2 Note: The following table appears in the printed Annual Report on the facing page of the Chairman's Letter and is referred to in that letter. Berkshire’s Corporate Performance vs. the S&P 500 Annual Percentage Change in Per-Share in S&P 500 Book Value of with Dividends Relative Berkshire Included Results Year (1) (2) (1)-(2) 1965 .................................................. 23.8 10.0 13.8 1966 .................................................. 20.3 (11.7) 32.0 1967 .................................................. 11.0 30.9 (19.9) 1968 .................................................. 19.0 11.0 8.0 1969 .................................................. 16.2 (8.4) 24.6 1970 .................................................. 12.0 3.9 8.1 1971 .................................................. 16.4 14.6 1.8 1972 .................................................. 21.7 18.9 2.8 1973 .................................................. 4.7 (14.8) 19.5 1974 .................................................. 5.5 (26.4) 31.9 1975 .................................................. 21.9 37.2 (15.3) 1976 .................................................. 59.3 23.6 35.7 1977 .................................................. 31.9 (7.4) 39.3 1978 .................................................. 24.0 6.4 17.6 1979 .................................................. 35.7 18.2 17.5 1980 .................................................. 19.3 32.3 (13.0) 1981 .................................................. 31.4 (5.0) 36.4 1982 .................................................. 40.0 21.4 18.6 1983 .................................................. 32.3 22.4 9.9 1984 .................................................. 13.6 6.1 7.5 1985 .................................................. 48.2 31.6 16.6 1986 .................................................. 26.1 18.6 7.5 1987 .................................................. 19.5 5.1 14.4 1988 .................................................. 20.1 16.6 3.5 1989 .................................................. 44.4 31.7 12.7 1990 .................................................. 7.4 (3.1) 10.5 1991 .................................................. 39.6 30.5 9.1 1992 .................................................. 20.3 7.6 12.7 1993 .................................................. 14.3 10.1 4.2 1994 .................................................. 13.9 1.3 12.6 1995 .................................................. 43.1 37.6 5.5 1996 .................................................. 31.8 23.0 8.8 1997 .................................................. 34.1 33.4 .7 1998 .................................................. 48.3 28.6 19.7 1999 .................................................. .5 21.0 (20.5) 2000 .................................................. 6.5 (9.1) 15.6 2001 .................................................. (6.2) (11.9) 5.7 2002 .................................................. 10.0 (22.1) 32.1 2003 .................................................. 21.0 28.7 (7.7) 2004 .................................................. 10.5 10.9 (.4)
Average Annual Gain — 1965-2004 21.9 10.4 11.5 Overall Gain — 1964-2004 286,865 5,318 Notes: Data are for calendar years with these exceptions: 1965 and 1966, year ended 9/30; 1967, 15 months ended 12/31. Starting in 1979, accounting rules required insurance companie s to value the equity securities they hold at market rather than at the lower of cost or market, which was prev iously the requirement. In this table, Berkshire’s results through 1978 have been restated to conform to the changed rule s. In all other respects, the results are calculated using the numbers originally reported. The S&P 500 numbers are pre-tax whereas the Berkshire numbers are after-tax. If a corporation such as Berkshire were simply to have owned the S&P 500 and accrued the appr opriate taxes, its results would have lagged the S&P 500 in years when that index showed a positive return, but would have exceeded the S&P in years when the index showed a negative return. Over the years, the tax costs would have caused the aggregate lag to be substantial. BERKSHIRE HATHAWAY INC. To the Shareholders of Berkshire Hathaway Inc.: Our gain in net worth during 2004 was $8.3 billion, which increased the per-share book value of both our Class A a nd Class B stock by 10.5%. Over the last 40 y ears (that is, since present management took over) book value has grown from $19 to $55,824, a rate of 21.9% compounded annually.* It’s pe r-share intrinsic val ue t hat cou nts, however, n ot bo ok val ue. Here, t he ne ws i s go od: Between 196 4 an d 200 4, Berk shire morphed fro m a st ruggling north ern tex tile b usiness whose in trinsic value was less th an book in to a d iversified en terprise w orth fa r m ore than book. Our 40-year gain in intrinsic value has therefore somewhat exceeded our 21.9% gain in book. (For an e xplanation of intrinsic value and the economic principles that guide Charlie Munger, my partner and B erkshire’s vice-chairman, and me in running Berkshire, please read our Owner’s Manual, beginning on page 73.) Despite their shortcomings, yearly calculations of book value are useful at Berkshire as a sligh tly understated gauge for measuring the long-term rate of increase in our intrinsic value. The calculations are less relevant, however, than they once were in rating any single year’s performance versus the S&P 500 index (a comparison we display on the facing page). Our equity holdings (including convertible preferreds) have fallen con siderably as a p ercentage of o ur n et wo rth, fr om an av erage of 114% in th e 1 980s, f or example, to less than 50% in recent years. Therefore, yearly movements in the stoc k market now affe ct a much s maller p ortion of ou r n et worth th an was once t he case, a fact th at will n ormally cau se us to underperform in years when stocks rise substantially and overperform in years when they fall.
However the yearly co mparisons work out, Berk shire’s long-term perform ance vers us the S&P remains all-important. Our shareholders can buy the S&P through an index fund at very low cost. Unless we achieve gains in per-share intrinsic value in the future that outdo the S&P, Charlie and I will be adding nothing to what you can accomplish on your own. Last year , Berk shire’s boo k-value gain of 10.5% f ell sho rt of t he index ’s 10 .9% return. Our lackluster performance was n ot due to any stumbles by the CEOs of our operating businesses: As always, they pulled more than their share of the load. My m essage to them is simple: Run your business as if it were the only asset your family will own over the next hundred years. Almost invariably they do just that and, after taking care of the needs of their business, send excess cash to Omaha for me to deploy. I didn’t do that job very well last year. My hope wa s to make several multi-billion dollar acquisitions that wou ld add new and significant streams of earnings to the many we alread y have. But I struck out. Additionally, I found very few attractive securities to buy. Berkshire therefore ended the year with $43 billion of cash equivalents, not a happy position. Charlie and I will work to translate some of this hoard into more interesting assets during 2005, though we can’t promise success. In one res pect, 2004 was a rem arkable year fo r the stoc k m arket, a fact burie d in the maze of numbers on page 2. If yo u examine the 35 years sin ce the 1960s ended, you will find th at an investor’s return, i ncluding dividends, from owni ng t he S&P has a veraged 11.2% annua lly (well above what we expect future returns to be). But if yo u look for years with returns any where close to that 11.2% – say, between 8% and 14% – you will find only one before 2004. In other words, last year’s “normal” return is anything but. * All figures used in this report apply to Berkshire’s A shares, the successor to the only stock that the company had outstanding before 1996. The B shares have an economic interest equal to 1/30th that of the A. 3 Over the 35 years, American business has delivered terrific results. It should therefore have been easy fo r inv estors to earn juicy retu rns: All th ey h ad to d o was piggyback Corporate Am erica in a diversified, low-expense way. An i ndex fund that they never touched would have done the job. In stead many investors have had experiences ranging from mediocre to disastrous.
There ha ve been three primary causes: first, high c osts, usually because inves tors t raded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a star t-and-stop approach to the market marked by untimely entries (after an advance has been long underway) and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time th eir participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful. Sector Results As managers, Charlie and I want to give our owners the financial information and commentary we would wish t o receive if our roles were re versed. To do this with both clar ity and reasonable bre vity becomes more di fficult as B erkshire’s sc ope widens. Some of o ur businesses have vast ly di fferent economic characteristics from others, which means that our consolidated statements, with their jumble of figures, make useful analysis almost impossible. On the following pages, therefore, we will present some balance sheet and earnings figures from our four major categories of businesses along with commentary about each. We particularly want you to understand the li mited circumstances under which we will use debt, given that we typically shun it. We will not, however, inundate you with data that has no real value in estimating Berkshire’s intrinsic value. Doing so would tend to obfuscate the facts that count. Regulated Utility Businesses We have an 80.5% (fully diluted) interest in MidAmerican Energy Holdings, which owns a wide variety of utility operations. The largest of these are (1) Yorkshire Electricity and Northern Electric, whose 3.7 m illion electric cu stomers m ake it t he th ird larg est d istributor of electricity in th e U.K.; (2) MidAmerican Energy, which serves 698,000 electric customers, primarily in Iowa; and (3) Kern River and Northern Natural pipelines, which carry 7.9% of the natural gas consumed in the U.S. The remaining 19.5% of MidAmerican is owned by three partners of ours: Dave Sokol and Greg Abel, th e brilliant managers o f th ese bu sinesses, an d Walter Sco tt, a lo ng-time frien d of m ine who introduced me to the company. Becau se MidAmerican is sub ject to the Pub lic Utility Ho lding Company Act (“PUHCA”), Berkshire’s voting interest is limited to 9.9%. Voting control rests with Walter.
Our limited v oting i nterest forces us to acco unt for Mi dAmerican in an ab breviated m anner. Instead of our fully incorporating the company’s assets, liabilities, revenues and expenses into Berkshire’s statements, we m ake o ne-line en tries only in both our balance sheet and in come a ccount. It’s lik ely, though, t hat PUHC A will someday – perhaps soon – be repeale d or that accoun ting rules will cha nge. Berkshire’s consolidated figures would then incorporate all of MidAmerican, including the substantial debt it utilizes (though this debt is not now, nor will it ever be, an obligation of Berkshire). At yearend, $1.478 billion of MidAmerican’s junior debt was payable to Berkshire. This debt has allowed ac quisitions t o be f inanced without o ur partners nee ding t o i ncrease their already s ubstantial investments in MidAmerican. By charging 11% interest, Berkshire is compensated fairly for putting up the funds needed for purchases, wh ile ou r p artners are sp ared dilution of th eir equ ity in terests. Becau se MidAmerican made no large acquisitions last year, it paid down $100 million of what it owes us. 4 MidAmerican also owns a significant non-utility business, HomeServices of America, the second largest real estate broker in the country. Unlike our utility operations, this business is highly cyclical, but nevertheless on e we view en thusiastically. We h ave an exceptional manager, Ron Peltier, wh o th rough both his acquisition and operational skills is building a brokerage powerhouse. HomeServices participated in $59.8 billion of transactions in 2004, a gain of $11.2 billion from 2003. About 24% o f t he i ncrease cam e fr om si x acqui sitions m ade d uring t he y ear. Th rough our 17 brokerage firms – all o f which retain their local identities – we em ploy more than 18,000 brokers in 1 8 states. HomeServices is almost certain to grow substantially in the ne xt decade as we continue to acquire leading localized operations. Last year MidAmerican wrote off a major investment in a zinc recovery project that was initiated in 1998 and became operational in 2002. Large quantities of zinc are present in the brine produced by our California ge othermal operat ions, an d we believed we c ould p rofitably ext ract t he metal. For m any months, it appeared that commercially- viable recov eries were i mminent. Bu t in mining, ju st as in o il exploration, prospects have a way of “teasing” their developers, and every time one problem was s olved, another popped up. In September, we threw in the towel.
