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2006 Shareholder Letter

Published on 28 February 2007

· Value Investing

The original 2006 Shareholder letter can be found here (

Measuring Intrinsic Value

Many people may feel that intrinsic value seems to be the most important criteria in deciding whether to invest or not, but that's not really the truth. While intrinsic value gives you a "benchmark" to decide whether the current prevailing stock price is sensible or not, the estimation of intrinsic value is inherently subjective and prone to miscalculation. However, the fact that it cannot be precise, doesn't mean it shouldn't be used. It just means you should probably pay more attention to it, and use a range rather than a single precise figure.

Charlie and I measure Berkshire’s progress and evaluate its intrinsic value in a number of ways. No single criterion is effective in doing these jobs, and even an avalanche of statistics will not capture some factors that are important.

Look for the best possible opportunity

When it comes to the capital allocation game, it's important to be clear, all the time, of what we're trying to achieve. We're trying to do the best with our money, even 1% difference makes a lot of difference in 10 years, so it makes sense to find the best "home" for our capital. We shouldn't waste time researching opportunities that we know won't make a good "home" whether it's because you disagree with the company's mission, or the industry is changing or there are many factors that you dont understand about the business. It's always important to focus most of our efforts on the deal that has the highest likelihood of making the most sense.

We continue, however, to need “elephants” in order for us to use Berkshire’s flood of incoming cash. Charlie and I must therefore ignore the pursuit of mice and focus our acquisition efforts on much bigger game.

Characteristics of a good investor

Interestingly enough, WB talks about a successor for the investment part of the business here, and inevitably touches on some of the important characteristics: lessons that we'll do well to try to incorporate if we are to become better investors as well. Another important point is that good investment managers may or may not stay on in the same place - another reason why it's difficult to allocate your capital to a professional fund, and hope that the same managers are there 15 years from now.

We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions. Temperament is also important. Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success. I’ve seen a lot of very smart people who have lacked these virtues.

Sidenote on Company Board Directors

In this letter, WB repeated his point that it's very difficult to have truly independent company board directors who only think on behalf of shareholders, as they should be. Unfortunately, as their appointments are mostly up to the CEO, it's difficult to have a situation in which they are truly independent.

In selecting a new director, we were guided by our long standing criteria, which are that board members be owner-oriented, business-savvy, interested and truly independent. I say “truly” because many directors who are now deemed independent by various authorities and observers are far from that, relying heavily as they do on directors’ fees to maintain their standard of living. T

The Gotrocks Family Again

Never ask a barber if you need a haircut - and if you ask a private wealth banker whether you need help managing your wealth, or if you ask your financial advisor friend whether you need financial advice, guess what the answer is. This year, WB points out that a large amount of funds have gone from institutional investors to private equity funds.

When someone with experience proposes a deal to someone with money, too often the fellow with money ends up with the experience, and the fellow with experience ends up with the money.

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