Secrets Of Success: Buffett is still far from a spent force

Still, Buffett's investment activities have been carried on for the past 40 years or so as chairman and chief executive of a publically quoted company. The market value of Berkshire Hathaway, his holding company, is today worth the best part of $100bn (£57bn).

Although he has little time for a lot of conventional corporate governance thinking, Buffett is all too aware of the need to confront the issue of succession - which he does in this year's annual report.

Shareholders will be comforted to know that the board has chosen a successor to be CEO of the core insurance and conglomerate business, should the need arise. Pure portfolio investment decisions, the buying of quoted shares and bonds, are a much smaller part of Berkshire Hathaway's activities than before. They will be delegated once Buffett goes, he says, to a proven investment manager.

The obvious candidate is Lou Simpson, who has run the investment portfolio of Buffett's Geico insurance company with almost as much success as his boss, but who may be too old by the time Buffett goes.

"The other question that must be addressed," Buffett continues, "is whether the board will be prepared to make a change if that need should arise not from my death, but rather from my decay, particularly if this decay is accompanied by my delusionally thinking that I am reaching new peaks of managerial brilliance. That problem would not be unique to me....

"Humans age at greatly varying rates. Some managers remain effective well into their eighties - Charlie [Munger, his long-serving business partner] is a wonder at 82 - and others noticeably fade in their sixties.

"When their abilities ebb, so usually do their powers of self-assessment. Someone else often needs to blow the whistle."

In the case of Berkshire Hathaway, that delicate duty, should it arise, will fall to the board of the company. The number of directors was recently increased, in part to confront this very issue. The new directors include Buffett's friend Bill Gates of Microsoft.

All the directors, Buffett points out, have big shareholdings in the company and will not hesitate to act if it proves necessary in shareholders' interest.

But will they? And should they be doing something already, on the grounds that Buffett's best days as an investor may be behind him?

That issue continues to crop up. In 2005, Berkshire Hathaway's net worth per share - the measure Buffett uses to record his progress - grew by 6 per cent, a performance that only narrowly beat the equally disappointing S&P 500 index over the period (US shares have underperformed the world market since the bear market ended).

This poor performance, coupled with Buffett's largely unsuccessful $20bn foreign currency bet against the dollar, has caused some commentators to call time already on his career. For example, in a recent critical article in a Canadian business publication, the author recalled a famous Buffett comment in 1974 when markets were as cheap as they have ever been in post-war history.

"I call investing the greatest business in the world because you never have to swing [baseball analogies have always been a Buffett stock in trade]. All day you can wait for the pitch you like; then when the fielders are asleep, you stand up and hit. Like an oversexed guy in a whorehouse, this is the time to start investing."

The writer then goes on: "Since the mighty Omaha slugger Warren Buffett made that statement 32 years ago, many fielders have been caught napping and shares in Berkshire Hathaway have soared from $5,700 to $87,675. That's an approximate 16-fold return. Berkshire shares are up about 5,000 times since 1966 when Buffett took control of the company.

"However, times have changed, and the Warren Buffett party has turned into a sombre affair. If I were a Berkshire shareholder, I'd be fed up with watching Buffett stand in the batters' box with his bat on his shoulder. I'd be wondering if the 75-year-old should be considering hanging up the cleats on a dazzling career.

"The investment world continues to worship Buffett, and yet the world's most famous investor has been nothing but an ordinary investor in the past decade....

"In the past 10 years, Berkshire has merely matched strides with the S&P 500 index with an annualised return of about 9 per cent. That's the sort of return you'd expect from a mediocre mutual fund."

Well that seems clear, but is it true? Compound return from Berkshire Hathaway shares since March 1996 has been 11 per cent a year, against 7 per cent for the S&P 500 index and less for the average mutual fund. If you go back another 12 months when Berkshire shares were up 50 per cent in a year, the comparable figures change to 14 per cent and 9 per cent.

The real difference is that while both Berkshire Hathaway and the S&P grew at 22 per cent compound in the bull-market years of 1995 to 2000, the average return from Berkshire since March 2000 has been 8 per cent, against a negative 1 per cent for the S&P 500 index.

That is not an exceptional record - but nor is it that bad for a failed old slugger. Buffett's real problem is not his age or mental capacity, but the sheer size of his business. There are not enough opportunities of a requisite size that can add 30 per cent or more to the value of his shareholders' investment in a year, as he once could.

So should he hang up his bat? There seems no good reason. During difficult markets experienced value-investors such as Buffett come into their own. In today's late bull-market conditions, when thanks to cheap money required rates of return are lower than for years, almost everyone is making money.

But will the same be true when things start to get more tricky? Unless the Great Reaper intervenes, my guess is still that Buffett has at least one last hurrah left in him. I wouldn't want to bet on the Berkshire Hathaway board having to troop in to tell the old boy he is gaga just yet.

jd@independent-investor.com

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