Warren Buffett Letter to Shareholders 2006 - Highlights

1. Geico has continued to improve its profit margins by increasing its productivity by 47% over a 3 year period. At the same time the company has increased its advertising expenses substantially from $238 mn in 2003 to $631 mn in 2006.

2. Buffett measures the growth in intrinsic value of Berkshire by two yardsticks:
o The first is the amount of investments (including cash and cash-equivalents) that Berkshire owns on a per-share basis and
o The second yardstick is the pre-tax earnings from non-insurance businesses.

3. Berkshire has concluded 2 key acquisitions in 2006:
o ISCAR – a manufacturer of small, consumable cutting tools that are used in conjunction with large and expensive machine tools, and
o TTI – a distributor of electronic components.

4. One of the key highlights was the explanation of the economics of the media industry in general and newspapers in particular. Key points are:
o The fundamentals are definitely eroding for the US Newspaper industry in favor of the cable & satellite broadcasting and the internet. This has caused the profitability of Berkshire’s newspaper operating business, viz, Buffalo News to fall.
o The profitability of the media (newspaper, of news channel, or the internet website) business is dependent on its relative reach. If the relative reach is high, the media can charge a higher charge for advertisements, which can be raised annually to keep increasing the profitability.
o One of the best business to own is a media business with a very high relative market share, which is like a uncontrolled monopoly with a huge pricing power.

5. Buffett expects his key investee companies to grow their earnings by 6% to 8% annually, a rate that would double their earnings every ten years or so.

6. Berkshire has, since 2002, made a profit of $2.2 billion from its bet on depreciation of US dollar.

7. According to Buffett, the slide in dollar is imminent due to the rise in US trade deficit, which has increased to an alarming 6% of GDP. This 6% of GDP is financed by capital account (foreigners buying into US dollar denominated assets). However, one of the most alarming trend is the investment income of US turning negative for the first time since 1915. According to Buffett, the US shall henceforth experience “reverse compounding”, i.e., pay net interest to foreigners on their investments in the USA.

8. Buffett has put out a disguised advertisement for a young fund manager who he wants to appoint to manage the portfolio of Berkshire. The key characteristics of the desired candidate are:
o He should have an impressive investment record
o He should be genetically programmed to recognize and avoid serious risks, including those never before encountered
o He should have independent thinking, emotional stability, and a keen understanding of both human and institutional behavior
o He should remain with Berkshire and not be lured away by money (having Berkshire on a resume would materially enhance the marketability of an investment manager)

9. Buffett has once again stressed the need for compensation to be tied to the operating performance of the manger and nothing else (like competitive payscales)

10. Buffett ridiculed market efficiency by giving the example of Walter Shloss, who has consistently beaten the markets by buying “Cheap Stocks”.