Source: The Future Music Club Author: Buffett

Buffett likes to invest in companies as the owner of the business rather than simply being an investor. In fact, Berkshire itself, managed by Buffett, is also a company, and it is a company with excellent management. The headquarters has a team of more than 20 people, manages more than 350,000 employees, is a well-run company with a scale of more than 600 billion US dollars.

In June 1996, Buffett published the “Owner's Manual (Owner's Manual)”. The purpose of the handbook is to explain Berkshire's basic business principles. This principle has been around since 1983. This version is a further updated version, and also reflects his thoughts on Berkshire's investment and business from the perspective of an “owner” shareholder. These thoughts also reflect Buffett's dual status as a business operator and investor, and his thoughts on “owner” investments. The following is the original text for reference.

The commercial principles of being an “owner” of business

In 1983, when we acquired Blue Chip (Blue Chip), I wrote down 13 shareholder-related business principles to let new shareholders understand our management methods. The reason they are called “principles” is because these 13 articles are in effect for a long time.

1. Partnership is a partner moving forward together

Although our organization is corporate, our attitude is partnership. Charlie and I see you as shareholder partners, and we are the partners responsible for the operation. (Considering our shareholding ratio, we are also considered a controlling partner.) The company itself is not the ultimate owner of corporate assets, but rather a channel for shareholders to hold assets.

I hope you, as shareholders, don't hold a bunch of paper whose price fluctuates every day. As soon as the external environment changes, you will first want to sell it. Hope you would like to own a farm or apartment with your family forever. When you entrust us with your assets, we don't think of you as strangers, but as partners who are willing to spend the rest of your life starting a business with us.

As it turns out, most Berkshire shareholders have a long-term value investment philosophy. Even without counting my shares, Berkshire's annual turnover rate is far lower than other US companies.

Just as our shareholders manage Berkshire shares, we manage our investments in the same way. As shareholders of Coca Cola and Express, we see ourselves as “uninvolved managing partners” of these two outstanding companies. The measure of the success or failure of our investments is their long-term value, not the stock price that changes daily. In fact, even if these companies stop trading in the next few years, there are no stock deals, and there are no stock quotes, we won't care at all. If we are optimistic about the company's development in the long term, the short-term price changes make no sense to us unless we want to add more shares at a more attractive price.

II. Shareholder-Oriented

Berkshire is a shareholder-oriented company. Most of our company's board members invest their main wealth in the company's shares. In other words, we dare to eat our own food.

Most of Charlie's family's wealth is Berkshire shares, and I have over 98%. Also, many of my relatives—my sister, sister, and cousin—have most of their assets in Berkshire stock.

Charlie and I are so comfortable with putting eggs in one basket because Berkshire has all kinds of really extraordinary businesses. These businesses — whether we hold or participate in — are not only of the highest quality, but also cover a wide range of fields. We believe they exist enough to make Berkshire unique!

Charlie and I can't guarantee your performance. But no matter when you become our partner, we can guarantee that your future earnings match ours. We have no interest in generous compensation, options, or other means of benefiting shareholders. We make money on the premise that our partners also profit at the same rate. If I had made some stupid decisions, I would have lost the same proportion, so I hope this gives you some comfort.

III. Long-term goals

Our long-term economic goal (subject to some conditions mentioned later) is to maximize the compound annualized yield of Berkshire's intrinsic value per share. We don't measure Berkshire's performance or economic significance by its size. What we value is an increase in intrinsic value per share. We confirm that as the scale of assets under management increases, the intrinsic value per share growth rate will gradually slow down in the future. However, it would be disappointing if our growth rate did not exceed the average of large US companies.

Since writing this principle at the end of 1983, our intrinsic value (which I'll discuss later) has grown at an annual rate of over 25%, a rate that certainly surprised Charlie and I. Despite this, the principles just mentioned are still valid: operating with large amounts of capital like today, our performance cannot be as good as before when operating with much less capital. The best return on intrinsic value we can even expect is an average of 15% per year, and we're probably far from reaching that goal. In fact, we think few large companies have the chance to compound intrinsic value at 15% per year over a long period of time. As a result, we may end up achieving our stated goal — above average — with returns well below 15%.

4. Buying Excellent Companies

First, we will directly buy all kinds of companies, different businesses, and types of companies, as long as these companies can bring abundant cash flow and return on investment above the market average. Second, we purchased shares of similar companies in the secondary market through our insurance companies. The specific asset allocation is determined by the price of the business available for investment and the capital requirements of the insurance company.

