Quality Investing by Lawrence A. Cunningham: Buffett’s Legacy and All That Makes Berkshire Unique

The critical takeaway from the recent annual meeting of Berkshire Hathaway BRK.A, +0.73% BRK.B, +0.75% has been the least reported: the shareholder base has changed radically and the only way to assure that Berkshire endures beyond Warren Buffett is for his controlling stake be preserved after he leaves the scene.  Buffett spent his life cultivating a high-quality…

The key takeaway from the Berkshire Hathaway annual meeting
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The most under-reported fact is that Berkshire’s shareholder base has changed dramatically. It is essential that Warren Buffett’s controlling stake in Berkshire be retained after Buffett leaves.

Buffett spent his life cultivating a high-quality shareholder base at Berkshire, mostly individuals and families who shared his specific views of corporate life. It begins with Buffett and shareholders being co-owners of the partnership. This includes uncommon practices like having a board made up of businesspeople who are knowledgeable about the company. It also gives managers extraordinary autonomy. The acquired companies are held forever and all capital is reinvested instead of being paid out in dividends.

As Buffett plans for Berkshire after he’s gone, he is relying on the durability of those trust-based practices. This trust requires that Buffett’s fellow shareholders also understand and accept the practices. To that end, Buffett’s estate would gradually transfer, over a 12-year period, his 32% voting stake to charities, which would sell them into the open market.

As long as these shares are held by high-quality shareholders they can be trusted to elect a board who understands and supports those principles. In turn, this board would appoint such managers. Berkshire’s shareholder base is changing dramatically over the years. Transferring the shares would allow asset managers to take control, which would be disastrous for the company as it is.

While Berkshire has many high-quality shareholders that understand the company’s culture and assets, a lot of Berkshire shareholder base includes institutional asset managers who do not care about specific company features but instead invest and vote formulaically.

Index giants like BlackRock
+2. 49%

CalPERS and other influential pension funds, such as CalPERS invest in almost all companies, rather than picking stocks. They vote on director elections and shareholder proposals. These votes are often based on proxy advisor advice, checklists, social activism campaigns, and proxy advisor advice. This can have little to no impact on the business of these companies or on their specific businesses.

Buffett could once count on his flock to tend to his company after he leaves the scene. This is not the case now.

Take the shareholder proposals to this year’s Berkshire Meeting. One shareholder suggested splitting the CEO and chairman roles, rather than having Buffett remain in each. These universally-minded, simple rules are a favorite of formulaic asset managers. But the proposal violated Berkshire’s trust-based partnership culture and was made in total ignorance of it. While it therefore should have gotten zero votes, it received some 20% of the non-Buffett shares. This is a serious concern for any company that depends on its shareholders’ future. Although it is not a majority, it is still a significant number.

Worse, there are three options to consolidate reporting on greenhouse gas emissions by business units and diversity of workforce. Berkshire’s board stated that it supports the goal of minimizing greenhouse gas emissions and maximising diversity. It argued, however, that these outcomes are more likely to occur using Berkshire’s autonomous trust-based culture rather than top-down consolidated reports. Yet these proposals received more than one-third of the non-Buffett votes — with some activists blasting headlines of 47% approval.

This is not a majority vote, but it’s possible to imagine votes on other topics that would undermine valuable Berkshire practices in the future. One person might suggest selling a subsidiary due to poor short-term performance. This would be in contradiction to Berkshire’s commitment for permanent ownership. One might suggest declaring large cash dividends in order to provide liquidity. This is despite Berkshire’s policy of protecting tax-paying shareholders through opportunistically reinvested all capital. These destructive votes might be passed with shareholders like them.

It is possible that these formulaic asset managers’ power will decrease in the future. Their power comes from the fact they vote for their clients on behalf of the ultimate owner. These managers will alter their approach if clients find out that their votes are not in line with their preferences. That pressure has led some of the larger indexers to promise just that and proposals abound in Washington to requir

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