Our failure here illustrates the importance of a guideline – stay with simple propositions – that we usually ap ply in inv estments as well as operations. If only on e variable is k ey t o a d ecision, an d th e variable has a 90% chance of going your way, the chance for a successful outcome is obviously 90%. But if ten independent variables need to break favorably for a successful result, and each has a 90% probability of s uccess, the likelihood of having a winner is only 35 %. In our zinc vent ure, we solved most of the problems. But one proved intractable, and t hat was one too many. Si nce a chai n is no stronger than its weakest link, it makes sense to look for – if you’ll excuse an oxymoron – mono-linked chains. A breakdown of MidAmerican’s results follows. In 2004, the “other” category includes a $7 2.2 million profit from sale of an Enro n receivable that was thrown in wh en we purc hased Northern Na tural two years earlier. Walter, Dave and I, as natives of Omaha, view this unanticipated gain as war reparations – partial compensation for the lo ss our city su ffered in 1986 when Ken Lay moved Northern to Houston, after promising to leave the company here. (For details, see Berkshire’s 2002 annual report.) Here are some key figures on MidAmerican’s operations: Earnings (in $ millions) 2004 2003 U.K. utilities ....................................................................................................... $ 326 $ 289 Iowa utility ......................................................................................................... 268 269 Pipelines ............................................................................................................. 288 261 HomeServices..................................................................................................... 130 113 Other (net) .......................................................................................................... 172 190 Loss from zinc project ........................................................................................ (579) (46) Earnings before corporate interest and taxes ...................................................... 605 1,076 Interest, other than to Berkshire ......................................................................... (212) (225) Interest on Berkshire junior debt ........................................................................ (170) (184) Income tax .......................................................................................................... (53) (251) Net earnings........................................................................................................ $ 170 $ 416 Earnings applicable to Berkshire*...................................................................... $ 237 $ 429 Debt owed to others............................................................................................ 10,528 10,296 Debt owed to Berkshire...................................................................................... 1,478 1,578
*Includes interest earned by Berkshire (net of related income taxes) of $110 in 2004 and $118 in 2003. 5 Insurance Since Berkshire purchased National Indemnity (“NICO”) in 1967, property-casualty insurance has been our core business and the propellant of our growth. Insurance has provided a fountain of funds with which we’ve acquired the securities and businesses that now give us an ever-widening variety of earnings streams. So in this section, I will be spending a little time telling you how we got where we are. The source of our insurance funds is “float,” which is money that doesn’t belong to us but that we temporarily hold. Most of our fl oat arises because (1) pre miums are pa id upfront though the servic e we provide – insurance protection – i s delivered over a pe riod that usually covers a y ear and; (2) loss events that occur today do not always resu lt in our immediately paying claims, because it sometim es takes many years for lo sses to b e repo rted (asb estos lo sses wou ld b e an ex ample), negotiated and settled . Th e $20 million of float that came with our 1967 purchase has now increased – both by way of internal growth and acquisitions – to $46.1 billion. Float i s w onderful – if it d oesn’t co me at a h igh price. Its co st is d etermined b y un derwriting results, meaning how the expenses and losses we will ultimately pay compare with the premiums we have received. When an underwriting profit is achieve d – as has been the case at Berkshire in about half of the 38 years we have been in the insurance business – float is better than free. In such years, we are actually paid for holding other people’s money. For m ost insurers, however, life has been far more difficult: In aggregate, the property-casualty i ndustry al most invariabl y ope rates at an underwriting loss . When that loss is large, float becomes expensive, sometimes devastatingly so. Insurers have generally ear ned poor ret urns f or a si mple reas on: They sel l a com modity-like product. P olicy forms are st andard, and the product is available from many suppliers, some of whom are mutual companies (“owned” by policyholders rather than stockholders) with profit g oals that are li mited. Moreover, most insureds don’t care f rom whom they buy. C ustomers by the millions say “I need some Gillette blades” or “I’ll have a Coke” but we wait in vain for “I’d like a National Indemnity policy, please.” Consequently, price competition in insurance is usually fierce. Think airline seats.
So, you may ask, how do Berkshire’s insurance operations overcome the dismal economics of the industry and achieve some measure of enduring competitive advantage? We’ve attacked that problem in several ways. Let’s look first at NICO’s strategy. When we purchased the company – a specialist in commercial auto and general liability insurance – it did not appear to have any attributes that would overcome the industry’s chronic troubles. It was not well-known, had no informational advantage (the company has never had an actuary), was not a l ow-cost operator, and sold through general age nts, a method m any people thou ght outdate d. Neve rtheless, for almost all of the past 38 years, NICO has been a star performer. Indeed, had we not made this acquisition, Berkshire would be lucky to be worth half of what it is today. What we ’ve h ad going f or us i s a m anagerial m indset that m ost i nsurers fi nd i mpossible t o replicate. Tak e a l ook at the facing page. Can you imagine any public company e mbracing a busi ness model t hat woul d l ead t o t he decl ine i n r evenue t hat w e expe rienced from 198 6 t hrough 1999? That colossal slide, it should be emphasized, did not occur because business was unobtainable. Many billions of premium dollars were readily available to NICO had we only been willing to cut prices. B ut we i nstead consistently priced to make a profit, not to match our most optimistic competitor. We never left customers – but they left us. Most American businesses harbor an “institutional imperative” that rejects extended decreases in volume. What CEO wants to report to his shareholders that not only did business contract last year but that it will continue to drop ? In insu rance, the urge to keep writing busi ness is also intensified because the consequences of foolishly-priced p olicies m ay not bec ome appare nt f or s ome t ime. If a n i nsurer i s optimistic in its reserving, reported earnings will b e overstated, and years m ay pass before true loss costs are revealed (a form of self-deception that nearly destroyed GEICO in the early 1970s). 6 Portrait of a Disciplined Underwriter National Indemnity Company Year Written Premium (In $ millions) No. of Employees at Year-End Ratio of Operating Expenses to Written Premium Underwriting Profit (Loss) as a Per- centage of Premiums (Calculated as of year end 2004)* 1980 ........................... $79.6 372 32.3% 8.2% 1981 ........................... 59.9 353 36.1% (.8%) 1982 ........................... 52.5 323 36.7% (15.3%) 1983 ........................... 58.2 308 35.6% (18.7%) 1984 ........................... 62.2 342 35.5% (17.0%) 1985 ........................... 160.7 380 28.0% 1.9% 1986 ........................... 366.2 403 25.9% 30.7% 1987 ........................... 232.3 368 29.5% 27.3% 1988 ........................... 139.9 347 31.7% 24.8% 1989 ........................... 98.4 320 35.9% 14.8% 1990 ........................... 87.8 289 37.4% 7.0% 1991 ........................... 88.3 284 35.7% 13.0% 1992 ........................... 82.7 277 37.9% 5.2% 1993 ........................... 86.8 279 36.1% 11.3% 1994 ........................... 85.9 263 34.6% 4.6% 1995 ........................... 78.0 258 36.6% 9.2% 1996 ........................... 74.0 243 36.5% 6.8% 1997 ........................... 65.3 240 40.4% 6.2% 1998 ........................... 56.8 231 40.4% 9.4% 1999 ........................... 54.5 222 41.2% 4.5% 2000 ........................... 68.1 230 38.4% 2.9% 2001 ........................... 161.3 254 28.8% (11.6%) 2002 ........................... 343.5 313 24.0% 16.8% 2003 ........................... 594.5 337 22.2% 18.1% 2004 ........................... 605.6 340 22.5% 5.1%
*It takes a long time to learn the tr ue profitability of any given year. First, many claims are received after the end of t he year, and we must estimate how many of these there will b e and what they will co st. (In insurance jargon, these claim s are te rmed IBNR – i ncurred but not reported.) Sec ond, claims often take years, or even decades, to settle, which means there can be many surprises along the way. For these reasons, the results in this column simply represent our best estimate at the end of 2004 as to how we have don e in prior year s. Pro fit m argins for t he year s thro ugh 1999 ar e pr obably clo se to corr ect because these years are “mature,” in the sense that they have few claims still outstanding. The more recent the year, th e more guesswork is invo lved. In particular, the results shown for 200 3 and 2004 are apt to change significantly. 7 Finally, there is a fear factor at work, in that a shri nking business usually leads to layoffs. To avoid pink slips, em ployees will ration alize in adequate pricin g, tellin g th emselves th at poorly-priced business must be tolerated in order to keep the organization intact and the distribution system happy. If this course isn’t follo wed, th ese e mployees will arg ue, th e company will n ot p articipate in th e recovery th at they invariably feel is just around the corner. To com bat em ployees’ nat ural t endency t o save t heir ow n ski ns, we ha ve al ways prom ised NICO’s workforce that no one will be fired because of declining volume, however severe the contraction. (This is not Donald Trump’s sort of place.) NICO is not labor-intensive, and, as the table suggests, can live with excess overhead. It can’t live, however, with underpriced business and the breakdown in underwriting discipline that accompanies it. An insurance organization that doesn’t care deeply about underwriting at a profit this year is unlikely to care next year either. Naturally, a business th at fo llows a n o-layoff policy m ust be especia lly careful to avoid overstaffing when times are good. Thirty years ago Tom Murphy, then CEO of Cap Cities, drove this point home t o m e with a hypothetical t ale about an em ployee w ho a sked his b oss for permission t o h ire an assistant. The employee assumed that adding $20,000 to the annual payroll would be inconsequential. But his boss told him the proposal should be evaluated as a $3 million decision, given that an additional person would probably cost at least that amount over his lifetime, factoring in raises, benefits and other expenses (more people, more toilet paper). And unless the company fell on very hard times, the employee added would be unlikely to be dismissed, however marginal his contribution to the business.
