In the Berkshire Hathaway Owner’s Manual, Warren Buffett explains why he is willing to reject interesting opportunities rather than over-leverage his balance sheet. Here’s an excerpt from the Owner’s Manual:
We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long-term fixed-rate basis. We will reject interesting opportunities rather than over-leverage our balance sheet.
This conservatism has penalized our results but it is the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders, lenders and the many equity holders who have committed unusually large portions of their net worth to our care.
(As one of the Indianapolis “500” winners said: “To finish first, you must first finish.”)
The financial calculus that Charlie and I employ would never permit our trading a good night’s sleep for a shot at a few extra percentage points of return. I’ve never believed in risking what my family and friends have and need in order to pursue what they don’t have and don’t need.
Besides, Berkshire has access to two low-cost, non-perilous sources of leverage that allow us to safely own far more assets than our equity capital alone would permit: deferred taxes and “float,” the funds of others that our insurance business holds because it receives premiums before needing to pay out losses.
Both of these funding sources have grown rapidly and now total about $32 billion.
Better yet, this funding to date has been cost-free. Deferred tax liabilities bear no interest. And as long as we can break even in our insurance underwriting – which we have done, on the average, during our 32 years in the business – the cost of the float developed from that operation is zero.
Neither item, of course, is equity; these are real liabilities. But they are liabilities without covenants or due dates attached to them. In effect, they give us the benefit of debt – an ability to have more assets working for us – but saddle us with none of its drawbacks.
Of course, there is no guarantee that we can obtain our float in the future at no cost. But we feel our chances of attaining that goal are as good as those of anyone in the insurance business. Not only have we reached the goal in the past (despite a number of important mistakes by your Chairman), our 1996 acquisition of GEICO materially improved our prospects for getting there in the future.
You can read the entire owner’s manual here:
Berkshire Hathaway – Owner’s Manual
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