(Ep.115) The Acquirers Podcast: Adam Mead – History Buffett: The Complete Financial History Of Berkshire Hathaway

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In this episode of The Acquirers Podcast, Tobias chats with Adam Mead, author of The Complete Financial History of Berkshire Hathaway. During the interview Adam provided some great insights into:

  • Buffett’s Mastery In Capital Allocation
  • Berkshire Hathaway: The World’s Greatest Conglomerate
  • Buffett’s Strategy Of Having No Strategy
  • Buffett Used The Word ‘Synergy’
  • Berkshire’s Big Pivot Point 1998
  • How Berkshire Changed The Insurance Industry
  • Buffett: There Is No Red Ribbon In The Newspaper Industry
  • Gen-Re Bled Red Ink
  • Buffett’s Most Important Acquisition
  • Berkshire Builds Its Regulated Utilities Platform 2005-2014
  • Berkshire Has The Most Property, Plant And Equipment In The U.S
  • Berkshire’s Preferred Stock Deals 1985-1994
  • Buffett’s Transformation Of Berkshire Hathaway
  • Berkshire Jettisons The Textile Business
  • Book Summary: The Complete Financial History of Berkshire Hathaway
  • Berkshire Hathaway Before Warren Buffett

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Full Transcript

Tobias: Hi, I’m Tobias Carlisle. This is The Acquirers Podcast. My special guest today is Adam Mead. We’re going to be talking about his new book, The Complete Financial History of Berkshire Hathaway. It’s an absolute monster. It goes into some great detail and it’s a fascinating discussion that’s coming up right after this.

[The Acquirers Podcast Intro]

Tobias: Man, this is a huge undertaking. 757 pages?

Adam: Yeah, I think the final word count came in at I think 210,000 or 215,000 words.

Tobias: Wow.

Adam: Amazon has dropped the price, but if you do the math at the headline price of $75, it’s under 10 cents a page. So, you’re getting a bargain.

Tobias: That’s a bargain. [laughs] How long does a project like this take to put together?

Adam: It took me, I estimated that all in, if I were working full time, probably two and a half years, but actual start date to finish date, five years. I started kicking around the idea in 2016, one thing led to another and then I said, “Well, geez, I’m going to run with it.” So, that’s how I ended up where I am today.

Book Summary: The Complete Financial History of Berkshire Hathaway

Tobias: When you engaged in a project of this magnitude and I see you’ve got a great foreword by the by the great Christopher Bloomstran, who may have done at least as much research as you have on Berkshire Hathaway. What did you learn through this project that you hadn’t understood about Berkshire Hathaway previously?

Adam: I came to really appreciate what they’ve built and even just more of the nuance in how it’s almost contradictory to say, but how simple the game plan was, but how difficult the execution was. There was a period there between 1982 and 1992, where they lost money in underwriting every single year. They were profitable because of investments, but what we see today is this incredible, appreciated, and admired business. It took a lot to really get it going and there were some times there during the 70s, they started some of these home state companies, these insurers that operate in individual states, and some of them failed. It really was this entrepreneurial venture and it took a lot to figure out.

It was fascinating to see Berkshire built year by year. That’s what I really wanted to do, Toby, was build a book– I wrote the book that I never found, which was Berkshire A-Z, year by year and so, I hope I’ve captured that awesome detail in the years, but also that broad– each chapters is 10 years and so, I hope I’ve captured both the broader lessons, the broader arc as well as is that lovely detail in each year but filled in, of course, I quote Buffett pretty extensively. I’m not trying to outdo him, but merely add some of that great detail that’s down in the 10k, that’s not always highlighted in his letters.

Tobias: He’s very quotable. I’ve said this before, but when I try to tweet out something that Buffett has written and often you’ve got that 280-character limit, it’s very hard to remove a word from what he says and still convey the same meaning that he has in what he has said. He is very sparing with the words that he uses and he’s very effective at communicating exactly what he means.

