This is the thirty-first in a series of blog posts that will analyze / summarize Warren Buffett's shareholder letters from 1977-2016. For all of the prior shareholder letters, see here.
The 2007 letter weighs in at 12,170 words, a 15.7% decrease from 14,420 words the prior year. Berkshire's gain in net worth during 2007 was $12.3 billion, or 11% of beginning 2007 net worth.
DOES TESLA HAVE A COMPETITIVE MOAT?
According to Buffett, in order to have a competitive 'moat' a business must have qualities inherent in its operations which largely immunize it from the deleterious effects of competition, regardless of who the CEO might be at any particular time. Here is Buffett's view on the matter...
[I]f a business requires a superstar to produce great results, the business itself cannot be deemed great. A medical partnership led by your area’s premier brain surgeon may enjoy outsized and growing earnings, but that tells little about its future. The partnership’s moat will go when the surgeon goes. You can count, though, on the moat of the Mayo Clinic to endure, even though you can’t name its CEO.
Some people presumed that Apple couldn't withstand the passing of Steve Jobs in late 2011 [see here for a contemporaneous summary of the debate], however this belief has clearly been disproven, as both Apple's stock price and the company's annual profits have soared over the past five years. Apple's moat, it turned out, lay in its products, not its CEO.
Similarly, one might imagine that Tesla's moat lies in the supposed genius of its CEO Elon Musk, rather than in the greatness of its products or its status as the potential low-cost producer of electric vehicles. Then again, the opposing viewpoint would be that Musk is attempting to create a sustainable competitive advantage over other electric vehicle producers by creating a phenomenal brand in conjunction with low-cost production bragging rights [for a summary of this view, see here]. Whether TSLA stock, currently trading over $300/share, can be considered 'reasonably priced' thus depends on what view one holds regarding the sustainability of Tesla's moat. If one believes that Musk's company will dominate the renewables space [i.e., energy storage and electric vehicles] for the next 30 years, then it probably is; if one thinks such an outcome is impossible to predict or unlikely, it isn't. We tend towards the latter view, leading us to the conclusion that buying TSLA at $300 or higher is impossible to justify; however, we clearly could be mistaken [and if so, it will simply be because the company resides outside our circle of competence]. Based on how attractive the Tesla Model 3 looks, though, we may indeed be wrong...
HOW TO SCORE AN 8-BAGGER IN 5 YEARS
Buffett scored an eight-bagger in his Petrochina investment, the details of which he describes as follows...
We made one large sale last year. In 2002 and 2003 Berkshire bought 1.3% of PetroChina for $488 million, a price that valued the entire business at about $37 billion. Charlie and I then felt that the company was worth about $100 billion. By 2007, two factors had materially increased its value: the price of oil had climbed significantly, and PetroChina’s management had done a great job in building oil and gas reserves. In the second half of last year, the market value of the company rose to $275 billion, about what we thought it was worth compared to other giant oil companies. So we sold our holdings for $4 billion.
Clearly, the key to the Petrochina bonanza was in the bargain purchase price. Buffett was able to put nearly half a billion dollars into a large cap company at what he and Munger judged as approximately one-third of its intrinsic value. Couple that with said intrinsic value growing substantially after the purchase and the market finally giving credit to Petrochina by 2007 and Buffett was able to realize just over 8X his original investment upon selling, generating a CAGR of over 50%. So much for the theory that the market is efficient with respect to large cap stocks.
AMAZON EUROBOND PURCHASE
Buffett had purchased Euro-denominated bonds of Amazon in 2001 and 2002, realizing large gains by 2007 from both the underlying bonds as well as the appreciation of the Euro against the dollar...
Our direct currency positions have yielded $2.3 billion of pre-tax profits over the past five years, and in addition we have profited by holding bonds of U.S. companies that are denominated in other currencies. For example, in 2001 and 2002 we purchased €310 million Amazon.com, Inc. 6 7/8 of 2010 at 57% of par. At the time, Amazon bonds were priced as “junk” credits, though they were anything but. (Yes, Virginia, you can occasionally find markets that are ridiculously inefficient – or at least you can find them anywhere except at the finance departments of some leading business schools.)
The Euro denomination of the Amazon bonds was a further, and important, attraction for us. The Euro was at 95¢ when we bought in 2002. Therefore, our cost in dollars came to only $169 million. Now the bonds sell at 102% of par and the Euro is worth $1.47. In 2005 and 2006 some of our bonds were called and we received $253 million for them. Our remaining bonds were valued at $162 million at yearend. Of our $246 million of realized and unrealized gain, about $118 million is attributable to the fall in the dollar. Currencies do matter.
Interestingly, had Buffett instead invested the same $169 million in Amazon common shares instead of its bonds in 2001 and 2002, this investment would be worth on the order of $11 to $12 billion today, or a 68-bagger at the midpoint, representing a 30% CAGR over 16 years. Perhaps, at least in this case, Buffett was too clever by half.
For the record, in 2007 Berkshire's stock rose 29%, beating the S&P 500 by 23%, the Red Sox swept the Cardinals 4-0 in the World Series, the Giants shocked the undefeated and 12-point favorite Pats 17-14 in Super Bowl XLII, and on October 12th the Dow Jones reached a peak of 14,100 before crashing 53% to 6,630 over the next year and a half. Next up, 2008, the year it seemed the world was entering the Second Great Depression.