We have carried out a series of acquisitions in recent years. Although there won't be as many acquisitions in future years as there are now, we expect the frequency of acquisitions to increase over the next few decades, and expect large-scale acquisitions. If the quality of these acquisitions remains at the same level as it used to be, then Berkshire's life will be better.

Our challenge is that cash is growing faster than finding good projects. Seen from this point of view, a sluggish stock market can help us a lot. First, if you want to buy the entire company, the price may be even lower. Second, a sluggish market allows our insurance companies to buy shares in excellent companies or increase our existing holdings at preferential prices. Again, excellent companies have always been long-term buyers of their shares, and the low price allows them to buy back more shares, which means that we, as their shareholders, follow the profits.

Overall, Berkshire and his long-term shareholders will benefit a lot from a sluggish stock market, just as people who go to the supermarket to buy food will benefit from discounts. When the stock market plummets — this happens often, whether due to panic or depression, it's good for Berkshire.

5. Evaluation methods

Due to our two-pronged investment strategy and the limitations of traditional accounting methods, the profit in the consolidated financial statements does not reflect our actual financial performance. Charlie and I, as shareholders and managers, have largely ignored the consolidated financial statement data. Nevertheless, we will keep you informed of the profits of every important large company we hold. This data, and a range of other information about the companies we invest in, should help you understand how they operate.

To keep things simple, we'll give those really important data and other information in our annual report. Charlie and I will keep a close eye on the performance of our companies, and we will also try to understand the market economy behind each company. For example, is the market environment in which our subsidiary is a smooth wind or a headwind? Charlie and I need to understand the current situation, adjust our expectations accordingly, and announce our findings to you.

Over the long term, the vast majority of our subsidiaries have surpassed our expectations. But sometimes we also find some disappointing situations, and we try to tell you the bad news as honestly as we would when we told you the good news. When we use unconventional measurement methods to record our progress — for example, you read information about floating deposits in our annual reports — we try to explain these concepts as much as possible and tell you why this information is important. In other words, we believe that by telling you our analytical methods, you can evaluate not only the quality of Berkshire subsidiaries, but also our management and asset allocation methods.

6. Profit Distribution Considerations

We don't allocate assets for the sake of the report. When the cost of buying is similar, we would rather buy companies that can't be recorded in financial statements but can bring in $2, or companies that can be recorded in financial statements but only bring in $1 in revenue. This is actually an option we often face in acquisitions, because the acquisition cost of a complete company (the proceeds can be fully recorded in financial statements) is proportionately twice as high as when a partial purchase (most of the proceeds cannot be recorded). Overall, in the long run, we expect that income not included in the financial statements will eventually be reflected in our intrinsic value through return on investment.

We found that in the long run, net profit from our investee companies is generally equally beneficial to Berkshire regardless of whether it is distributed, although if distributed to Berkshire, it means that it can be recorded in Berkshire's financial statements. Such excellent results stem from the fact that most of our investee companies are excellent companies that can make perfect use of capital. They either used the capital for their own operations or to buy back their shares. Obviously, not every capital decision will benefit Berkshire as a shareholder, but overall, we are getting far more from their retained earnings than the retained earnings themselves. Therefore, we will look at surpluses as an actual reflection of our annual operating income.

7. Leverage

We seldom issue debt. Even when issuing bonds, they will try to issue bonds with a fixed long-term interest rate. We'd rather miss out on opportunities than overuse leverage. This conservative investment approach has had an impact on our earnings, but given our fiduciary responsibilities to our insurance clients, creditors, and shareholders who invest most of our personal assets in Berkshire, it is the only method we can accept. (One winner of the Indianapolis 500 Mile race once said, “To be the first to reach the finish line, you must first get to the finish line.”)

Charlie and I used an investment strategy that allowed us not to sacrifice the quality of our sleep to reap a few percent higher returns. I've never wanted to risk losing what my family and friends needed to get something they didn't need.

Additionally, Berkshire has two low-cost, low-risk financing channels to create financial leverage to hold assets far higher than our equity capital: deferred income taxes and insured surplus funds. Insurance surpluses are clients' funds held on hold by our insurers, as insurers need to pre-receive their premiums for future claims. These two financing channels have been growing rapidly, and the total value has now reached about 168 billion US dollars.

Even better, these financings have so far been cost-free. There is no interest on deferred income tax obligations. And as long as we can balance our income and expenses in the insurance industry, there is no cost for floating deposits generated during the business process. However, neither of them are equity and are recorded as liabilities by accounting standards. But they are all debts with no contractual terms or due dates. Effectively, they provide debt-like advantages — the ability to make more assets work for us — but they don't have the unpleasant downsides of debt.