Adam: Yeah, actually you mentioned Chris Bloomstran. He really helped me find my voice in this book. The earlier drafts of the manuscripts were very much, “Buffett said, Buffett said, Buffett said,” and what Chris really helped me do was keep Buffett’s words, “I can’t outdo Buffett,” he said it beautifully in every year, but really just add to it, but also do it in my own voice, because you’re right and stringing all of these together– Buffett’s letters, you can read them and anybody can really do what I did in digesting 10,000 pages of research material and I’d encourage anybody to do it. So, by contrast, maybe 750 pages doesn’t seem so much and so, I hope I’ve added something to the library that’s already out there on Berkshire Hathaway.

Berkshire Hathaway Before Warren Buffett

Tobias: Well, let’s start from the beginning. I’m sure that most folks who listen to this podcast are probably students of Buffett and have spent some time reading through the letters and if they haven’t, shame on you. Go do that right now. But let’s start from the very beginning. How does Warren Buffett come to be in control of Berkshire Hathaway?

Adam: Well, we can even take it in just a quick story. When I first started writing the book– 1965 is the origin, Warren Buffett takes control of Berkshire Hathaway. So, that’s the origin, that’s the nexus of how the book is centered. So, then, I’m going to go back to 1955, look at what the company did during that preceding decade and then work my way year by year and then stop at each 10-year period. So, I wrote the first two chapters, roughly 1955 to 1974, and I sent those off to Warren, and to my surprise and delight, he wrote back and said, “Glad, you’re doing this. Wouldn’t it be interesting if you went back to the World War II era and took a look at this brief respite of profitability that the companies had before resuming this downward spiral?” Of course, Warren Buffett suggesting this, “I’m going to do it.”

Tobias: [laughs] “No thanks, Warren. You just stay in your lane. I’m writing this book.”

Adam: Yeah, but that really led me to go back– I said, if I’m going to go back to the 30s or 40s, I might as well go back all the way to the beginning and so, I’m really lucky to live in New Hampshire, which is right next door to Massachusetts. I went down to the Boston Public Library. I had access to all of this wonderful history of the early Berkshire predecessor companies from the 1800s all the way up until they emerged in 1955 to form Berkshire Hathaway.

The book literally starts with the textile industry. You look at Berkshire today, it’s nothing like it was back then, but there’s so many lessons in those early years and I don’t spend an inordinate amount of time on those early years, but it is instructive to see both how that industry developed and then the challenges that they encountered, which ultimately led to where the action happens in 1955, which is when Berkshire Fine Spinning and Hathaway Manufacturing merged to create Berkshire Hathaway.

What was really fascinating to see is the managers of Berkshire Hathaway from 1955 to 1965, they returned about half of the capital back to shareholders in the form of dividends and buybacks. Those actions were actually what attracted Buffett to the stock in the first place. So, 1962, he starts picking up shares for Buffett Partnership, Ltd. Then the famous snuff, where Seabury Stanton tells Buffett that he’s going to give him one price and the tender offer comes in at 12.5 cents lower and the rest is history. So, Buffett takes over at the famous board meeting in May of 1965. That’s why when we look at Berkshire’s history today, that’s really where it starts.

Buffett’s Transformation Of Berkshire Hathaway

Tobias: So, once he gets control, he’s got this basically a moribund textile manufacturer and he transforms it into what we’ve seen today. How does that transformation begin?

Adam: You have to remember this time, Buffett ultimately went all in on Berkshire when he wound up his partnership in 1969. But at this point, Berkshire was just one of many investments in Buffett Partnership Ltd. But Berkshire became this platform and he called it a mistake, but the biggest event that happened for Berkshire was in 1967, when they bought National Indemnity Insurance Company in Omaha for $8.6 million, I think. That became the platform to grow and became the powerhouse of what it is today. But the business– and Berkshire built off of that, Warren learned a ton about insurance. That was the first capital reallocation that happened for Berkshire Hathaway.

Then interestingly, Toby, in 1969, Berkshire bought the Illinois National Bank and Trustee of Rockford Illinois. That acquisition was actually the largest acquisition as a percentage of Berkshire’s equity capital at the time at about 44%. So, it was a huge move. They actually borrowed some money to make the acquisition, it was about a little under $18 million. Those two first big acquisitions are really the start of reallocating the capital from a dying textile business into something better. All the while, Buffett’s of course picking stocks within Berkshire Hathaway for the account for National Indemnity and then of course with his partnership, but that’s really the shift to allocating capital to wholly owned businesses. And then, of course, 1972, See’s Candy and then some of the other bigger, more well-known investments like the Washington Post, which happened during that time as well.