It takes real fortitude – embedded deep within a c ompany’s culture – to operate as NICO does. Anyone examining the table can scan the years from 1986 to 1999 quickly. But living day after day with dwindling volume – while competitors are b oasting of growth and reaping Wall Street’s applause – is an experience few managers can tolerate. NICO, however, has had four CEOs since its formation in 1940 and none have bent. (It should be noted that only one of the four graduated from college. Our experience tells us that extraordinary business ability is largely innate.) The cu rrent m anagerial st ar – m ake t hat supe rstar – at NIC O is Do n Wu rster (y es, he’s “the graduate”), who has been running things since 1989. His slugging percentage is right up there with Barry Bonds’ because, like Barry, Don will accept a walk rather than swing at a bad pitch. Don has now amassed $950 million of float at NICO that over time is almost certain to be proved the negative-cost kind. Because insurance prices are falling, Don’s volume will soon decline very significantly and, as it does, Charlie and I will applaud him ever more loudly. * * * * * * * * * * * * Another way to prosper in a commodity-type business is to be the low-cost operator. Among auto insurers operating on a broad scale, GEICO holds that cherished title. For NICO, as we have seen, an ebb- and-flow b usiness m odel m akes se nse. But a c ompany hol ding a l ow-cost a dvantage m ust p ursue a n unrelenting foot-to-the-floor strategy. And that’s just what we do at GEICO. A century ago, when autos first appeared, the property-casualty industry operated as a cartel. The major companies, most of wh ich were base d in the Northeast, established “bureau” rates and t hat was it. No one cut prices to attract business. Instead, insurers competed for strong, well-regarded agents, a focus that produced high commissions for agents and high prices for consumers. In 1922, State Farm was formed by George Mecherle, a farmer from Merna, Illinois, who aimed to take adva ntage of t he pri cing um brella maintained by t he hi gh-cost gi ants of t he i ndustry. St ate Farm employed a “captive” agency force, a system keeping its acquisition costs lower than those incurred by the bureau insurers (whose “independent” agents successfully played off on e company against another). With its low-c ost s tructure, State Farm event ually captured about 25% of t he personal lines (a uto and homeowners) busi ness, far o utdistancing i ts once -mighty com petitors. Al lstate, for med i n 19 31, put a similar distribution system into place a nd soon became the runner-up in personal lines t o State Farm . Capitalism had worked its magic, and these low-cost operations looked unstoppable.
8 But a man named Leo G oodwin had an i dea for an even more efficient auto ins urer and, with a skimpy $200,000, started GEICO in 1936. Goodwin’s plan was to eliminate the agent entirely and to deal instead di rectly with the auto ow ner. Why, he as ked him self, shoul d there be any unnecessary and expensive links in the distribution mechanism when t he product, auto insurance, was both mandatory and costly. Purc hasers o f business i nsurance, he reas oned, might wel l req uire p rofessional advi ce, b ut most consumers knew what they needed in an auto policy. That was a powerful insight. Originally, GEICO m ailed its low-cost message to a l imited audience of government employees. Later, it widened its horizons and shifted its marketing emphasis to the phone, working inquiries that came from broadcast and print advertising. And today the Internet is coming on strong. Between 1936 and 1975, GEICO grew from a standing start to a 4% m arket share, becoming the country’s fo urth larg est au to insurer. Duri ng m ost o f th is p eriod, th e co mpany was su perbly managed, achieving both excellent volume gains and high profits. I t looked unstoppable. B ut after my friend and hero L orimer Davi dson retired as C EO i n 19 70, his suc cessors s oon made a h uge mistake by un der- reserving for losses. This produced faulty cost information, which in turn produced inadequate pricing. By 1976, GEICO was on the brink of failure. Jack Byrne then joined GEICO as CEO and, almost single-handedly, saved the company by heroic efforts that included major price incr eases. Though GEICO’s survi val required these, policyholders fled the company, and by 1980 its market share had fallen to 1.8%. Subsequently, the company embarked on some u nwise diversification m oves. This sh ift of emphasis away from its extraordinary c ore bus iness stunted GEICO’s growth, and by 1993 its market share had grown only fractionally, to 1.9%. Then Tony Nicely took charge. And what a differen ce th at’s made: In 2005 GEICO will p robably secu re a 6% m arket sh are. Better yet, To ny h as m atched g rowth with p rofitability. In deed, GEICO d elivers all of its co nstituents major benefits: In 2004 its customers saved $1 billion or so compared to what they would otherwise have paid for coverage, its associates earned a $191 million profit-sharing bonus that averaged 24.3% of salary, and its owner – that’s us – enjoyed excellent financial returns.
There’s mo re g ood n ews. W hen J ack Byr ne was re scuing the com pany in 1976, New Je rsey refused t o grant hi m the rat es he needed to operate p rofitably. He t herefore promptly – an d properly – withdrew from the state. Subsequently, GEICO avoided both New Jersey and Massachusetts, recognizing them as two jurisdictions in which insurers were destined to struggle. In 2003, however, New Jersey took a new look at its chronic auto-insurance problems and enacted legislation that would curb fraud and allow insurers a fair playing field. Even so, one might have expected the state’s bureaucracy to make change slow and difficult. But just the opposite occurred. Holly Bakke, the New Jersey insurance commissioner, who would be a success i n any lin e of work, was determined to tu rn th e law’s in tent in to reality. With h er staff’s cooperation, GEICO iro ned out th e d etails fo r re-entering the state and was license d last August. Since then, we’ve received a response from New Jersey drivers that is multiples of my expectations. We are n ow serving 140,000 policyholders – abo ut 4% of the New Jersey market – and sa ving them substantial sums (as we do drivers everywhere). Word-of-mouth recommendations within the state are causing inquiries to pour in. A nd once we hea r from a New Jersey prospect, our closure rate – the percentage of policies issued to inquiries received – is far higher in the state than it is nationally. We make no claim, of co urse, that we can save everyone money. Som e companies, using rating systems that are different from o urs, will o ffer certain classes o f drivers a lower rate than we do. Bu t we believe GEICO offers the lowest price more often than any other national company that serves all segments of t he public. In a ddition, in m ost states, includi ng Ne w Jersey, Be rkshire share holders recei ve a n 8% discount. So gam ble fifteen minutes of y our time and go to GEICO.com – or cal l 800-847-7536 – to see 9 whether y ou can save big money (whi ch y ou m ight want t o use , of cou rse, t o buy ot her B erkshire products). * * * * * * * * * * * * Reinsurance – insura nce sol d to othe r ins urers w ho wish t o l ay off p art of t he ri sks t hey have assumed – should not be a commodity product. At bottom, any insurance policy is simply a promise, and as everyone knows, promises vary enormously in their quality.
At th e prim ary in surance lev el, n evertheless, just w ho makes t he p romise i s oft en of m inor importance. In personal-lines insurance, for example, states levy assessments on solvent companies to pay the po licyholders of co mpanies th at go broke. In the b usiness-insurance fi eld, the sam e arrangement applies to workers’ compensation policies. “Protected” policies of these types account for about 60% of the property-casualty industry’s volume. Prudently-run insurers are irritated by the need to subsidize poor or reckless management elsewhere, but that’s the way it is. Other forms of business insurance at the primary level involve promises that carry greater risks for the insured. When Reliance Insurance and Home Insurance were run into the ground, for e xample, their promises proved to be worthless. C onsequently, many holders of their business policies (other than those covering workers’ compensation) suffered painful losses. The solvency risk in primary policies, however, pales in comparison to that lurking in reinsurance policies. When a reinsurer goes broke, staggering losses almost always strike the primary companies it has dealt with. Th is risk is far from minor: GEICO has suffered tens of millio ns in losses from its care less selection of reinsurers in the early 1980s. Were a tru e mega-catastrophe to occur in th e next decade or two – and that’s a real possibility – some reinsurers would not survive. Th e largest insured loss to date is th e World Trade Center disaster, which cost the insurance industry an estimated $35 billion. Hurricane Andrew cost insurers about $15.5 billion in 1992 (though that loss would be far higher in today’s dollars). Both events rocked the insurance and reinsurance world. But a $100 billion event, or even a larger catastrophe, remains a possibility if either a particularly severe ea rthquake or hurricane hits just the wrong place. Four significant hurricanes struck Florida during 2004, causing an aggregate of $25 billion or so in insured losses. Two o f these – Charley and Ivan – could have done at least three times the damage they did had they entered the U.S. not far from their actual landing points. Many insurers regard a $100 billion industry loss as “unthinkable” and won’t even plan for it. But at Berkshire, we are fully prepared. Our share of the loss would probably be 3% to 5%, and earnings from our investments and other businesses would comfortably exceed that cost. When “the day after” arrives, Berkshire’s checks will clear.
Though th e hurricanes h it u s with a $1 .25 billion lo ss, ou r reinsurance o perations d id well last year. At General Re, Joe Brandon has restored a long-admired culture of underwriting discipline that, for a time, had lost its way. The excellent results he realized in 2004 on current business, however, were offset by adverse developments from the years before he t ook the helm. At NICO’s reinsurance operation, Ajit Jain continues to succes sfully underwrite huge risks that no other rei nsurer is willing or a ble to ac cept. Ajit’s value to Berkshire is enormous. * * * * * * * * * * * * Our insuran ce m anagers, m aximizing th e competitive st rengths I’v e mentioned in t his section , again delivered first-class un derwriting results last year. As a c onsequence, o ur fl oat was bet ter than costless. Here’s the scorecard: 10 (in $ millions) Underwriting Profit Yearend Float Insurance Operations 2004 2004 2003 General Re ....................... $ 3 $23,120 $23,654 B-H Reinsurance.............. 417 15,278 13,948 GEICO ............................. 970 5,960 5,287 Other Primary*................. 161 1,736 1,331 Total................................. $1,551 $46,094 $44,220 *Includes, in addition to National Indemnity, a v ariety of other exceptional insurance businesses, run by Rod Eldred, John Kizer, Tom Nerney and Don Towle. Berkshire’s float in creased $1 .9 b illion in 2 004, ev en tho ugh a few insu reds op ted to co mmute (that is, unwind) certain reinsurance contracts. We agree to such commutations only when we believe the economics are favorable to us (after giving due weight to what we might earn in the future on the money we are returning). To summarize, last year we were p aid more than $1.5 billion to hold an av erage of about $45.2 billion. In 2005 pricing will b e less attractive than it has been. Nevertheless, absent a m ega-catastrophe, we have a decent chance of achieving no-cost float again this year. Finance and Finance Products Last year in th is sectio n we d iscussed a potpourri of act ivities. In t his report, we’ll sk ip over several that are now of lesser importance: B erkadia is down to tag ends; Value Capital h as added other investors, ne gating o ur e xpectation t hat we wo uld nee d to co nsolidate its fin ancials in to ou rs; and th e trading operation that I run continues to shrink.