Of course, that doesn't mean we can also use our insurance savings accounts at zero cost in the future. But we think there are as many opportunities for us to use floating deposits as there are other insurance companies. Not only have we achieved this goal in the past (although your chairman has made many important mistakes), it is also very likely that we will be able to achieve this goal in the future due to our acquisition of a government employee insurance company in 1996.

The way we operate now allows us to use additional, non-recourse loans for utilities and railway companies. Therefore, we will continue to prefer long-term, fixed-rate loans.

8. Management and shareholders have the same interests

Management will not infringe on shareholders' interests for their own selfish desires. We will not use diversification as a reason to buy a company with no long-term benefit to shareholders at a premium. We treat your capital as our own, and when diversifying our investments on the open market, we assume that it brings added value to your investment portfolio.

Charlie and I will only buy companies that increase the intrinsic value of each Berkshire share. How much we pay and how big our office is has nothing to do with the size of Berkshire's balance sheet.

IX. Long-term results orientation

We believe that even the lofty goals require periodic evaluations based on results. Our criteria for evaluating whether a dividend should be paid is whether every dollar retained brings at least one dollar of market value in the long run. So far, Berkshire has been able to pass this test. We will continue to conduct this rolling performance evaluation over the past five years in the future. As our book value continues to increase, it becomes more difficult to use retained earnings effectively.

Maybe I should change the term “for a period of five years”. This is a mistake I didn't realize until I was asked a related question at the 2009 shareholders' meeting.

When the stock market falls for five consecutive years, sometimes the premium on our stock price compared to book value decreases. When this happens, Berkshire will not be able to pass the tests mentioned earlier. In fact, before I wrote down these principles in 1983, our stock price was far below the book value per share between 1971-1975.

The five-year test should look like this: (1) our book value grew more than Standard & Poor's during this period, and (2) can our stock price continue to be higher than the book value per share, meaning that every $1 of retained earnings can bring in more than $1 in value? If these tests are met, the act of not paying dividends is reasonable.

10. Prudently issue additional shares

We will only issue additional common stock if we get as much value as we pay. This rule applies to all types of additional issuances — not only mergers and acquisitions or public offerings, but also stock and bond conversions, options, and convertible securities. We will not sell part of the company's shares to others at a price disproportionate to the overall value of the company.

When we issued B-shares in 1996, we stated that Berkshire shares were not undervalued, and some people were shocked. But they shouldn't have been shocked; they should have been surprised if we issue additional shares when our stock prices are undervalued. Management clearly or implied that the stock price was undervalued during the public offering, either ignoring the facts or disregarding shareholders' interests: if assets worth 1 dollar were sold for 80 cents, this would be an unfair loss for shareholders. We didn't make this mistake when issuing B-grade shares, and we won't in the future. (However, we also never mentioned that our stock was overvalued during the launch; these remarks are due to media misinterpretation.)

11. Investment Attitudes

You should have fully noticed that Charlie and I have an investment attitude that is bad for return on investment: no matter what prices others offer, we have no plans to sell the high performing companies we own in Berkshire. We are also very reluctant to sell underperforming companies as long as they can generate at least some cash, and we are still satisfied with their management and labor relationships.

We hope we don't repeat the investment mistakes that would make us buy underperforming companies. We are also quite cautious about thinking that underperforming companies will improve their future operations after investing large amounts of capital.

Still, the Golden Rummy style of management (abandoning one of the worst performing subsidiaries every round) isn't our style. We'd rather sacrifice a portion of our overall average earnings than engage in this kind of behavior.

We will continue to avoid this kind of Golden Rummy style behavior. Indeed, we abandoned the textile company that had been struggling for 20 years in the 80s simply because we thought it would continue to lose money forever in the future. We haven't considered selling subsidiaries that sell well at good prices or abandoning our subsidiaries that aren't progressing well, although we will find ways to deal with the issues that cause them to perform poorly. Here, we want to clear up some misconceptions that came up in 2016. The principle of no sale we are emphasizing here is for our holding subsidiaries, not the marketable securities we hold.

12. Honesty

We will candidly inform you about our performance and highlight the strengths and weaknesses of the companies we own. Our guideline is to tell you the information we would like to know if we think empathically, and we don't have more information than you know. Furthermore, as a large company that owns many mainstream news media companies, it is unforgivable to use lower standards of accuracy, balance, and acuity when reporting results than when reporting to others. At the same time, we also believe that honesty is beneficial to us as managers: those who misunderstand others will eventually mislead themselves.

