MGMT326 Buffet Letter Assignment 1

American University of Armenia
MGMT 326
Instructor: Vardan Khachatryan
Students:
Ani Khachatryan
Astghik Sargsyan
Arsen Grigoryan
Yelena Yeghyan
Marat Khachatryan
Assignment 1
1) What is the characteristic of well managed companies and why it is important – given the
example for Buffet’s case?
According to the case, well-managed industrial companies don’t distribute to the shareholders all
of their earned profits, instead they prefer to reinvest to continue the growth and development of
the company.
2) What are the criteria Buffet looks when making a decision to invest in a business?
Although reinvestment in the productive operating assets is the top priority for Berkshire, in
order to remain the investments diverse it is essential to continuously look for new businesses
and spheres to invest in. For this, Buffet points several criteria that should be taken into account
when buying a new business.
First of all, Berkshire is looking for companies that have outstanding returns on the net tangible
capital required in their operation. Another important factor that should be taken into account is
the characteristics of managers who run those businesses such as honesty. In addition, it is
important for the price to be reasonably set.
Because the businesses that correspond to the criteria mentioned above are rare, in case of
spotting such companies Berkshire buys 100 per cent of those companies, otherwise, stock
market serves as an alternative for buying large positions in the companies meeting the
standards.
3) Which company among the holdings of businesses of Buffet/Berkshire has the best metric
described by Buffet?
From the list of 10 largest stock-market holdings of Berkshire it can be found that Apple's year-
end retained earnings are highest among other companies. The dividends paid by Apple are also
the highest of all despite the fact that the year-end ownership percentage was not that high
compared to other investments. As Buffet mentions, dividends are Berkshire's share of the
earnings that the investors retain and put back to work. The reinvested funds serve as excess
funds coming back to those companies and are usually used for development and increasing
efficiency. Apple’s figures show the highest results out of all and also the market value of its
shares is the highest.
4) What is unique in the Buffet/Berkshire’s portfolio company of BHE?

The case mentions that when Berkshire entered the utility market, customers paid 8.8cents per
kilowatt-hour. Since then, the prices increased by less than 1% a year, and the base rate was not
supposed to increase. In comparison with this, other major companies in the market set prices
significantly higher (about 61%) than BHE. BHE provides energy with lower cost due to their
efficient operations, specifically their ability to sell wind-sourced energy. They expect to
increase the production of wind-energy, and it is expected that by 2021 the output will be
approximately 25.2mln megawatt-hours. In comparison with local competitors, major ones use
wind to generate about 10% of the output.
BHE’s competitive advantage is that none of the local competitors achieved such a position of
being wind self-sufficient. BHE can be considered as a low-cost and renewable energy supplier.
Another improvement of BHE is that a few decades ago the company was mainly a provider of
energy to the agricultural industry, while in 2020-2021 its main customers are high-tech
companies.
BHE also considered the inconsistency of wind, as their turbines are working only a part of the
time. The company took the advantage of the possibility of non-wind generators, to secure the
energy volume required by the customers. Hence, the company decreased its dependence from
external factors, such as the absence of wind. In case of excessive volume of energy produced
(because of stronger wind), the company sells energy to other utilities, to compensate for their
usage of coal or natural gas.
Currently, BHE is focused on internal improvements, and that’s why BHE has never paid
dividends to Berkshire Hathaway. All its earnings are being reinvested.
5)What does Buffet say about equities as an investment?

Buffet mentions that in the long run equity investments have advantage compared to fixed-rate
debt instruments as Berkshire is not much engaged in forecasting interest rates and making
decisions based on those forecasts, but rather, based on the assumption that in the future the rates
will mainly be close to the current ones and corporate tax rates will not face radical changes, they
are certain that over time the equity investments will perform much better.
As Buffet points with combination of compounding effect that Mr. Smith explains as a result of
an increase in the value of property due to the reinvestment of retained earnings for the
development and the American Tailwind will make equities the much better long-term choice for
the individual who does not use borrowed money and who can control his or her emotions. Thus,
Berkshire group expects its equity holdings to deliver major gains though in an unstable manner.
6)What does Buffet say about managers who wish to game numbers?
The quality of work provided by the audit department has been improved recently owing to the
seriousness and hard work of auditors. However, managers and CEOs who have the desire to
manipulate some numbers do not encourage recent changes. There is a shred of interesting
evidence that shows that CEOs and managers tend to manipulate the numbers not only for
financial purposes but also because of personal satisfaction or in a word ego.
It is hard to indicate the rates for upcoming years as forecasting is not an easy thing. Hence, it
can be claimed that the specialists who express an opinion about these certain topics mainly
make assumptions about themselves rather than about the future.
7) What does Buffet want to say when he gives an example of - Don’t ask the barber whether
you need a haircut comparison in his letter?
One of the main problems for board members is acquisition proposals. It should be taken into
account that the arrangement of deal preparation has been improved. However that does not
mean that the good result of a deal is ensured.
As a rule of thumb, the deals usually envied by the CEOs or other chief executives of the
company are being processed. In fact, there are several ways to improve the acquisition
experience of the company. For instance, it can hire two acquisition specialists with different
backgrounds so that they can express different opinions on the same deal, and the one whose
points would outweigh the other advisor's viewpoint would get an award. Unfortunately, it is not
realistic to wait for this kind of improvement in the foreseeable future. The reason is that the
current system favors CEOs or other staff members whom the deals may benefit.
8) What is the recommendation of Buffet on the director’s independence – he feels more

comfortable when the directors do what kind of action?
Buffet values owner-oriented and company-oriented directors, with strong interest in the
development of the company. It’s also important for them to be a good citizen both for their
community and country. And finally, it’s important for directors to have experience in
purchasing shares with their own savings, as by this, they will have more wisdom in creating
portfolios.
9. What characteristics does Buffet value in managers of his company?
Buffet values skilled and devoted top management. He considers that for managers it is
important to be company-oriented, and when their positions at Berkshire are not just high-paying
or prestigious jobs. Managers should also be customer-oriented, good citizens for their
communities and country.

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American University of Armenia

4) What is unique in the Buffet/Berkshire’s portfolio company of BHE?

5)What does Buffet say about equities as an investment?

8) What is the recommendation of Buffet on the director’s independence – he feels more

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