• Both of Berkshire’s leasing operations rebounded last year. At CORT (office furniture), earnings remain i nadequate, but are t rending upward. X TRA disposed o f i ts c ontainer a nd i ntermodal businesses in order to co ncentrate on trailer leasin g, long its stro ng su it. Ov erhead h as b een reduced, asset u tilization is u p and decent profits are now b eing achieved under Bill Franz, the company’s new CEO. • The wind-down of Gen Re Securities continues. We decided to exit this derivative operation three years ago, but getting out is easier said than done. Though derivative instruments are purported to be highly liquid – and though we have had the benefit of a benign market while liquidating ours – we still h ad 2,890 con tracts outstanding at yearend , down fro m 2 3,218 at th e peak. Like Hell, derivative trading is easy to enter but difficult to leave. (Other similarities come to mind as well.) Gen Re’s derivative contracts have always been required to be marked to market, and I believe the company’s m anagement co nscientiously t ried t o m ake rea listic “m arks.” The m arket pri ces of derivatives, however, can be v ery fuzzy in a world i n wh ich settlemen t o f a tran saction is sometimes decades away and o ften involves multiple variables as well. In the interim the marks influence t he managerial an d t rading bonuses t hat are paid annually. It’s s mall wonde r that phantom profits are often recorded. Investors should und erstand that in all types of fin ancial institutions, rap id grow th sometimes masks major underlying problems (and occasionally fraud). The re al test of the earning power of a derivatives operation is what it ach ieves after operating for an extended period in a no-growth mode. You only learn who has been swimming naked when the tide goes out. • After 40 years, we’ve finally generated a little synergy at Berkshire: Clayton Homes is doing well and th at’s in part due to its asso ciation with B erkshire. T he m anufactured ho me in dustry 11 continues to reside in the intensive care unit of Corporate America, having sold less than 135,000 new ho mes la st year, abou t the same as in 20 03. Vo lume in th ese y ears was th e lo west since 1962, an d i t was al so only abo ut 40% of ann ual sales d uring th e year s 19 95-99. That era, characterized by irresponsible financing and naïve funders, was a fool’s paradise for the industry.
Because one major le nder after anot her has fle d the field, fi nancing continues t o be devil manufacturers, ret ailers an d purchasers of manufactured homes. He re Berkshire’s s upport has proven valuable t o C layton. We st and r eady to fund whatever m akes sen se, an d last year Clayton’s management found much that qualified. As we explained in our 2003 report, we believe in using borrowed money to support profitable, interest-bearing receivables. At the beginning of last year, we had borrowed $2 billion to relend to Clayton (at a one percentage-point markup) and by January 2005 the total was $7.35 billion. Most of the dollars added were borrowed by us on January 4, 2005, to finance a seasoned portfolio that Clayton purchased on December 30, 2004 from a bank exiting the business. We now have two additional portfolio purchases in the works, totaling about $1.6 billion, but it’s quite unlikely that we will secure others of any significance. Therefore, Clayton’s receivables (in which o riginations will roughly offset p ayoffs) will probab ly ho ver arou nd $9 billion for so me time and should deliver steady earnings. This pattern will be far different from that of the past, in which Clayton, like all major players in its industry, “securitized” its receivables, causing earnings to be front-ended. In the last two years, the securitization market has dried up. The limited funds available t oday com e onl y at hi gher c ost an d with harsh t erms. Ha d C layton rem ained independent in this period, it would have had mediocre earnings as it struggled with financing. In April, Clayton completed the acquisition of Oakwood Homes and is now th e industry’s largest producer and retailer of manufactured homes. We love putting more assets in the hands of Kevin Clayton, the company’s CEO. He is a prototype Berkshire manager. Today, Clayton has 11,837 employees, up from 7,136 when we purchased it, and Charlie and I are pleased that Berkshire has been useful in facilitating this growth. For simplicity’s sake, we include all of Clayton’s earnings in this sector, t hough a sizable portion of these are derived from areas other than consumer finance. (in $ millions) Pre-Tax Earnings Interest-Bearing Liabilities 2004 2003 2004 2003 Trading – ordinary income ............................ $ 264 $ 355 $5,751 $7,826 Gen Re Securities ........................................... (44) (99) 5,437* 8,041* Life and annuity operation.............................. (57) 85 2,467 2,331 Value Capital.................................................. 30 31 N/A N/A Berkadia ......................................................... 1 101 — 525 Leasing operations.......................................... 92 34 391 482 Manufactured housing finance (Clayton) ....... 220 37** 3,636 2,032 Other............................................................... 78 75 N/A N/A Income before capital gains............................ 584 619 Trading – capital gains ................................... 1,750 1,215 Total ............................................................... $2,334 $1,834
* Includes all liabilities ** From date of acquisition, August 7, 2003 12 Manufacturing, Service and Retailing Operations Our activities in this category cover the waterfront. But let’s look at a summary balance sheet and earnings statement consolidating the entire group. Balance Sheet 12/31/04 (in $ millions) Assets Liabilities and Equity Cash and equivalents ................................. $ 899 Notes payable ............................... $ 1,143 Accounts and notes receivable .................. 3,074 Other current liabilities................. 4,685 Inventory ................................................... 3,842 Total current liabilities ................. 5,828 Other current assets ................................... 254 Total current assets.................................... 8,069 Goodwill and other intangibles.................. 8,362 Deferred taxes............................... 248 Fixed assets................................................ 6,161 Term debt and other liabilities...... 1,965 Other assets................................................ 1,044 Equity ........................................... 15,595 $23,636 $23,636 Earnings Statement (in $ millions) 2004 2003 Revenues ................................................................................................................. $44,142 $32,106 Operating expenses (including depreciation of $676 in 2004 and $605 in 2003)............................................................................................. 41,604 29,885 Interest expense (net)............................................................................................... 57 64 Pre-tax earnings....................................................................................................... 2,481 2,157 Income taxes............................................................................................................ 941 813 Net income .............................................................................................................. $ 1,540 $ 1,344 This eclectic group, which sells products ranging from Dilly Bars to fractional interests in Boeing 737s, earned a very respectable 21.7% on average tangible net worth last year, compared to 20.7% in 2003. It’s noteworthy that these operations used only minor financial leverage in achieving these returns. Clearly, we own some very good businesses. We purchased many of them, however, at substantial premiums to net worth – a m atter that is reflected in th e goodwill item shown on the balance sheet – and that fact reduces the earnings on our average carrying value to 9.9%.
Here are the pre-tax earnings for the larger categories or units. Pre-Tax Earnings (in $ millions) 2004 2003 Building Products .................................................................................................... $ 643 $ 559 Shaw Industries ....................................................................................................... 466 436 Apparel & Footwear................................................................................................ 325 289 Retailing of Jewelry, Home Furnishings and Candy ............................................... 215 224 Flight Services......................................................................................................... 191 72 McLane.................................................................................................................... 228 150* Other businesses ...................................................................................................... 413 427 $2,481 $2,157 * From date of acquisition, May 23, 2003. • In the building-products sector and at Shaw, we’ve experienced staggering cost increases for both raw- materials and energy. By Dece mber, for e xample, steel costs at MiTek (whose prim ary business is connectors for ro of tru sses) were ru nning 100% ov er a year ear lier. And MiTek uses 665 m illion pounds o f st eel every y ear. Ne vertheless, t he c ompany co ntinues t o be a n outstanding performer. 13 Since we purchased MiTek in 2 001, Gene To ombs, its CEO, h as m ade so me b rilliant “bo lt-on” acquisitions and is on his way to creating a mini-Berkshire. Shaw fielded a barrage of price increases in its main fiber materials during the year, a hit that added more th an $300 m illion to its co sts. (Wh en you walk on ca rpet y ou a re, i n e ffect, stepping on processed oil.) Though we followed these hikes in costs with price increases of our own, there was an inevitable lag. Therefore, margins narrowed as the year progressed and remain under pressure today. Despite these roadblocks, Shaw, led by Bob Shaw and Julian Saul, earned an o utstanding 25.6% on tangible equity in 2004. The company is a powerhouse and has a bright future. • In app arel, Fru it of th e Loom increased un it sales b y 10 m illion do zen, or 14 %, with sh ipments of intimate apparel for women and girls growing by 31%. Charlie, who is far more knowledgeable than I am on this subject, assures me that women are not wearing more underwear. With this expert input, I can only conclude that our market share in the women’s category must be growing rapidly. Thanks to John Holland, Fruit is on the move.