At Berkshire, we don't use accounting manipulation methods such as “huge write-offs” or “restructuring,” and we don't smooth out any quarterly or annual reports. We'll be telling the truth about how many strokes it took us to get into the hole without trying to fiddle with the scoreboard. When we have to use very rough estimates, such as insurance reserves, we try our best to ensure that the estimation method is consistent and conservative.

We will communicate with you in a variety of ways. Through the annual report, I will endeavour to provide as much detail as possible about the value of all companies in a reasonable amount of time. We will also try to provide information on short but important quarterly statements that have already been published online, although those aren't written by me (hosting a concert once a year is enough). Another important channel of communication was our Annual Shareholders' Meeting, where Charlie and I were happy to spend over five hours answering questions about Berkshire. But there's one way of communicating that we can't do: one-on-one. Given Berkshire's tens of thousands of shareholders, this isn't an option.

In all of our communications, we want to treat all of our shareholders fairly: we don't want to use common industry practices to provide profit “guidance” or other important information tips to analysts or major shareholders. Our goal is for all shareholders to have access to information at the same time.

13. Purposeful reservations

Although our policy emphasizes honesty, our disclosure of information on listed securities is limited to the extent required by law. Good investment opportunities, like good product and commercial acquisition opportunities, are rare and precious, and are easy to get ahead of the curve. So we don't usually talk publicly about our investment ideas. This confidentiality measure even applies to securities we have sold (since we may buy them back in the future) and securities that people mistakenly think we will buy. If we reject some rumors and say “nothing to comment on” on other situations, then no comment becomes an admission.

Although we will continue to have reservations about specific individual stock announcements, we are willing to talk openly about our business and investment philosophy. I have benefited greatly from Benjamin Graham's generous knowledge-sharing. He's the greatest teacher in the history of finance, so I think I should continue to pass on the knowledge I've learned from him to others, even though doing so will train new potential competitors for Berkshire, just like Benjamin once experienced.

XIV. Newly added principles

Further expanding, we expect every Berkshire shareholder to have the same rate of change in share price as the intrinsic value of each share during the period of holding shares. To achieve this, the relationship between intrinsic value and market value needs to be consistent, and the relationship of our preferences is 1 to 1. This is implicit; we'd rather see Berkshire's stock price at fair value rather than high price. It's clear that Charlie and I have no control over Berkshire's share price.

But through our policies and communication, we can encourage reasonable shareholders to work together to promote a reasonable price. The way we are unwilling to neither overestimate nor undervalue stock prices may disappoint some shareholders. But we believe it will appeal to long-term investors who want to profit from Berkshire's business development rather than from the mistakes of other investors.

We periodically compare changes in Berkshire's book value per share with the performance of S&P 500. In the long run, we hope we can beat this benchmark. Otherwise, why should investors choose us? However, there are certain shortcomings in this measurement method, which will be mentioned in the next section. Furthermore, the comparison of current yearly performance is not as meaningful as before. That's because compared to many years ago, the portion of the shares we hold that changes in the same proportion as the S&P 500 is getting smaller and smaller. Meanwhile, S&P's earnings calculation doesn't take cost into account, while Berkshire's earnings are only 65% after tax is taken into account. As a result, we expect to outperform the S&P Index when the market performance is sluggish and be beaten by S&P when the market's performance is excellent.

15. Intrinsic value

Now let's focus on one of the keywords we mentioned earlier, and you'll see it in future annual reports.

Intrinsic value is a very important concept, and it is the only logical way to evaluate investment and commercial value. Intrinsic value can be simply defined as the discounted value of all future cash flows obtained over the future life of a company.

But calculating intrinsic value isn't that simple. Our definition suggests that intrinsic value is an estimate rather than an accurate calculation, and that this value requires constant adjustment based on changes in discount rates or projected cash flow. What's more, two different people may have different conclusions about the same facts, and even Charlie and I would be different. This is one reason we won't give you an estimate of Berkshire's intrinsic value. However, our annual reports provide all the information we use to calculate intrinsic value.

At the same time, we will periodically publish our book value per share, a value that is easier to calculate, although the specific results are not good. The defect is not in the listed securities; the book value of the listed securities is directly equal to the market price. The defect in book value is related to our holding subsidiaries, and the book value of these holding subsidiaries is sometimes very different from the actual intrinsic value.