Buffett’s Most Important Acquisition Was National Indemnity

Tobias: Buffett spends a lot of time talking about See’s Candy as manifesting a sea change in the way that he had thought about investing for all the reasons that we’ve discussed in the past. Which do you think is a more transformative acquisition moving from a textile manufacture into insurance and banking or then moving again into this higher-return investment style?

Adam: Yeah. The most important acquisition probably was National Indemnity. I would argue, and I think Buffett would probably agree, that he didn’t realize how good of an acquisition it was at the time. When he bought it for front a little under $9 million, it had about 19 million of float. So, today was, “Oh, geez, that’s a steal,” but it really became the platform upon which Berkshire was built and became this rocket fuel with float. Like I said, it took a little while for them to understand how to run it appropriately and so, he could see– Jack Ringwald was an excellent manager. He could see that the national indemnity can be run really well. So, he could see the potential there. He also saw the potential in banking in a well-run bank, The Rockford Bank.

But in insurance, which is really what they went into heavily, you have all of these insurance companies, the home state companies that I mentioned, formed in the 1970s. Again, some of which failed and it was interesting to me, I don’t spend any time talking about Buffett’s personal life, because others have done a better job at that. But it was interesting to me to see his entrepreneurial spirit manifest itself in Berkshire Hathaway. He was not afraid to start these companies. Again, some of them failed, merged into other ones, they bought this Home and Auto Insurance business in Chicago, tried to replicate in Miami. It failed. It was a tough go in those early years, but insurance really became the powerhouse and then, of course, they figured out, “Okay, we can go into the supercap business” and then ultimately, reinsurance where they said, “We can operate conservatively, but still be aggressive in the sense of taking the lumpiness looking at this from a probabilistic standpoint and saying, ‘Okay, we can–‘” The famous quote about accepting lumpy 15% returns, instead of a smooth 12, he was actually talking about insurance. But of course, it applies to equity investments as well. He really found a way to leverage Berkshire’s strengths in a major way during that time.

How Berkshire Changed The Insurance Industry

Tobias: What was the main challenge in setting up those new insurance companies? Why did they fail so frequently?

Adam: He had some managerial issues actually and some of it was informational as well. So, they figured out that– and again– the focus today on underwriting profitability first and foremost was the lesson that had to be learned. You don’t know what insurance until possibly many years down the road, the risks you’re taking on today and so, part of it was the people and then it, of course, famously in 1985, Ajit Jain comes on and really– insurance takes off at that point. So, it was the managers and then with the home and auto business in Miami was actually an accounting issue.

Just to remember, a remember and this is maybe very apt today. The inflation of the 1970s– They were not getting the information on how the policies, how the risks and the costs associated with repairing vehicles and bodies were changing and so, they were continuing to write policies that ultimately, if they had the information, they would have stopped writing them, but they didn’t. Part people, part information flow, and really trying to get all of this to work together.

Tobias: So, there was an inflation kicking off and then I think that the awards, they started getting punitive damages for awards which meant that the payments were bigger again, even then inflation might have [unintelligible [00:15:57] and so they were just under-reserving for those ballooning costs through the 70s.

Adam: Yeah, he termed it social and judicial inflation where the juries were effectively providing coverage retroactively that they had not priced in.

Buffett: There Is No Red Ribbon In The Newspaper Industry

Tobias: So, let’s talk about the 70s, 1975 to 1984, so, he’s completed the acquisition of See’s, expressed this desire to pay for higher-quality businesses, what happens through that period?

Adam: Well, interestingly this shows you the power of the [unintelligible [00:16:39] base that he started with. 1975, they bought Welbeck Mills, which was another textile operation, actually 10 miles up the road here from me in Manchester, New Hampshire. He was still in this, “I see the power of them, but I know these other businesses.” But that decade also featured The Buffalo News, and I love The Buffalo News because it had a couple of stumbles at the beginning, but they bought that business basically at book value and once the competitor went out, The Courier Express, that was the classic excellent business.

