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Berkshire Hathaway is one of the most interesting cases of successful investments. Under the inspirational leadership of Warren Buffett, the company's evolution is a great object of study for both scholars and investors. This paper aims at pointing out the key points in Berkshire's history, Buffett's influence, how the company's structure was built, what is its current financial status and whether an investor should consider buying its stock.
In a 1999 article from Business Week, Warren Buffett, the force behind the Berkshire Hathaway Business, was described as follows: "If Buffett had a business card, it would identify him as chairman and chief executive of Berkshire Hathaway Inc. But he is far better known -- indeed, world-famous -- as the greatest stock market investor of modern times. The figures, though often cited, still astound: Had you put $10,000 into Berkshire when Buffett bought control of it in 1965, you'd have $51 million now, vs. just $497,431 if the money were invested in the Standard & Poor's 500-stock index."
Buffett concentrated lately on acquiring entire companies, a business which was not alien to Berkshire, but certainly wasn't its main activity. After buying 4.3% of McDonald's Corp. In 1995, Buffett turned to purchasing whole companies from various industries, ranging from aviation to fast-food and home furnishings. One of the greatest acquisitions Buffett made was that of the reinsurer General Re Corp, for a total amount of $22 billion, in 1998. Buffett's influence on Berkshire's development is difficult to estimate. The number of employees working for Berkshire, its stock values, assets and businesses make it one of the most remarkable companies of today's corporate environment.
The Hathaway Manufacturing Company appeared in 1888 and was founded by Horatio Hathaway, a China trader, who made his profits from whaling in the Pacific Ocean. The main activity of the company was milling cotton, which was a very profitable business at the time. Unfortunately for Hathaway and his partners, the cotton industry started to decline after World War 1. The man who kept the firm going was Seabury Stanton, who put much of his own money into the company just to keep it afloat during this rough period.
Following the years of the Depression, the company was again making a lot of money, the years when business went bad being an exception. Stanton decided in the mid-1950's to merge the company with Berkshire Fine Spinning Associates Inc., which was also into milling and which has a centrury and a half of experience. The new company, based in New Bedford, was truly immense, with a combined capacity of 15 plants, over 12,000 employees and a total revenue exceeding 120 million dollars.
The thing that lead to change eventually was that Seabury Stanton, despite his good-will, was a miller and managed the firm having one single objective: keeping the business going. However, the fact the he invested mainly into working capital, despite the fact that cotton prices were constantly decreasing, resulted in additional internal and international competition. The lack of financial expertise which characterized Stanton was a source of constant quarrels between the people in the company who didn't want change and the ones who wanted to get involved into emerging products.
The short-term results of Stanton's policies was that, by the end of the 1950's, several of the company's plants had to be closed, and a large number of workers had to be laid off. Since the stock prices had fallen, financial analysts didn't give the company much chance.
1962 was the year when Warren Buffett decided to intervene. Considering that the stock price was substantially below the intrinsic value, Buffett began to buy shares. By 1963, he and his associates held the majority votes in the company, so Buffett began to manifest an increased interest in the company.
Disputes between him and Jack Stanton, who had taken over the leadership of the company from his father, were something usual of the time. As a consequence, Buffett, who gradually increased his shareholding to 49 per cent, used his power to change the company's management. As a Chairman of the executive committee, he appointed Ken Chance as President and instructed him to take care of the milling operations of the company. In the mean time, Buffett intended to solve Berkshire's financial troubles.
The policy Buffett used characterizes his entire business philosophy. He didn't entertain a stock price package for the executive team, although he paid nice salaries, packed with incentives and provided loans in order to permit the executive to buy company shares, should they wish for such a thing. However, stock options were something Buffett wasn't willing to allow.
At the time, although the company had only two working mills left, operated by some 2,300 employees, the stocks were up from about $15 (that's what Buffett paid for them) to $18. The objectives and structure of the company also suffered important modifications. Berkshire Hathaway had now a dual role: the textile business was still the core of the organization. In addition., Buffett began to use it as an investment vehicle.
The textile business was not doing very well at the time, and Buffett was too smart not to realize the difficulties and future problems that the companies in the textile industry had to overcome. Still, he persevered, although his reasons are not quite clear. He admitted that closing the plants would have significant effects on jobs and that such an action would cause dysfunctions in the community, but he also believed that he could operate the business profitably. He stated at the time that he is not willing to shut down a business with lower than average profits just to increase by a little bit his business returns.
Still, as time passed, foreign competition and high structural costs were too much for Buffett to handle. The textile industry in America was not doing well at all, so, in 1985, the company terminated its textile business. Ironically, not even Warren 'Midas' Buffett could not stop a sure thing from happening, so the structurally unprofitable business operations were simply eliminated.
The second of the company's roles and a key element of its structural identity began in 1967, when Buffett turned his attention to the insurance business. His interest was expressed in the acquisition of two Nebraska companies, National Indemnity and National Fire and Marine Insurance. Still, the difference between the classical textile business and the insurance industry are obvious. Risk is a lot higher, competition is extremely tough and top management is required just to keep an insurance company going. However, a financial wizard like Buffett was much more comfortable when working with money than with commodities.
Insurance companies charge premiums against a risk that may or may not happen. The consequence is that huge amounts of liquidities are generated by such a company. Therefore, the insurance companies need to look for other places to invest their spare resources. Depending on their managers' ability, such operations could greatly increase the company's profits. The problem is that, should the insured risk take place, an indemnity has to be paid, so the insurance company has to invest its money in liquid assets. The only assets that are liquid enough to satisfy these demands are stock and bonds.
An additional factor made Buffett make up his mind. The financial solidity of an insurance company transmits confidence to its customers and agents. These people have to believe that the company will be able to honor its debts, despite increased competition or larger than usual claims.
One of Buffett's policies in the insurance business was that he preferred concentrating on premium safety that in the volume of business. Suppose that the insurance company gains very few from an insurance policy. Buffett dismissed such a possibility and allowed his agents to write off policies only when they were rational. Even if the customers decided to buy insurance products elsewhere, Buffett would not sacrifice the safety of his companies. After all, Buffett is well-known for arguing that one has to wait forever, if necessary, in order to buy a share at the right price.
These investments in the insurance sector were the start of Berkshire Hathaway's rise to the statute of investment legend. After a few years, Berkshire was in a position to acquire GEICO General Insurance Company, which allowed Buffett to expand his profits and his investment possibilities.
As for the company's present structure, the Business Week article from July, 1999 presents it as follows: "If Berkshire were in fact a painting, it would look like a Jackson Pollock: an idiosyncratic product of inspired improvisation. In building his company virtually from scratch over the past quarter-century, Buffett conjured no overarching strategic vision, followed no master plan other than to buy good businesses at the right price. Even when he erred -- a rare occurrence -- he enfolded his purchases in an embrace intended to be permanent. "We buy everything, even a stock, with the idea that we will hold it forever," he says."
At the moment, Berkshire's…[continue]
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