A sm aller ope ration, Garan, al so ha d a n excellent y ear. Le d by Seymour Li chtenstein an d Jerry Kamiel, this company manufactures the popular Garanimals line for children. Next time you are in a Wal-Mart, check out this imaginative product. • Among our re tailers, Ben Bridge (jewelry) a nd R. C . Willey (hom e furnishi ngs) were pa rticular standouts last year. At Ben Bridge same-store sal es grew 11.4%, the best gain among the publicly-held jewelers whose reports I have seen. Additionally, the company’s profit marg in widened. Last year was not a fl uke: During the past decade, the same-store sales gains of the company have averaged 8.8%. Ed and Jon Bridge are fourth-generation managers and run the business exactly as if it were their own – which it is in every res pect except for Berkshire’s name on the stock certificates. The Bridges have expanded successfully by securing the right locations and, more importantly, by staffing these stores with enthusiastic and knowledgeable associates. We will move into Minneapolis-St. Paul this year. At Utah-based R. C. Willey, the gains from expansion have been even more dramatic, with 41.9% of 2004 sales coming from out-of-state stores that didn’t exist before 1999. The company also improved its profit margin in 2004, propelled by its two new stores in Las Vegas. I would like to tell you that these stores were my idea. In truth, I thought they were mistakes. I knew, of course, how brilliantly Bill Child had run the R. C. Willey operation in Utah, where its market share had long been huge. But I felt our closed-on-Sunday policy would prove disastrous away from home. Even our first out-of-state store in Boise, which was highly successful, left me unconvinced. I kept asking w hether Las Ve gas r esidents, c onditioned t o seve n-day-a-week retailers, w ould ad just t o us. Our fi rst Las Vegas store, ope ned i n 2001, a nswered t his q uestion i n a re sounding m anner, immediately becoming our number one unit. Bill and Sc ott Hymas, his successor as CEO, t hen proposed a sec ond Las Vegas store, only about 20 minutes away. I fel t this expansion would cannibalize the first unit, adding significant costs but only modest sales. The result? Each store is now doing about 26% more volume than any other store in the chain and is consistently showing large year-over-year gains. R. C. Willey will soon open in Reno. Before making this commitment, Bill and Scott again asked for my advice. Initially, I was pretty puffed up about the fact that they were consulting me. B ut then it dawned on me that the opinion of someone who is always wrong has its own special utility to decision- makers.
14 • Earnings improved in flight services. At FlightSafety, the world’s leader in pilot training, profits rose as corporate aviation rebounded and our business with regional airlines increased. We now operate 283 simulators with an original cost of $1.2 billion. Pilots are trained one at a time on this expensive equipment. This means that as much as $3.50 of capital investment is required to produce $1 of annual revenue. With this level of capital intensity, FlightSafety requires very high operating margins in order to obtain reasonable returns on capital, which means that utilization rates are all-important. Last year, FlightSafety’s return on tangible equity improved to 15.1% from 8.4% in 2003. In another 2004 event, Al Ueltschi, who founded FlightSafety in 1951 with $10,000, turned over the CEO position to Bruce Whitman, a 43-year v eteran at the company. (But Al’s not going anywhere; I won’t let him.) Bruce shares Al’s conviction that flying an aircraft is a privilege to be extended only to people who re gularly receive the highest quality of traini ng a nd are undeniably com petent. A few years ago, Charlie was asked to intervene with Al on behalf of a tycoon friend whom FlightSafety had flunked. Al’s reply to Charlie: “Tell your pal he belongs in the back of the plane, not the cockpit.” FlightSafety’s number one customer is NetJets, our aircraft fractional-ownership subsidiary. Its 2,100 pilots spend an average of 18 days a year i n training. Additionally, these pilots fly only one aircraft type whe reas many fl ight o perations juggle pi lots among seve ral t ypes. Net Jets’ high st andards o n both fronts are two of the reasons I signed up with the company years before Berkshire bought it. Fully as im portant i n m y d ecisions t o both use a nd buy Net Jets, ho wever, was t he fact t hat t he company was managed by Rich Santulli, the creator of the fractional-ownership industry and a fanatic about safety and service. I viewed the selection of a flight provider as akin to picking a brain surgeon: you simply want the best. (Let someone else experiment with the low bidder.) Last year NetJets again gained about 70% of the net new business (measured by dollar value) going to the four c ompanies that dominate the industry. A portion of our growth came from the 25-hour card offered by M arquis Jet Pa rtners. M arquis is not owned by Net Jets, but i s i nstead a customer t hat repackages the purchases it makes from us into smaller packages that it sells through its card. Marquis deals exclusively with NetJets, utilizing the power of our reputation in its marketing.
Our U. S. co ntracts, i ncluding M arquis cust omers, gre w fr om 3,87 7 t o 4,9 67 i n 20 04 ( versus approximately 1,200 contracts when Berkshire bought NetJets in 1998). Some clients (including me) enter into multiple contracts because they wish to use more tha n one type of aircraft, selecting for any given trip whichever type best fits the mission at hand. NetJets earned a m odest amount in the U.S. last year. B ut what we earned domestically was l argely offset by l osses i n E urope. We are n ow, however, ge nerating real m omentum abroa d. C ontracts (including 25-hour cards that we ourselves market in Europe) increased from 364 to 693 during the year. We will ag ain have a very significant European loss in 2005, but domestic earnings will likely put us in the black overall. Europe has been expensive for NetJets – fa r more expensive than I ant icipated – but it is essential to building a fligh t operation that will fo rever be in a class by itself. Our U.S. owners already want a quality serv ice wh erever they trav el an d th eir wish fo r fligh t ho urs ab road is certain to g row dramatically in the decades ahead. Last year, U.S. owners made 2,003 flights in Europe, up 22% from the previous year and 137% from 2000. Just as important, our European owners made 1,067 flights in the U.S., up 65% from 2003 and 239% from 2000. 15 Investments We show below our common stock investments. Those that had a market value of more than $600 million at the end of 2004 are itemized. 12/31/04 Percentage of Shares Company Company Owned Cost* Market (in $ millions) 151,610,700 American Express Company ................... 12.1 $1,470 $ 8,546 200,000,000 The Coca-Cola Company ........................ 8.3 1,299 8,328 96,000,000 The Gillette Company ............................. 9.7 600 4,299 14,350,600 H&R Block, Inc....................................... 8.7 223 703 6,708,760 M&T Bank Corporation .......................... 5.8 103 723 24,000,000 Moody’s Corporation .............................. 16.2 499 2,084 2,338,961,000 PetroChina “H” shares (or equivalents)... 1.3 488 1,249 1,727,765 The Washington Post Company .............. 18.1 11 1,698 56,448,380 Wells Fargo & Company......................... 3.3 463 3,508 1,724,200 White Mountains Insurance..................... 16.0 369 1,114 Others ...................................................... 3,531 5,465 Total Common Stocks ............................. $9,056 $37,717
*This i s o ur a ctual pu rchase pri ce a nd al so o ur t ax basis; GA AP “c ost” di ffers i n a few case s because of write-ups or write-downs that have been required. Some people may look at this table and view it as a list of stocks to be bought and sold based upon chart patterns, brokers’ opinions, or estimates of near-term earnings. Charlie and I ignore such distractions and i nstead vi ew o ur h oldings as fract ional owne rships i n b usinesses. Thi s i s an impo rtant di stinction. Indeed, this thinking has been the cornerstone of m y investment behavior since I was 19. At that time I read Be n Gra ham’s The In telligent Investor, and the scale s fell from my ey es. (P reviously, I had been entranced by the stock market, but didn’t have a clue about how to invest.) Let’s look at how the businesses of our “Big Four” – American Express, Coca-Cola, Gillette and Wells Fargo – have fared since we bo ught into these companies. As the tab le shows, we in vested $3.83 billion in the four, by way of multiple transactions between May 1988 and October 2003. On a composite basis, o ur d ollar-weighted p urchase dat e i s Jul y 19 92. B y y earend 2 004, t herefore, we had held these “business interests,” on a weighted basis, about 12½ years. In 2004, Berkshire’s share of the group’s earnings amounted to $1.2 billion. These earnings might legitimately be considered “normal.” True, they were swelled because Gillette and Wells Fargo omitted option costs in their presentation of earnings; but on the other hand they were reduced because Coke had a non-recurring write-off. Our share of the earnings of these four companies has grown almost every year, and now amounts to abo ut 31.3% o f our co st. Th eir cash distr ibutions to us h ave also gr own con sistently, to taling $434 million in 2004, or about 11.3% of cost. All in all, the Big Four have delivered us a satisfactory, though far from spectacular, business result. That’s true as well of our experience in the market with the group. Since o ur original purchases, valuation gains have somewhat exceeded earnings growth because price/earnings ratios have increased. On a year-to-year basis, however, the business and market performances have often diverged, sometimes to an extraordinary degree. During The Great Bubble, market-value gains far outstripped the performance of the businesses. In the aftermath of the Bubble, the reverse was true. 16
Clearly, Berkshire’s results would have been far better if I had caught this swing of the pendulum. That m ay see m easy to d o when on e look s th rough an always-clean, rear-view mirror. Unfort unately, however, it’s the windshield through which investors must peer, a nd that glass is invariably fogged. Our huge positions add to the difficulty of our nimbly dancing in and out of holdings as valuations swing. Nevertheless, I can properly be criticized for merely clucking about nose-bleed valuations during the Bubble rather than acting on m y views. Though I said at the tim e that certain of the stocks we held were priced ahead of themselves, I underestimated just how severe the overvaluation was. I talk ed when I should have walked. What Charlie and I would like is a little action now. We don’t enjoy sitting on $43 billion of cash equivalents that are earni ng paltry returns. Instead, we yearn to buy more fractional interests similar to those we now own or – better still – more large businesses outright. We will do either, however, only when purchases can be made at prices that offer us the prospect of a reasonable return on our investment. * * * * * * * * * * * * We’ve re peatedly e mphasized that the “rea lized” gains that we re port quarterly or ann ually ar e meaningless for analytical purposes. We have a huge amount of unrealized gains on our books, and our thinking about when, and if, to cash them depends not at all on a desire to report earnings at one specific time or anot her. A f urther complication in our reported gains occurs because GAAP requires that foreign exchange contracts be m arked to m arket, a stipula tion th at cau ses unrealized g ains or lo sses in th ese holdings to flow through our published earnings as if we had sold our positions. Despite the problems enumerated, you may be interested in a breakdown of the gains we reported in 2 003 and 2004. Th e data r eflect actual sales exce pt in the cas e of cu rrency gai ns, w hich are a combination of sales and marks to market. Category Pre-Tax Gain (in $ millions) 2004 2003 Common Stocks ............................. $ 870 $ 448 U.S. Government Bonds................. 104 1,485 Junk Bonds ..................................... 730 1,138 Foreign Exchange Contracts........... 1,839 825 Other............................................... (47) 233 Total ............................................... $3,496 $4,129
