Warren Buffett pressed the case at Berkshire Hathaway Inc.’s annual meeting for why takeovers make more sense for the company than the stock picks that propelled growth for decades.

The billionaire told thousands of shareholders at the CenturyLink Center in Omaha, Neb. on May 3 that he and business partner Charles Munger are focused on acquiring large companies to create “more enduring” value.

“What we really want to do at our present size and scope, and with the objectives we’ve got for our shareholders, is we want to buy big businesses with good managements at reasonable prices and then try to build them over time,” said Buffett, Berkshire’s chairman and chief executive officer. “It’s a different sort of buildup of value” than investing in stocks, he added. “We’ve moved into phase two.”

Warren Buffett  (AP Photo/Nati Harnik, File)
Warren Buffett
(AP Photo/Nati Harnik, File)

Buffett, 83, transformed Berkshire over the past half century from a textile maker into the world’s fifth-largest company by market value. In his first decades as CEO, he focused on using premiums from insurance units to buy stocks. That strategy evolved, and now the company derives most of its earnings from operating businesses in industries from energy and manufacturing to transportation and retail.

“He became famous as a stock picker, and that reputation still dominates in the public image,” said Lawrence Cunningham, a professor at George Washington University and author of the forthcoming book “Berkshire Beyond Buffett.” He was “very good at doing that, but that has not been the definition or content of Berkshire” in recent years.

Energy Deals

Less than 20 percent of Berkshire’s earnings came from investment income at insurance businesses in 2013. That compares with about half in 1988, according to the company’s annual reports.

First-quarter net income slipped 3.8 percent to $4.71 billion from a year earlier on worse underwriting results at insurance subsidiaries, the company said May 2. Profit climbed 15 percent at Berkshire Hathaway Energy, which purchased a Nevada utility in December and announced a deal May 1 to buy SNC-Lavalin Group Inc.’s AltaLink for about $2.9 billion to expand in electricity transmission in western Canada.

Berkshire was also transformed by the 2010 purchase of railroad Burlington Northern Santa Fe in Buffett’s largest deal. BNSF contributed $3.8 billion of Berkshire’s $19.5 billion profit last year.

Shareholders have sought to glean for years what the company will be like after Buffett is no longer in charge, and many questions at the meeting centered on that topic. Buffett has never publicly identified his successor, though he has said that the board is in agreement on an individual and that his roles will be split.

Capital Allocation

“The problem at Berkshire is not that the company is going to blow up when Warren Buffett dies,” said James Armstrong, president at Henry H. Armstrong Associates, which manages about $500 million. “The problem at Berkshire is how is the company going to reinvest” the billions of dollars it will generate. “The wisest thing to do is to buy more Burlingtons,” he said.

Buffett has said that his son, Howard, will become nonexecutive chairman to help guard the culture. Investments will be overseen by Todd Combs and Ted Weschler, money managers that the elder Buffett hired in 2010 and 2011, respectively. Each now oversees about $7 billion.

Berkshire’s stock portfolio was valued at $118.5 billion at the end of March, and more than half of it was in just four companies: Wells Fargo & Co., Coca-Cola Co., International Business Machines Corp. and American Express Co.

Buffett’s Canary

Buffett faced a new succession question this year, beyond the usual inquiries about the next CEO. He was asked whether the board had decided on someone to take over the duties held by Munger. Buffett said the directors had not, then quipped: “He’s my canary in the coal mine.”

“Charlie turned 90,” Buffett said. “I find it very encouraging how he’s handling middle age.”

Buffett said that he hopes his successor will find a partner like Munger and that Berkshire is better off because of their collaboration. Such a joint effort will add to the new CEO’s achievements and the “fun they have,” he said.

Buffett also told shareholders that they shouldn’t “make any judgments” about succession planning at Berkshire based on what happens at subsidiaries. Matt Rose, 55, took on the job of executive chairman at BNSF in January after being CEO for 13 years. The shift fueled speculation that the railroad executive was being primed for a larger role.

Management Challenge

As Berkshire has expanded, Buffett has increasingly been asked how he’s able to manage such a sprawling operation with more than 300,000 employees. The company operates in a decentralized fashion, and managers of the more than 80 subsidiaries are given autonomy. Still, Buffett said at the meeting he would devote part of his annual letter next year to address how the organization could be structured.

Previously, Buffett had indicated that such decisions might be left up to his successor. The comments at this year’s meeting may mean there’s some sort of intermediate step, said Richard Cook, co-founder of Cook & Bynum Capital Management LLC, which invests in Buffett’s company.

“Clearly, Berkshire needs some sort of infrastructure to deal with the operating businesses as more and more of them are not run by the person who sold them” to Buffett, said Cook, who helps oversee about $310 million. “There are too many of them for anyone to follow.”

Buffett’s Juice

While Buffett said that his acquisition strategy still has “some juice” left, he also told shareholders that a day may come when Berkshire can’t find ways to reinvest all its funds. “There’s no question at some point we will have more cash than we can intelligently deploy in the business,” Buffett said.

Berkshire ended the first quarter with almost $49 billion in cash. Investors rejected a shareholder proposal this year to consider paying a dividend.

With the shift toward buying operating companies, Buffett was asked why he continues to evaluate performance against the Standard & Poor’s 500 Index. Buffett publishes a chart at the beginning of his annual report comparing the change in Berkshire’s book value per share with the return of the equity benchmark, including dividends.

The five-year period that ended in 2013 was the first stretch of that length that Buffett failed to beat the benchmark, partly because of the market rally. Also, the book value per share number is an after-tax figure, while the benchmark isn’t.

“Warren has set a ridiculously tough standard,” Munger said. “If this is failure, I want more of it.”