It was a monopoly in the Buffalo area, it could print money, but what I love about The Buffalo News is you can follow that business through Berkshire over time and see it go from this excellent franchise to a good business, to a really tough business and ultimately, last year it was sold to Lee Enterprises. You can follow it through Berkshire Hathaway and as it changed– It reminds me and I think the lesson to take there is, again, to use Buffett’s words, “Investing is a movie, not a picture and really business evolves overtime and things change,” and so, I really like that example. But this decade also sees Nebraska Furniture Mart, some of the big investments in GEICO and General Foods and those kinds of things. There’s this sense of moving towards better businesses, but also just picking up some of these other good ones as well.

Tobias: We jumped over a little bit, but I think The Buffalo News, like you point out, is an illustrative business for them to have acquired because the initial acquisition, they lost money for a long time while they work in that knife fight with the competitor in Buffalo, and I think that Charlie Munger may have been writing blue chip stamps, or he was discussing contemporaneously at the time where he was saying he may never recover from this acquisition. So, do you want to talk a little bit about the nature of that acquisition and what happened in the immediate period after it was acquired?

Adam: Yeah, they figure it out. Their thesis was multi or two-newspaper towns were going to become one-newspaper towns and when you had one-newspaper that got the most readership, the most advertising, it was a virtuous cycle. Again, another lesson from The Buffalo News, it was not clear going in that this would be a winner. So, Buffalo had The Buffalo News and The Courier Express. The Courier had the dominant Sunday edition and so when Buffett came in, purchased this, he said, “We’re going to institute a Sunday edition.” Economics, competitive dynamics being what they are, The Courier Express is not just going to sit there and take this.

They fight back, there’s a couple of years of red ink and again, it shows there was not room for two– I think Buffett had said, “There’s no red ribbon in the newspaper business like this,” and again, it was a couple of years of fighting with this duo. So, for us to look back and say, “Oh, Buffalo News, that was a cinch, it’s a great franchise, and this and that,” it really from the ground up was more difficult than that may have seemed even though they could see the potential for it. But that business, they paid I think about $35 million for it. It pretty quickly paid for itself once The Courier Express folded. And then, of course, we just talked about the history of it declining, but it was interesting to see.

Actually, another operational lesson from The Buffalo News, where The Buffalo News is actually shares similarities with See’s Candy is this focus on quality. The Buffalo News had a 50% newshole and a newshole is– you think of the whole paper, the news percentage of the whole paper. So, that the focus was on delivering this high-quality news set, and that propelled this cycle.

As the business declined, there really was a focus on maintaining the editorial, that the new staff not cutting on cutting the meat out. That was the same with See’s Candy. When they couldn’t find ingredients or inflation to go over that, they did not skimp on the ingredients. So, it was the same thing with the paper and so the lessons they’re not just for investors, but I think with managers and with operating businesses that focus really on what’s going to drive things for the customer and with The Buffalo News, they were able to increase readership even above what The Courier Express enjoyed during its heyday. So, it was clearly, a winning formula.

Berkshire Jettisons The Textile Business

Tobias: The next decade from 1985 to 1994 is a particularly interesting one because that’s when you get the leveraged buyout boom, and the junk-fueled takeovers and all of that stuff happening. So, take us through the 1985 to 1994 period.

Adam: Sure, the biggest thing, I think that in this decade is jettisoning the textile business. 1985, they shut that down and it’s interesting just to think of all of the business that Berkshire is at that time was spawned from this dying textile businesses, so that that lesson there that, you don’t have to stay in the same business and capital allocation really does work to transform a business. One of my favorite acquisitions in this decade, Toby, is Scott Fetzer. That business at the time– Scott Fetzer was this mini-conglomerate. Like you said, it was part of this LBO boom. It was a great business. Management tried to buy it out with an ESOP plan. It didn’t work. It ultimately ends up in Berkshire Hathaway and at that time, Scott Fetzer, the two big divisions where the World Book and Kirby, and then about call it 15 to 18 other businesses made up the remaining 20%.

