The next CEO
Given the importance of thoughtful capital allocation to Berkshire's success over the years, much has been written about Berkshire's succession strategy and the possible effects on the firm when Buffett eventually steps down. Both Buffett and Munger addressed the issue, offering a few hints along the way.
"Both the board and I believe we now have the right person to succeed me as CEO," Buffett wrote, "a successor ready to assume the job the day after I die or step down. In certain important respects, this person will do a better job than I am doing."
Beyond confirming that the future CEO would come from internal candidates and would be "relatively young, so that he or she can have a long run in the job" Buffett didn't name any names. Munger, however, mentioned in his own forward-looking portion of the letter, "Ajit Jain [who heads several of Berkshire's reinsurance businesses] and Greg Abel [president and CEO of Berkshire Hathaway Energy] are proven performers who would probably be under-described as 'world-class.' 'World-leading' would be the description I would choose. In some important ways, each is a better business executive than Buffett."
Looking back at the ingredients of Berkshire's success, both Buffett and Munger interestingly noted the importance of keeping it simple and fending off bureaucracy, which will continue to be key for the firm's next CEO.
"At headquarters, we have never had a committee nor have we ever required our subsidiaries to submit budgets (though many use them as an important internal tool)," Buffett wrote. "We don't have a legal office nor departments that other companies take for granted: human relations, public relations, investor relations, strategy, acquisitions, you name it."
Munger touched on the same in describing the guiding tenets of Berkshire: "There would be almost nothing at conglomerate headquarters except a tiny office suite containing a Chairman, a CFO, and a few assistants who mostly helped the CFO with auditing, internal control, etc."
The next 50 years
Looking forward, both Buffett and Munger were optimistic about Berkshire's prospects.
"I believe that the chance of permanent capital loss for patient Berkshire shareholders is as low as can be found among single-company investments," Buffett wrote. "That's because our per-share intrinsic business value is almost certain to advance over time."
"Intrinsic value" is the key phrase, as we know market price and intrinsic value don't always go hand in hand. Investors must mind valuation, even for the best of companies. "A sound investment can morph into a rash speculation if it is bought at an elevated price," Buffett noted. "Berkshire is not exempt from this truth."
(For the record, Morningstar estimates Berkshire's intrinsic, or fair value, at $157 per B share today, just a touch above its current trading price of $147 and change, meaning the shares look essentially fairly valued.)
Backing that intrinsic value growth, Buffett wrote, is the firm's solid financial strength and diversified earnings stream. "We will always be prepared for the thousand-year flood," Buffett wrote, pointing to Berkshire's role as "first responder" during the market crisis. The firm's cash on hand ("at least $20 billion--and usually far more") plays a major role not only in its ability to pounce on opportunities, but also in riding through the inevitable market panic. "Cash is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent," Buffett noted.
In the short term, the stock's market performance, Buffett admitted, is anyone's guess. "Movements of the general stock market during such abbreviated periods will likely be far more important in determining your results than the concomitant change in the intrinsic value of your Berkshire shares," he wrote, recommending at least a five-year holding period time.
As for the long term, Buffett echoed past comments in advising shareholders to moderate expectations. "The bad news is that Berkshire's long-term gains--measured by percentages, not by dollars--cannot be dramatic and will not come close to those achieved in the past 50 years," he noted. "Probably between ten and twenty years from now, Berkshire's earnings and capital resources will reach a level that will not allow management to intelligently reinvest all of the company's earnings."
For Berkshire's shareholders, that could mean dividends or buybacks, but for now the firm sees plenty of use for its cash flow.
Munger noted, for instance, that Berkshire's railroad and utility subsidiaries provide sizable opportunity to invest in new fixed assets and that the environment for acquisitions could improve. "With Berkshire now so large and the age of activism upon us, I think some desirable acquisition opportunities will come and that Berkshire's $60 billion in cash will constructively decrease," he wrote.