This deviation can occur in two directions. For example, in 1964, we can say that Berkshire's book value per share was 19.46 US dollars. However, this value greatly overestimates the company's intrinsic value because all of the company's resources are trapped in a textile company that doesn't make much money. The intrinsic value of our textile industry assets, whether calculated under the premise of continuous operation or bankruptcy liquidation, is not equal to its book value. Today, however, the opposite is true in Berkshire, where book value is far below intrinsic value. This is because the intrinsic value of our subsidiaries is far greater than their book value.

Despite their limited ability to present facts, we are showing Berkshire's book value data because they can still be used as a rough, albeit greatly underestimated, measure intrinsic value. In other words, the annual rate of change in book value can be considered reasonably close to the rate of change in intrinsic value.

If you want to understand the difference between book value and intrinsic value, a college education can be an example of an investment reference. University tuition is a book value. If you want to calculate it more accurately, it should also include wages lost due to not being able to work during college.

For the sake of convenience, we are ignoring the non-economic benefits of college here and focusing only on the economic value. First, we need to evaluate the wage income that college graduates will receive in their lifetime, and then subtract the income they can get if they don't go to college. This excess income is then discounted at a fixed interest rate until the student's graduation day. The calculated result is the intrinsic value of college education.

Some graduates will find that the book value of college education is higher than the intrinsic value, which means that college tuition is not worth it. In other cases, the intrinsic value of education is much higher than the book value, and this result can prove that capital is being used effectively. At any rate, you should understand that book value doesn't have much to do with intrinsic value.

XVI. Management of Berkshire

Finally, I would like to talk about Berkshire's current and future management. As stated in the first shareholder principle, Charlie and I are managing partners at Berkshire. But we delegated complex management responsibilities to our subsidiary's manager. In fact, we are almost completely decentralized: although the entire Berkshire Group has 367,000 employees, the headquarters only has 25 people.

Charlie and I are mainly concerned with allocating capital and supervising managers. Most of them prefer to take full control of the company themselves, which is our default management method for managers. This will give them full control over the company's operating strategy and the amount of revenue retained. When they hand over their cash to us, they won't be tempted to manage the extra money. Furthermore, Charlie and I have more investment opportunities than our managers in their own industry.

Most of our managers have achieved financial freedom, which requires us to cultivate a corporate culture that allows them to work for Berkshire rather than go golfing or fishing. That means we need to treat them fairly and put ourselves in their shoes.

As for capital allocation, this is an area where Charlie and I are both happy to do and have gained some experience. Generally speaking, age doesn't affect our performance: you don't need very good coordination of movements or strong muscles to manage capital (thank God). As long as our brains work effectively, Charlie and I can continue to work as we did before.

Berkshire's shareholder structure will change after my death, but there will be no disruptive impact: my shares will not be sold to distribute my estate or pay taxes, and my other assets will be sufficient to meet estate claims. All of my Berkshire shares will be distributed over several years to multiple foundations in roughly the same amount each year.

After my death, the Buffett family will not participate in the management of the company, but as major shareholders, they will participate in selecting and supervising the company's managers. Of course who will take my place depends on when I leave. But I can predict that the management structure will be: basically my responsibilities will be divided into two parts. A general manager will be the CEO and manage the day-to-day operations. Investment responsibilities will be assigned to one or more general managers. If there is a new acquisition project, these general managers make decisions together when necessary, with the permission of the board of directors. We will continue to maintain a shareholder-oriented board of directors whose interests are in line with yours.

If for some reason we need to immediately implement the management structure I just mentioned, the Board knows who my candidates are in the two sections. All candidates are either already working in Berkshire or are ready to work for Berkshire. They are all people I trust completely. Our manager list is at its best ever.

I will keep the Board informed about candidates. Since Berkshire's holdings are almost all of my assets, and will also be an important asset for many foundations for a long time to come, you can rest assured that the board and I have carefully considered and prepared the candidate's questions. You can also trust that the shareholder principles we have always applied will continue to lead my heirs, and that our effective and distinct corporate culture will continue to be maintained. As an added guarantee, I believe it would be a good idea to have a member of the Buffett family as an unpaid non-executive board member when I'm no longer CEO. Whether it will be adopted will depend on the Board's decision at that time.

Despite all the bad things we've talked about, I want to tell you that I've never been happier. I love managing Berkshire. If people who love life live a long time, then Marshallah's (note: very long-lived person) longevity record may be broken by me.

edit/lambor