So, this is a little mini-conglomerate in its own right, but it basically, doubles Berkshire’s revenue base. That business literally fades to a footnote in the, I think, 2002, 2003 financial statements. But yet, it remained a really good business and the lesson there is, you can essentially harvest profits. Growth is not the be-all end-all. It’s about the cash generation of the business and the manager of that business, Ralph Shea, actually improved the business such that they were able to grow earnings while returning more than 100% of earnings to Omaha. It’s a little forgotten business in Berkshire. You really don’t hear too much about it or its subsidiary companies today. But it’s one of my favorites for illustrating a lot of these lessons that happened during that time.

Tobias: When does Buffett revisit American Express?

Adam: What is it, he revisited it?

Tobias: So, he had bought it initially in the partnership, and he had made a great deal about the fact that it was a business that didn’t find its value in the assets and it was he had it in a partnership at the time and there were two other– I think there were net-nets or subliquidation value companies and American Express was a distinctly different base to the two that he had previously acquired. I just wasn’t sure whether it was in that the tail end of that 1985 to 1994 decade or is it the next decade?

Adam: Yeah, I’m racking my memory here, but it actually shows up in the early days actually, it was part of the portfolio in the 60s. I’m going to have to double-check myself there. But it was definitely there in the earlier days. When they went into that heavily, I’m going to have to– I want to say you’re right on that, but I don’t want to give you a specific answer, which is a casualty of writing a book about such a well-studied company, like, “Oho, somebody’s going to ask me some specific questions.” So, you’ve caught me here, Toby.

Tobias: Do you know much about the American Express acquisition, is that one that you’ve canvassed in some detail?

Adam: Not in any great detail and it was a challenge for me to– each of these, you could write– and my bookshelf behind me here, there were books written on some of these subsidiaries. The challenge even within almost 800 pages to tell enough about it but not go too deep was certainly a challenge.

Tobias: You’ve got two Poor Charlies back there, did you need a second one?

Adam: Well, one’s a first edition, and then the second is a signed third edition.

Tobias: Oh, fantastic.

Adam: I kicked myself, I had an opportunity to buy a first edition signed copy. I passed on it and the price went up.

Berkshire’s Preferred Stock Deals 1985-1994

Tobias: What else happens in that 1985 to 1994 decade? Is that when they start acquiring the junk bonds after the bust?

Adam: So, I guess that decade was think that that was well around that time, the 90s. 1985 to 1994, you have these couple of preferred stock deals during that time. Of course, the most famous is the Salomon issue, which was 1987. I think it was a $700 million dollar issue, and it was something like 10% of Berkshire’s equity capital. But they also had issues, Gillette, Champion and US Air, of course, was the one that that had its fall. The junk bond stuff I think happened in the next decade. There was a couple of different periods.

They picked up Fruit of the Loom, it was originally a junk bond issue. They purchased Amazon. They actually purchased some Amazon junk bonds, I think, in 2003 and that was famously or maybe not so famously now, I think Amazon was one of two companies that expensed stock options and so, it was more about, “Hey, we can trust this management team.” It was really interesting to see some of these historical artifacts pop up, and even some of the same players coming around from year-to-year or decade-to-decade.

Berkshire’s Big Pivot Point 1998

Tobias: I think another very interesting decade is 1995 to 2004, because that’s the late 1990s. Berkshires doing very well, but also, we go into the dotcom mania, but Chris Bloomstran pointed out the elegance or the beauty of the acquisition of Gen Re. Do you want to talk us through that decade and maybe just a expand a little bit on Gen Re?

Adam: Yeah, so, the 1995 to 2004 decade, there was a lot that went on in this decade. GEICO, they bought the remaining half of GEICO in 1996. There was actually a number of– This was the same year they issued the B-shares with that whole potential debacle. They had a couple of acquisitions where they issued shares as well as purchased acquisitions for cash. So, there was FlightSafety. Dairy Queen was another one. Executive Jet, which is now known as NetJets. And then in the 2000s, there was this whole host of acquisitions of boring businesses like Acme Brick, which was Justin Industries, and they bought the utility business.