The junk bond profits include a foreign exchange component. When we bought these bonds in 2001 and 2002, we focused first, of course, on the credit quality of the issuers, all of which were American corporations. Some of t hese com panies, however, had i ssued bonds denominated i n f oreign cu rrencies. Because of our views on the dollar, we favored these for purchase when they were available. As an e xample, we b ought €254 million of Level 3 b onds (10 ¾% of 2008) in 2001 at 51.7% of par, and sold these at 85% of par in December 2004. This issue was traded in Euros that cost us 88¢ at the time of purchase but that brought $1.29 when we sold. Thus, of our $163 million overall gain, about $85 million cam e fro m th e m arket’s rev ised opinion ab out Lev el 3’s cred it quality, with t he rem aining $78 million resulting from the a ppreciation of the Euro. (In addition, we received cash interest during our holding period that amounted to about 25% annually on our dollar cost.) * * * * * * * * * * * * The m edia con tinue to report th at “B uffett b uys” th is or th at sto ck. Statements lik e th ese are almost al ways base d o n fi lings B erkshire makes wi th the SEC and are therefore wrong. As I’ ve said before, the stories should say “Berkshire buys.” 17 Portrait of a Disciplined Investor Lou Simpson Return from Year GEICO Equities S&P Return Relative Results 1980 ................................................ 23.7% 32.3% (8.6%) 1981 ................................................ 5.4% (5.0%) 10.4% 1982 ................................................ 45.8% 21.4% 24.4% 1983 ................................................ 36.0% 22.4% 13.6% 1984 ................................................ 21.8% 6.1% 15.7% 1985 ................................................ 45.8% 31.6% 14.2% 1986 ................................................ 38.7% 18.6% 20.1% 1987 ................................................ (10.0%) 5.1% (15.1%) 1988 ................................................ 30.0% 16.6% 13.4% 1989 ................................................ 36.1% 31.7% 4.4% 1990 ................................................ (9.9%) (3.1%) (6.8%) 1991 ................................................ 56.5% 30.5% 26.0% 1992 ................................................ 10.8% 7.6% 3.2% 1993 ................................................ 4.6% 10.1% (5.5%) 1994 ................................................ 13.4% 1.3% 12.1% 1995 ................................................ 39.8% 37.6% 2.2% 1996 ................................................ 29.2% 23.0% 6.2% 1997 ................................................ 24.6% 33.4% (8.8%) 1998 ................................................ 18.6% 28.6% (10.0%) 1999 ................................................ 7.2% 21.0% (13.8%) 2000 ................................................ 20.9% (9.1%) 30.0% 2001 ................................................ 5.2% (11.9%) 17.1% 2002 ................................................ (8.1%) (22.1%) 14.0% 2003 ................................................ 38.3% 28.7% 9.6% 2004 ................................................ 16.9% 10.9% 6.0%
Average Annual Gain 1980-2004 20.3% 13.5% 6.8% 18 Even then, it is typically not I who make the buying decisions. Lou Simpson manages about $2½ billion of eq uities that are held b y GEICO, and it is h is tran sactions that Berk shire is u sually reporting. Customarily his pu rchases are in the $200-$300 million range and are i n companies that are sm aller than the ones I foc us on. Ta ke a look at the fa cing page to see wh y Lo u is a cin ch to be in ducted in to th e investment Hall of Fame. You may be sur prised to learn that Lou does not necessarily inform me about what he is doing. When Charlie and I assign responsibility, we truly hand over the baton – and we give it to Lou just as we do to our operating managers. Th erefore, I typically learn of Lou’s transactions about ten days after the end of each month. Sometimes, it should be added, I silently disagree with his decisions. But he’s usually right. Foreign Currencies Berkshire owned about $21.4 billion of foreign exchange contracts at yearend, s pread among 12 currencies. A s I m entioned last year, holdings of this kind are a deci ded change for us. B efore March 2002, neither Berkshire nor I had ever traded in currencies. But the evidence grows that our trade policies will p ut un remitting p ressure on th e do llar for m any years to co me – so since 20 02 we’v e heeded th at warning in setting our investment course. (As W.C. Fields once said when asked for a ha ndout: “Sorry, son, all my money’s tied up in currency.”) Be clear on one point: In no way does our thinking about currencies rest on doubts about America. We live in an extraordinarily rich country, the product of a system that values market economics, the rule of law a nd e quality of opportunity. Our economy is far and away th e strongest in the world a nd will continue to be. We are lucky to live here. But as I argued in a November 10, 2003 article in Fortune, (available at berkshirehathaway.com), our country’s trade practices are we ighing d own th e dollar. Th e d ecline in its v alue h as alread y been substantial, but is n evertheless likely to continue. Without policy changes, currency markets could even become disorderly and generate spillover effects, both political and financial. No one knows whether these problems will materialize. But such a scenario is a far-from-remote possibility that policymakers should be considering now. Their bent, however, is to lean toward not-so-benign neglect: A 318-page Congressional study of t he co nsequences of un remitting trad e deficits was published in Nov ember 2 000 an d has b een gathering dust ever since. The study was ordered after the deficit hit a then-alarming $263 billion in 1999; by last year it had risen to $618 billion.
Charlie and I, it should be emphasized, believe that true trade – that is, the exchange of goods and services with other co untries – i s eno rmously benefi cial fo r b oth us an d t hem. Last year we ha d $ 1.15 trillion o f su ch ho nest-to-God trad e and th e m ore o f th is, th e b etter. Bu t, as n oted, o ur cou ntry also purchased an ad ditional $6 18 billion in g oods and serv ices fro m the rest of the world th at was unreciprocated. That is a staggering figure and one that has important consequences. The balancing item to this one-way pseudo-trade — in economics there is always an offset — is a transfer of wealth from the U.S. to the rest of the world. The transfer may materialize in the form of IOUs our private or governmental institutions give to foreigners, or by way o f their assuming ownership of o ur assets, such as stocks and real estate. In e ither case, Americans end up owning a r educed portion of our country while non-Americans own a greater part. This force-feeding of American wealth to the rest of the world is now p roceeding at th e rate of $1 .8 billion daily, an increase of 2 0% since I wrote you last year. Consequently, other countries and their citizens now own a net of about $3 trillion of the U.S. A decade ago their net ownership was negligible. The m ention of trillio ns nu mbs m ost b rains. A furth er so urce of con fusion is th at th e cu rrent account deficit (the sum of three item s, the most important by far being the trade deficit) and our national budget deficit are ofte n lum ped as “twins.” T hey are any thing b ut. They ha ve different cause s and different consequences. 19 A budget deficit in no way reduces the portion of the national pie that goes to Americans. As long as other countries and their ci tizens have no net ow nership of the U.S ., 100% of o ur country’s o utput belongs to our citizens under any budget scenario, even one involving a huge deficit. As a rich “famil y” awash in goo ds, Am ericans will argu e th rough their leg islators as to ho w government should redistribute the national output – that is who pays taxes and who receives governmental benefits. If “en titlement” p romises fro m an earlie r day have to b e reex amined, “fam ily members” will angrily debate among themselves as to who feels the pain. Mayb e taxes will go up; maybe promises will be modified; maybe more internal debt will b e issued. Bu t when the fight is fin ished, all of the fa mily’s huge pie remains available for its members, however it is divided. No slice must be sent abroad.
Large and persisting current account deficits produce an entirely different result. As time passes, and as claims against us grow, we own less and less of what we produce. In eff ect, the rest of the world enjoys an ev er-growing ro yalty o n Am erican ou tput. Here, we are lik e a fam ily th at co nsistently overspends its income. As time p asses, the family finds that it is w orking more and more for the “finance company” and less for itself. Should we con tinue to run current account deficits comparable to those now prevailing, the net ownership of the U.S. by other countries and their citizens a decade fr om now will amount to roughly $11 trillion. And, if foreign investors were to earn only 5% on that net holding, we would need to send a net of $.55 trillion of goods and services abroad every year merely to service the U.S. investments then held by foreigners. At that date, a decade out, our GDP would probably total about $18 trillion (assuming low inflation, which is far from a sure thing). Therefore, our U.S. “family” would then be delivering 3% of its annual output to the rest o f the world simply as tri bute for the overi ndulgences of t he past. In t his case, unlike that involving budget deficits, the sons would truly pay for the sins of their fathers. This an nual r oyalty pai d t he wo rld – which wo uld not di sappear unless t he U.S . massively underconsumed an d began t o r un co nsistent an d l arge t rade s urpluses – would undoubtedly produce significant political unrest in the U.S. Americans would still b e living very well, in deed better than now because of the growth i n our economy. But they woul d chafe at the ide a of pe rpetually paying tribut e to their creditors and owners abroad. A country that is now aspiring to an “Ownership Society” will not find happiness in – and I’ll use hyperbole here for emphasis – a “Sharecropper’s Society.” But that’s precisely where our trade policies, supported by Republicans and Democrats alike, are taking us. Many pr ominent U.S . fi nancial fi gures, b oth i n an d o ut of g overnment, ha ve st ated that o ur current-account d eficits can not p ersist. For in stance, the minutes o f the Fed eral Reser ve Open Mar ket Committee of June 29-30, 2004 say: “The staff noted that outsized external deficits could not be sustained indefinitely.” But, despite the constant handwringing by luminaries, they offer no substantive suggestions to tame the burgeoning imbalance.
