25, 2012, the best oddsmaker in America— who happens to live not in Las Vegas or Atlantic City, but in Omaha—penned his annual letter to shareholders on the bets placed the year before. To translate the dry, quantitative concepts of business into Buffettese is an exacting task, and one that he approaches with legendary skill. While he takes credit for performance when it’s due, he is equally enthusiastic about pointing out the errata in his storied quest for value creation. Both are examples of what sets great chief executives apart: a palpable conviction in their vision and a willingness to learn from downdrafts as well as windfalls. In adhering to a rule of “anything but truth is unspeakable,” always borne by the facts, argued with determination and proffered to shareholders who decide with their wallets, Buffett reveals how well he knows his customer. Berkshire’s shareholders expect nothing less than that the boss subject himself to the same fierce scrutiny that he demands of his bullish investments. He has been at this for more than 40 years, so he’s fairly confident of the mechanics of the enterprise, yet not a year goes by without something that shocks and amazes him. And when it does, like an excited schoolboy, he can’t wait to bring the new learnings to the attention of his shareholders. Here are the eight rules distilled from one of the greatest businessmen of our lifetime.
Rule 1: Master the art of understatement.
“Charlie Munger, Berkshire’s Vice Chairman and my partner, and I feel good about the company’s progress during 2011.”
Rule 2: Give your board credit.
“The primary job of a Board of Directors is to see that the right people are running the business and to be sure that the next generation of leaders is identified and ready to take over tomorrow. I have been on 19 corporate boards, and Berkshire’s directors are at the top of the list in the time and diligence they have devoted to succession planning. What’s more, their efforts have paid off.”
Rule 3: Bring up succession without sounding like you’re looking at retirement homes.
“Your Board is equally enthusiastic about my successor as CEO, an individual to whom they have had a great deal of exposure and whose managerial and human qualities they admire. (We have two superb back-up candidates as well.) When a transfer of responsibility is required, it will be seamless, and Berkshire’s prospects will remain bright….Do not, however, infer from this discussion that Charlie and I are going anywhere; we continue to be in excellent health, and we love what we do.”
Rule 4: Your shareholders have forgotten all about your business model. Remind them.
“Our insurance operations continued their delivery of costless capital that funds a myriad of other opportunities. This business produces “float”—money that doesn’t belong to us, but that we get to invest for Berkshire’s benefit. And if we pay out less in losses and expenses than we receive in premiums, we additionally earn an underwriting profit, meaning the float costs us less than nothing. Though we are sure to have underwriting losses from time to time, we’ve now had nine consecutive years of underwriting profits, totaling about $17 billion. Over the same nine years our float increased from $41 billion to its current record of $70 billion. Insurance has been good to us.”
Rule 5: Appeal to universal, not personal, greed, because, after all, it is about money.
“We expect the combined earnings of the four [business units]—and their dividends as well—to increase in 2012 and, for that matter, almost every year for a long time to come. A decade from now, our current holdings of the four companies might well account for earnings of $7 billion, of which $2 billion in dividends would come to us.”
Rule 6: If there’s bad news, hit them over the head with it. This way your shareholders won’t have to take notes.
“I’ve run out of good news. Here are some developments that hurt us during 2011: A few years back, I spent about $2 billion buying several bond issues of Energy Future Holdings, an electric utility operation serving portions of Texas. That was a mistake—a big mistake….Last year, I told you that ‘a housing recovery will probably begin within a year or so.’ I was dead wrong.”
Rule 7: Use the specifics of your business to show Wall Street how your performance should be measured.
“Charlie and I measure our performance by the rate of gain in Berkshire’s per-share intrinsic business value. If our gain over time outstrips the performance of the S&P 500, we have earned our paychecks. If it doesn’t, we are overpaid at any price.”
Rule 8: Talk about your team from a shareholder perspective and show why they care as much as the CEO.
“For good reason, I regularly extol the accomplishments of our operating managers. They are truly All-Stars, who run their businesses as if they were the only asset owned by their families. I believe their mindset to be as shareholder-oriented as can be found in the universe of large publicly owned companies. Most have no financial need to work; the joy of hitting business ‘home runs’ means as much to them as their paycheck.”
Even Warren Buffett Needs an Editor
Carol Loomis, a senior editor at Fortune magazine, has edited Warren Buffett’s annual letter to shareholders for more than 30 years. In a recent interview, Loomis said Buffett first approached her about reviewing his letter in 1977. By that time, the CEO of Berkshire Hathaway and Loomis had been friends for at least 10 years. “He trusted me,” she says.
According to Loomis, Buffett had been asked to serve on a study committee by the Securities and Exchange Commission to better understand how to improve shareholder communications and had decided to change the annual report. “I joke that in the first letter I asked him to change an ‘a’ to a ‘the’ and from there it grew,” she recounts. In those days, Buffett handwrote the letter, then his assistant typed it up and overnighted it to Loomis’ home, where she would mark up changes and send it back overnight. (All of Berkshire’s letters are archived on the company’s website.)
Loomis says she doesn’t see a first draft. Buffett probably writes and edits at least a couple of versions of the letter before he sends it to her to read. “I send him my changes, and he either accepts them or he doesn’t. We don’t talk about it or go back and forth on the phone because we both get too angry. But if I feel strongly, I will argue.”
Mostly, Loomis is reviewing for tone and substance. The basis of the relationship, she says, is that “he had a fair amount of trust in me to begin with that has just built up over the years. He knows that I am really interested in making [the letter] as good as it can be—that I have no ulterior motive.” Whenever Loomis writes about Buffett for Fortune, where she has been writer for more than 50 years—as she did recently when it was disclosed that the Oracle of Omaha, as he has become known, has prostate cancer—there is a disclosure that she is both a friend of Buffett’s and a Berkshire Hathaway shareholder.
Are there any usage faux pas that Buffett routinely makes? While describing him as “quick to learn,” Loomis says she kids Buffett that “he missed the class where they taught active verbs,” and that often she has to remove “adjectives that are plowed up in front of a noun.” What they sometimes disagree about is a joke: whether it’s funny or not. In the early days, Buffett pictured that his readership—whom he was writing for—were his two sisters, Bertie and Doris, and presumably they laughed on cue.
In troubled times, readers recognize that Buffett’s letters can be particularly instructive. He doesn’t shy away from the negative. Instead, in his own plain-talking style, as common to his writing as it is when his is being interviewed on stage in front of tens of thousands of shareholders, Buffett lays it on the line. Loomis, who reads annual reports as a matter of course as a business journalist, says most other CE Os simply do not give the exercise the attention it deserves. “They should use their annual report as a means of communicating with their shareholders, and they just don’t,” she says.
A case in point: Two years ago at a dinner, Loomis says she found herself seated next to a CE O who had just taken over a troubled company and was about to write his first annual report letter. He said he wanted to write about the good and the bad, but his public relations people felt otherwise. Loomis says she told him, “You have a chance here to establish your personality with your shareholders. You want to lay it all out there. I know he was convinced, and I waited for his letter. I was disappointed to see that his PR people had won.”
If you contrast Buffett’s with the average CEO annual letter, it will be obvious to most that the majority are written by the public relations department. That’s an acceptable approach. Writing may not be among the CEO’s strong suits. But every writer needs an editor, even if that writer is the CEO of Berkshire Hathaway. —Judy Warner