But 1998 was really that pivot point, and it’s interesting, it’s a topic of debate, if you will, as to whether that was a conscious effort by Buffett to make this switch. At that time, Berkshire shares were selling over two times book value and they had a pretty heavy stock-to-bond concentration. So, the argument that Chris makes is that it was an elegant way to shift, using expensive shares to buy Gen Re in an all $22 billion stock deal, and essentially, shift the stock bond allocation in a tax-free way.

Buffett Used The Word ‘Synergy’

The way I’ve looked at it in the book, Toby, is I do mention that the stock bond switch. I guess I don’t really have an opinion on whether that was intentional or not, but it is interesting, the way I’ve looked at it, the way it looked at the GEICO acquisition in 1996 is cost of float. So, when you adjust the float or you adjust the price for the ratio of intrinsic value of Berkshire shares at that time, Berkshire paid basically one times float or about $14 billion for Gen Re. I’m not sure, it may have been all of the same, but it’s interesting in the press release for Gen Re, you hear Buffett say a word which he very rarely says in a positive context and that’s “synergy.”

Tobias: [chuckles]

Adam: He actually uses the word “synergy,” and so, Gen Re had a really good history of writing business right around a little bit below 100% combined ratio, the last couple of years before they bought it were a little bit over that 100%. But they were capital constrained, they couldn’t do certain things because they were a standalone entity. So, I think it was more that– those other things were incidental, but the real push was really this platform to buy by a reinsurer. Of course, they had a major interest in Cologne Re and some of these other German reinsurers, but Gen Re, I think at the time was around maybe $6 billion worth of premiums, which dwarfed Berkshire’s own reinsurance operation. So, it was that other platform of insurance where you had the home state businesses, the organic primary businesses, GEICO, Berkshire Hathaway Reinsurance, and then Gen Re comes in there as a last piece of the puzzle, if you will.

Tobias: The weapons of mass destruction in reference to all of the features in the odd structured finance deals, did they come out of the Gen Re deal?

Gen-Re Bled Red Ink For Quite A While

Adam: Yeah. So, you see Buffett sort of turn on Ron Ferguson, who was the manager at the time. He praised him. He was actually invited to be on the Berkshire board and declined. Buffett told Ajit Jain and Ron Ferguson to cut their exposure on the World Trade Center. Ajit did it, Ferguson did not. Buffett was livid when the Trade Center happened, more because he saw it happening. Saw the potential for something to happen. There were a couple other things there too, where you really see it in the praise of Ajit Jain, where he knows his risks, he doesn’t extend himself, he stays true to the four principles of good underwriting. Ferguson, I think, was attracted to these exciting things and Buffett talks about, “The one-foot bar step over versus the seven-foot things to leap over.” Ajit was fine just finding these, 1 in 100 odds that they were getting paid 1 to 10 type of things, and in some ways, Gen Re was getting dictated terms by its customers instead of the other way around. So, there were some painful years there and I think even Buffett wrote that he thought at one time that it could have been a mistake to purchase the company, because it bled red ink for quite a while.

Berkshire Builds Its Regulated Utilities Platform 2005-2014

Tobias: So, that brings us to the 2005 to 2014 period. What’s the signature transaction through that period?

Adam: Jesus, a lot that goes on in that decade too. I probably have to say that the BNSF acquisition in 2010. They issued shares. It was $35 billion acquisition. Huge, huge deal and just a little tidbit of trivia, if you will, the entire Class 1 railroad, that is BNSF is owned by National Indemnity. So, they buy it for $8.6 million in 1967 and it purchases a $35 billion railroad in 2010. It illustrates how Berkshire has put together and it has these resiliencies, and the railroad operates on its own, but its earnings help support the insurance, which helps keep the ratios down, the capital ratios good, just a little tidbit. But they buy ISCAR during this decade. They buy Marmon, and Marmon I think it’s there in my bookshelf, that that was, we talked about Scott Fetzer as a conglomerate. Marmon had something like 100 businesses.

This was a big business that Berkshire Hathaway swallowed up. They purchased, it was about $9 billion, half of that $4.5 billion in 2008 and then the remainder, they purchased over time. Lubrizol was another big one. They really start– In 1999, they bought, what’s now Berkshire Hathaway energy was MidAmerican Energy. That became this platform for regulated utilities and so, you see them by NV Energy, which is a West Coast, United States business and they added to that over time.