In the article I wrote for Fortune 16 months ago, I warned that “a gently declining dollar would not provide the answer.” And so far it hasn’t. Yet policymakers continue to hope for a “s oft landing,” meanwhile counseling other countries to stimulate (read “inflate”) their economies and Americans to save more. I n my view these admonitions miss the mark: There are deep-rooted structural problems that will cause Am erica to continue to run a huge current-account deficit unless trade poli cies either c hange materially or the dollar declines by a degree that could prove unsettling to financial markets. Proponents o f t he t rade st atus qu o are f ond of q uoting A dam Sm ith: “What i s pr udence i n t he conduct of every family can scarce be folly in that of a great kingdom. If a foreign country can supply us with a c ommodity cheape r t han we ourselves ca n m ake it, b etter bu y it o f th em with so me p art of the produce of our own industry, employed in a way in which we have some advantage.” I agree. Note, however, that Mr. Smith’s statement refers to tra de of product for product, not of wealth for product as our country is doing to the tune of $.6 trillion annually. Moreover, I am sure that he would never have suggested that “prudence” consisted of his “family” selling off part of its farm every day 20 in order to finance its overconsumption. Yet that is just what the “great kingdom” called the United States is doing. If t he U.S. was ru nning a $.6 trillio n curren t-account surplus, commentators w orldwide wo uld violently conde mn ou r policy, v iewing it as an ex treme form o f “m ercantilism” – a lo ng-discredited economic strategy under which countries fostered exports, discouraged imports, and piled up treasure. I would condemn such a policy as well. But, in effect if not in intent, the rest of th e world is practicing mercantilism in respect to the U.S., an act made possible by our vast store of assets and our pristine credit history. I ndeed, t he world would ne ver l et any ot her c ountry use a c redit car d denominated i n i ts o wn currency to t he insatiable extent we are e mploying ours. Prese ntly, most foreign investors are sanguine: they may view us as spending junkies, but they know we are rich junkies as well. Our spendthrift behavior won’t, however, be tolerated indefinitely. And though it’s impossible to forecast just when a nd how t he tr ade problem will be resolve d, it’s improbable that the resoluti on will foster an increase in the value of our currency relative to that of our trading partners.
We hope the U.S. adopts policies th at will quickly and substantially reduce the current-account deficit. Tru e, a p rompt so lution would lik ely cau se Berk shire to record lo sses on its foreign-exchange contracts. But Berkshire’s resources remain heavily concentrated in dollar-based assets, and both a strong dollar and a low-inflation environment are very much in our interest. If y ou wis h t o keep abreas t of trade and curre ncy m atters, read The Fi nancial Ti mes. This London-based paper has long been the leading source for daily international financial news and now has an excellent American edition. Both its reporting and commentary on trade are first-class. * * * * * * * * * * * * And, again, our usual caveat: macro-economics is a tough game in which few people, Charlie and I in cluded, have d emonstrated sk ill. W e may well turn ou t to b e wrong in our currency judgm ents. (Indeed, the fact that so m any pundits now predict weakness for the dollar makes us uneasy.) If so, our mistake will be very public. The i rony is that if we chos e the opposite course, leaving all of Berkshire’s assets in dollars even as they declined significantly in value, no one would notice our mistake. John Maynard Keynes said in his masterful The General Theory: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” (Or, to put it in less elegant terms, lemmings as a cl ass may be deri ded but never does an individual lemming get criticized.) Fro m a reputational st andpoint, Ch arlie an d I run a clear risk wi th ou r foreign -exchange co mmitment. Bu t we believe in managing Berkshire as if we owned 100% of it ourselves. And, were that the case, we would not be following a dollar-only policy. Miscellaneous • Last year I told you about a group of University of Tennessee finance students who played a key role in our $1.7 billion acquisition of Clayton Homes. Earlier, they had been brought to Omaha by their professor, Al Auxier – he brings a cl ass every year – to tour Nebraska Furniture Mart and Borsheim’s, eat at Gorat’s and ha ve a Q&A session with me at Kiewit Plaza. These visitors, like those who c ome for our a nnual m eeting, l eave i mpressed by both t he ci ty and i ts fri endly residents. Other colleges and universities have now co me calling. Th is school year we will h ave visiting classes, ranging in size from 30 to 100 students, from Chicago, Dartmouth (Tuck), Delaware State, Florida State, Indiana, Iowa, Iowa State, Mary land, Nebraska, Northwest Nazarene, Pennsylvania (Wharton), Stanford, Tennessee, Texas, Te xas A&M, Toronto (Rotman), Union and Utah. M ost of the students are MBA cand idates, and I’ve been impressed by their quality. Th ey are keenly interested in business and investments, but their questions indicate that they also have more on their minds than simply making money. I always feel good after meeting them.
21 At our sessions, I tell the newcomers the story of the Tennessee group and its spotting of Clayton Homes. I do th is in th e sp irit o f th e farmer wh o en ters his h en house with an ostrich egg and admonishes the flo ck: “I do n’t like to complain, girls, but this is j ust a s mall sample of what the competition is d oing.” To date, our new scouts have not brought us deals. Bu t their mission in life has been made clear to them. • You should be aware of an accounting rule that mildly distorts our financial statements in a pain- today, gain-tomorrow manner. B erkshire purchases life insurance policies from individuals and corporations who would otherwise surrender them for cash. As the new holder of the policies, we pay any premiums that become due and ul timately – wh en the original holder dies – collect the face value of the policies. The original policyholder is u sually in good health when we purchase the p olicy. Still, th e price we p ay for it is always well ab ove its cash surrend er value (“CSV”). So metimes th e o riginal policyholder has bo rrowed ag ainst th e C SV to make pr emium paym ents. I n t hat case, t he remaining CSV will b e tiny and our purchase p rice will be a larg e multiple of what the original policyholder would have received, had he cashed out by surrendering it. Under account ing rules, we must immediately char ge as a realized capi tal loss the excess over CSV that we pay upon purchasing the policy. We also must make additional charges each year for the amount by which the premium we pay to keep the policy in force exceeds the increase in CSV. But obviously, we don’t think these bookkeeping charges represent economic losses. I f we did, we wouldn’t buy the policies. During 2 004, we rec orded n et “l osses” fr om t he purc hase of policies ( and from t he prem ium payments required to maintain them) totaling $207 million, which was ch arged against realized investment gains in our earnings statement (included in “other” i n the table on page 17). When the proceeds from these policies are receive d in th e future, we will record as realized inve stment gain the excess over the then-CSV. • Two post-bubble governance reforms have been particularly useful at Berkshire, and I fault myself for not p utting them in p lace many years a go. Th e first involves regular meetings o f d irectors without the CEO present. I’ve sat on 19 boards, and on many occasions this process would have led to dub ious plans being examined more thoroughly. In a few cases, CEO changes that were needed would also have been made more promptly. There i s no do wnside to this process, an d there are many possible benefits.
The second reform concerns the “whistleblower line,” an a rrangement through which employees can send information to me and the board’s audit committee without fear of reprisal. Berkshire’s extreme decentralization m akes this system particularly valuable both to me and the committee. (In a spra wling “city” of 18 0,000 – B erkshire’s current employee count – n ot every sparrow that falls will be noticed at headqua rters.) Most of the complaints we have received are of “the guy next to me has ba d breath” variety, but on occasion I have learned of important problems at our subsidiaries t hat I ot herwise wo uld have missed. The issues rai sed a re us ually not of a t ype discoverable by audit, but relate instead to personnel and business practices. B erkshire would be more valuable today if I had put in a whistleblower line decades ago. • Charlie and I love the idea of shareholders thinking and behaving like owners. Sometimes that requires them to be pro-active. And in this arena large institutional owners should lead the way. So far, however, t he m oves made by i nstitutions h ave been l ess t han a we-inspiring. Us ually, they’ve focused on m inutiae an d igno red th e th ree questions th at tru ly co unt. First, d oes th e company have the right CEO? Second, is he/she overreaching in terms of compensation? Third, are proposed acquisitions more likely to create or destroy per-share value? 22 On such questions, t he i nterests of t he C EO m ay wel l di ffer from thos e o f t he shareholders. Directors, moreover, sometimes lack the knowledge or gumption to overrule the CEO. Therefore, it’s vital that large owners focus on these three questions and speak up when necessary. Instead many simply follow a “checklist” approach to the issue du jour. Last year I was on the receiving end of a judgm ent reached in that manner. Se veral institutional share holders and their advisors deci ded I lac ked “independence” in my role as a director of Coca-Cola. One group wanted m e rem oved fr om the b oard a nd anot her si mply want ed m e bo oted from t he au dit committee. My first impulse was to secretly fund the group behind the second idea. Why anyone would wish to be on an audit committee is beyond me. But since directors must be assigned to one committee or another, and since no CEO wants me on his compensation committee, it’s often been my lot to get an audit committee assignment. As it turned out, the institutions that opposed me failed and I was re-elected to the audit job. (I fought off the urge to ask for a recount.)
Some institutions questioned my “independence” because, among other things, McLane and Dairy Queen buy lots of Coke products. (Do they want us to favor Pepsi?) But independence is defined in Webster’s as “not subject to control by others.” I’m puzzled how anyone could conclude that our C oke p urchases w ould “ control” m y deci sion-making w hen t he co unterweight i s t he wel l- being of $ 8 billion o f C oke stock hel d by Berkshire. Assuming I ’m even m arginally rat ional, elementary arithmetic should make it clear that my heart and mind belong to the owners of Coke, not to its management. I can’t resist mentioning that Jesus understood the calibration of independence far more clearly than do the protesting institutions. In Matthew 6:21 He observed: “For wh ere your treasure is, there will yo ur h eart b e also .” Ev en to an institutional in vestor, $8 billion sh ould q ualify as “treasure” that dwarfs any profits Berkshire might earn on its routine transactions with Coke. Measured by the biblical standard, the Berkshire board is a model: (a) every director is a member of a fam ily o wning at l east $ 4 m illion o f st ock; (b) none of t hese s hares were ac quired from Berkshire via options or grants; (c) no directors receive committee, consulting or board fees from the company that are more than a tiny portion of their annual income; and (d) although we have a standard corporate indemnity arrangement, we carry no liability insurance for directors. At Berkshire, board members travel the same road as shareholders. * * * * * * * * * * * * Charlie an d I have see n m uch be havior c onfirming t he Bible’s “t reasure” p oint. I n our vi ew, based on our considerable boardroom experience, the least independent directors are likely to be those who receive an im portant fra ction of their annual incom e from the fees they receive for board service (and who hope as well to be recommended for election to other boards and thereby to bo ost th eir income fu rther). Yet th ese are the very board m embers most ofte n classed as “independent.” Most directors of this type are decent people and do a first-class job. But they wouldn’t be human if they weren’t tempted to thwart actions that would threaten their livelihood. Some may go on to succumb to such temptations. Let’s look at an example based upon circumstantial evidence. I have first-hand knowledge of a recent acquisition proposal (not from Berkshire) that was favored by management, blessed by the company’s i nvestment banke r and sl ated t o go f orward at a price above the lev el at which th e stock had sold for some years (or now sells for). In addition, a number of directors favored the transaction and wanted it proposed to shareholders.