Berkshire Has The Most Property, Plant And Equipment In The U.S

But one other thing, one other element and the way I’ve structured the book, as you’ve seen, is decade by decade, but looking at the major capital allocation decisions that they made over those periods of time. A couple things that stood out, just this decade, they invested something like, $75 billion in capital expenditures, which was about two times the amount of depreciation. So, just the organic investment was massive, really massive and then of course, the recent annual meeting, Buffett talked about how Berkshire has the most property, plant, and equipment of any business in the United States today, and there’s a reason for that.

But one interesting thing that came out of, I sort of pause at the 50-year mark, which was 2014. Berkshire really– We think about this concentration in Berkshire’s common stock portfolio and that’s true. But it’s also true in the operating businesses that they’ve purchased. Berkshire over time has just continually purchased larger and larger businesses. Of course, the largest being the 44% of equity capital in the Rockford Bank. But in each subsequent decade, it was no less than 15% of Berkshires equity capital was the largest acquisition. So, you have The Buffalo News, Scott Fetzer was a big one, I think it was 19% or 20%. GEICO, when they bought that that was a big one and then BNSF. So, it’s this continual concentration of bets, both in the investment portfolio as well as the operating businesses. You roll that forward and you say– You can see the challenges that Berkshire has today in buying a large business, because the universe has just shrunk dramatically as they’ve retained their capital over time.

Buffett’s Mastery In Capital Allocation

Tobias: I just want to take you back a little bit to the BNSF. I remember reading some analysis of this. I’m not entirely sure when, over the last five years, where somebody said, ‘They paid $35 billion for this, but they got a lot of their capital back really quickly.” I forget the exact numbers now, but it was some– in a very short order, they had a lot of their capital back, but potentially all of their capital back from that acquisition. Do you have any detail on that?

Adam: I do and again– I’ll plug my website, theoraclesclassroom.com. I’ve actually released my spreadsheet that I used to put together the book on the Sheets, it’s about 200 tabs. I do have in there, the dividends. Because BNSF is a large business that has public debt, it has to file 10Ks of its own and so, we’re lucky to be able to see basically everything that BNSF is doing. So, you’re right. I don’t have the exact figures on the tip of my tongue, but you can see the dividends that were paid from BNSF up to Berkshire ever since it was acquired and I think you’re right. They were large over time and I think I’m pretty confident in saying that at this point, they’ve exceeded the purchase price and then of course, Berkshire has this wonderful earning asset still on the books.

Tobias: I just think it’s one of the underappreciated aspects of what Buffett does, that he buys these things and the capital is rapidly returned to Berkshire and then he ends up owning the business. Scott Fetzer is another great example of a business that he saw that he could get the capital back. Then, I wasn’t aware, but Berkshire Hathaway itself, you say initially the thing that attracted him to it was that it was returning so much capital beforehand. So, it’s not something I’ve heard discussed a lot, but I think it’s an important aspect of what he does.

Adam: Yeah, and he’s gotten criticism for it. It’s almost this paradox of Buffett loves getting cash, but he won’t give it out. But that’s the structure of Berkshire Hathaway, where they can move the capital upstream to any other business and it really is about maximizing the potential of the business and so, if it’s a cash flow stream that grows and they can reinvest at high rates of return, great. Good rates of return, that’s good too.

I’m thinking of Berkshire Hathaway Energy, when they have not paid a dividend up to Berkshire, the parent at all. They purchased in 1999, they’ve retained all their earnings and so, that’s allowed them to grow. So, he doesn’t always grab that cash, I think he would just prefer it come to him, and again, with Scott Fetzer. You can start to incorporate all of these examples of all these other things like management compensation, and incentivizing the manager based on the business itself, and using a hurdle return, so that they’re incentivized to send that capital and not just sit on it or reinvest it in something poorly. There’s all these wonderful details that come out of study of Berkshire Hathaway.

Tobias: See’s too. I remember it. I think he wrote in 2011, he wrote about buying it in 1972 for $27 million, and pointing out, I think in 2011, it had returned a billion dollars or so, a number like that over the course of the Berkshire’s holding in it.

Adam: Yeah, I think that the latest figure was maybe $2 billion and that number’s probably– The last actual figure that I saw was something like $85 million in earnings. So, you do the math, that number has to be closer to $2.5 billion I would bet, today.

Buffett’s Strategy Of Having No Strategy

Tobias: As an investor, having conducted this extensive research on the great industrialist of our age, what do you take out of it that you want to use in your own process?

Adam: I really came to appreciate– Again, it’s almost paradoxical that the simplicity but also the complexity of it. The model that I used in the book to look at all these acquisitions over time is this pretax return on capital. You have very basically, how much capital does the business need to operate? What’s the capital intensity? What are the margins? I came to realize that Buffett hangs everything off of that. You listen to his words, and it’s okay, what will cause margins to change? What will cause capital intensity to change up or down? What will competition do to affect those things? And so, it’s a very simple model, but it’s very hard to figure out.

I really came to appreciate just how hard it is, I guess, even though it is simple. This patient approach, and Buffett even writes about several times, this strategy of having no strategy where you just have to keep turning over rocks, keep going, but be opportunistic when things come along and really just do the best thing that’s in front of you at the time, and all of the mistakes, but we’re so lucky that Buffett highlights his mistakes– and all these mistakes are just reassurance that you know, geez, he’s going to make mistakes, learn from them, but also, don’t beat yourself up too much when you make the mistakes.

Berkshire: The World’s Greatest Conglomerate

Tobias: You’ve got a chapter, World’s Greatest Conglomerate. Why’s Berkshire the world’s greatest conglomerate?

Adam: If I could have gone– and I didn’t have any explicit limitation, but I stopped. I wanted to have a chapter on conglomerates and actually that spreadsheet that I referenced has a couple of tabs on these early conglomerates. Textron, ITT, LTV, Ling-Temco-Vought. These early conglomerates of the 60s, they were a trend, they were the hot thing of the day, they didn’t really work out, because they were based on accounting machinations and trying to put together businesses that really shouldn’t be put together or tinkering in them.

Berkshire really benefited– and part of it was luck, let’s say it how it is, in starting so early, they had the benefit to find all of these great businesses, put them together and do it in such a way that it really maximized business potential, but also human potential is the way I’ve put it in that– I think it was their early years and I say they, Munger and Buffett, of operating investment portfolios of stocks. So, the way I’ve termed it as a portfolio approach, they really don’t care whether they own 10% or 100% of a business, it’s all the same to them.

I think it was natural for them to put these businesses together under the same roof in terms of ownership, but leave them alone from an operational standpoint, and maximizing the potential of each individual business, like we just talked about in terms of taking the cash, but not meddling in the operations and to put together this insurance powerhouse, and all of these operating businesses, and to do it in a really sustainable way that has rightly garnered so much appreciation today. Even though, I don’t think it’s fully appreciated what Berkshire Hathaway is today in terms of the ways in which, it allows businesses to maximize their potential, but does not step on the toes or try to meddle in operations, it has the best of tax implications, as well as the operational things that they’ve done.

I think even in the book, I say, I won’t say it will never happen, but I think just again, that the luck that they started when they did, the time in which they’ve had to compound this thing, it probably will not be eclipsed, I won’t say never, but I think it’ll be a very, very high bar for anybody to jump over.

Tobias: Look, I can’t think of a better note to leave it on. Adam, if folks want to get in contact with you, follow along with what you’re doing, or buy the book, how do they go about doing that?

Adam: So, the website I mentioned, my blog is theoraclesclassroom.com. You can also go to brkbook.com, that’ll also get you there. I’m on Twitter @BRK_Student and I also write a newsletter, watchlistinvesting.com. That’s me and I look forward to hearing from people and my Twitter handle really says it all. I really still think of myself as a student. I’m sure there’s things I missed in the book. Please, let me know what I missed, but also just continue the conversation. We can all continue to learn from Berkshire Hathaway and all the wonderful lessons that it has to teach us.

Tobias: Well, thank you for a fascinating discussion, Adam Mead. The book is called The Complete Financial History of Berkshire Hathaway. Thank you very much.

Adam: Thanks, Toby. This was a lot of fun.


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