23 Several of t heir brethren, however, each of whom received board and committee fees totaling about $100,000 annually, scuttled the proposal, which meant that shareholders never learned of this multi-billion offer. Non-management directors owned little sto ck except for shares they had received from the company. Their open-market purchases in rece nt y ears had meanwhile been nominal, even though the stock had sold far below the acquisition price proposed. In other words, these di rectors di dn’t want t he sha reholders t o be offe red X eve n t hough t hey ha d consi stently declined the opportunity to buy stock for their own account at a fraction of X. I do n’t kn ow which di rectors op posed l etting s hareholders see t he offe r. B ut I do k now t hat $100,000 is an important portion of the annual income of som e of t hose deemed “independent,” clearly meeting the Matthew 6:21 definition of “treasure.” If the deal had gone through, these fees would have ended. Neither th e shareholders nor I will ev er kn ow what motivated th e d issenters. Indeed t hey themselves will n ot li kely kno w, given t hat sel f-interest i nevitably blurs in trospection. We do know one thing, though: At the same meeting at which the deal was rejected, the board voted itself a significant increase in directors’ fees. • While we are on th e sub ject o f self-i nterest, let’s tu rn again to the m ost i mportant acco unting mechanism sti ll av ailable to CEOs who wish to overstate earni ngs: t he non-expensing of st ock options. T he accomplices in perpetuating t his absurdity have been many members of Congress who have defied the arguments put forth by all Big Four auditors, all members of the Financial Accounting Standards Board and virtually all investment professionals. I’m enclosing an op-ed piece I wrote for The Washington Post describing a truly breathtaking bill that was passed 312-111 by the House last summer. Thanks to Senator Richard Shelby, the Senate didn’t ratify th e Ho use’s foo lishness. And , to h is great cred it, Bill Do naldson, th e in vestor- minded Chairman of the SEC, has stood firm against massive political pressure, generated by the check-waving CEOs who first muscled Congress in 1993 about the issue of option accounting and then repeated the tactic last year. Because the attempts to obfuscate the stock-option issue continue, it’s worth pointing out that no one – neither the FASB, nor investors generally, nor I – are t alking about restricting the use o f options in a ny way. Indeed, my successor at Berkshire may well receive m uch of his pay via options, albeit logically-structured ones in respect to 1) an appropriate strike price, 2) an escalation in price that reflects the retention of earnings, and 3) a ban on his quickly disposing of any shares purchased t hrough o ptions. We chee r arra ngements t hat motivate managers, w hether t hese be cash bonuses or options. And if a co mpany is tru ly receiving value for the options it issues, we see no reason why recording their cost should cut down on their use.
The simple fact is th at certain CEOs know their own compensation would be far more rationally determined if options were expensed. They also suspect that their stock would sell at a lower price if realistic accounting were employed, meaning that they would reap less in the market when they unloaded their personal holdings. To these CEOs such unpleasant prospects are a fate to be fought with all th e resources they have at hand – even though the funds they use in t hat fight normally don’t belong to them, but are instead put up by their shareholders. Option-expensing i s sc heduled t o become mandatory o n J une 15th. You ca n the refore expect intensified efforts to stall o r emasculate this rule between now and then. Let yo ur Congressman and Senators know what you think on this issue. 24 The Annual Meeting There are two cha nges this year concerning t he an nual meeting. Fi rst, we ha ve sc heduled t he meeting for the last Satu rday in Ap ril (the 3 0th), rath er th an the u sual first Saturd ay in May. Th is year Mother’s Day falls on May 8, and it would be unfair to ask the employees of Borsheim’s and Gorat’s to take care of us at that special time – so we’ve m oved everything up a week. Next year we’ll return to our regular timing, holding the meeting on May 6, 2006. Additionally, we are c hanging the sequence of e vents on meeting day, April 30. J ust as al ways, the doors will open at the Qwest Center at 7 a.m. and the movie will be shown at 8:30. At 9:30, however, we will go directly to the question and answer period, which (allowing for lunch at the Qwest’s stands) will last until 3:00. Then, after a short recess, Charlie and I will convene the annual meeting at 3:15. We have made this change because a number of shareholders complained last year about the time consumed by two speakers who advocated proposals of limited interest to the majority of t he audience – and who were no doubt relishing their chance to talk to a captive group of about 19,500. With our n ew procedure, those shareholders who wish to hear it all can stick around for the formal meeting and those who don’t can leave – or better yet shop. There w ill b e plenty of opportunity fo r th at p astime in th e v ast ex hibition h all th at adj oins th e meeting area. Kelly Muchemore, the Fl o Zi egfeld of B erkshire, put o n a magnificent sh opping extravaganza last year, and she says that was just a warm-up for this year. (Kelly, I am delighted to report, is getting married in October. I’m giving her away and suggested that she make a little history by holding the wedding at the annual meeting. She balked, however, when Charlie insisted that he be the ringbearer.)
Again we will showcase a 2,1 00 square foot Cl ayton home (featuring Acme brick, Shaw carpet, Johns Manville insulation, MiTek fasteners, Carefree awnings and NFM furniture). Take a t our through the home. Better yet, buy it. GEICO will have a booth staffed by a number of its top counselors from around the country, all of them ready to supply you with auto insurance quotes. In m ost cases, GEICO will b e able to give you a special shareholder discount (us ually 8%). This special offer is permitted by 45 of t he 50 jurisdictions in which we o perate. B ring the details of y our existing insurance and check out whether we can sa ve you money. On Saturd ay, at the Omaha airport, we will have t he u sual array of aircraft from NetJets® available for your inspection. Stop by the NetJets booth at the Qwest t o learn about viewing these planes. Come to Omaha by bus; leave in your new plane. The Bookworm shop did a terrific business last year selling Berkshire-related books. Di splaying 18 titles, they sold 2,920 copies for $61,000. Since we charge the shop no rent (I must be getting soft), it gives shareholders a 20% discount. This year I’ve asked The Bookworm to add Graham Allison’s Nuclear Terrorism: The Ultimate Preventable Catastrophe, a must-read for those concerned with the safety of our country. In addition, the shop will premiere Poor Charlie’s Almanack, a book compiled by Peter Kaufman. Scholars have for too long debated whether Charlie is the reincarnation of Ben Franklin. This book should settle the question. An attachment to the proxy material that is enclosed with this report explains how you can obtain the credential you will n eed for ad mission to the meeting and other events. As fo r plane, hotel and car reservations, we have again signed up American Express (800-799-6634) to give you special help. They do a terrific job for us each year, and I thank them for it. At Nebraska Furniture Mart, located on a 77-acre site on 72nd Street between Dodge and Pacific, we will again be having “Berkshire Weekend” pricing. We initiated this special event at NFM eight years ago, and sales during the “Weekend” grew from $5.3 million in 1997 to $25.1 million in 2004 (up 45% 25 from a year earlier). Every year has set a new record, and on Saturday of l ast year, we had the largest single-day sales in NFM’s history – $6.1 million. To get t he discount, y ou m ust make y our purchases between Th ursday, A pril 2 8 a nd M onday, May 2 inclusive, and also present your meeting credential. The period’s special pricing will even apply to the products of several prestigious manufacturers that normally have ironclad rules against discounting but that, i n t he s pirit of our s hareholder weekend, have m ade a n exce ption for y ou. We a ppreciate their cooperation. NFM is open from 10 a.m. to 9 p.m . Monday through Saturday, and 10 a.m. to 6 p. m. on Sunday. On Saturday this year, from 5:30 p.m. to 8 p.m. we are having a special affair for s hareholders only. I’ll be there, eating barbeque and drinking Coke.
Borsheim’s – the largest jewelry store in the country except for Tiffany’s Manhattan store – will have two shareholder-only events. The first will be a cocktail reception from 6 p.m. to 10 p.m. on Friday, April 29. Th e second, the main gala, will b e from 9 a.m. to 4 p.m. on Sunday, May 1 . On Saturday, we will be open until 6 p.m. We w ill h ave h uge crow ds at Bo rsheim’s th roughout th e w eekend. Fo r your con venience, therefore, shareholder prices will be available from Monday, April 25 through Saturday, May 7 . During that pe riod, j ust i dentify y ourself as a s hareholder t hrough y our m eeting c redentials o r a b rokerage statement. Borsheim’s o perates on a gross m argin th at is fu lly twenty p ercentage points below t hat of its major rivals, even before the shareholders’ discount. Last year, business over the weekend increased 73% from 2003, setting a record that will be tough to beat. Show me it can be done. In a tent outside of Borsheim’s, Patrick Wolff, twice U.S. chess champion, will take on all comers in groups of six – blindfolded. Additionally, we will have Bob Hamman and Sharon Osberg, two of th e world’s top bridge experts, available to play with our shareholders on Sunday afternoon. They plan to keep their eyes open – but Bob never sorts his cards, even when playing for a national championship. Gorat’s – my fav orite steakhouse – will again be open exclusively for Berk shire shareholders on Sunday, May 1, and will be serving from 4 p.m. until 10 p.m. Please remember that to come to Gorat’s on that day, you must have a reservation. To make one, call 40 2-551-3733 on April 1 ( but not before). If Sunday is sold out, try Gorat’s on one of the other evenings you will be in town. Enhance your reputation as an epicure by ordering, as I do, a rare T-bone with a double helping of hash browns. We will again have a special r eception from 4:00 to 5: 30 on Saturday afternoon for shareholders who have come from outside of North America. Every year our meeting draws many people from around the globe, and Charlie and I want to be sure we personally greet those who have come so far. Last year we enjoyed meeting more than 400 of you including at least 100 from Australia. Any shareholder who comes from other than the U.S. or Canada will be g iven a special credential and instructions for atten ding this function. * * * * * * * * * * * * Charlie and I are lucky. We have jobs that we love and are helped every day in a myriad of ways by talented and cheerful associates. No wonder we tap-dance to work. But nothing is more fun for us than getting together with our shareholder-partners at Berkshire’s annual meeting. So join us on April 30th at the Qwest for our annual Woodstock for Capitalists. February 28, 2005 Warren E. Buffett Chairm an of the Board 26