2011 Letter to Shareholders

To the Shareholders of Berkshire Hathaway Inc.

In 2011, I devoted considerable space in this letter to the dangers of derivatives. These instruments are widely misunderstood and create risks that are both invisible and potentially catastrophic.

"Derivatives make it impossible to cut ties with the past. Their values are tied to past events that may have been wrongly evaluated at the time and are certainly difficult to analyze in retrospect."

The Illusion of Risk Management

Most risk models assume that the future will resemble the past. They use historical correlations and volatilities to estimate future losses. This approach is fatally flawed.

The 2008-2009 financial crisis proved that correlations can jump to one precisely when you need diversification most. When everyone sells simultaneously, every asset class falls. Risk models that assumed diversification would protect investors failed spectacularly.

Berkshire takes a different approach. We maintain enormous financial strength so that we never face forced selling. We don't need risk models that assume normal conditions; we plan for abnormal ones.

IBM: A New Position

In 2011, we initiated a significant position in IBM. The company had transformed itself from a hardware business into a services and software company, with predictable recurring revenue from its mainframe installations and consulting contracts.

IBM fits our criteria: a wide business moat, management aligned with shareholders, and a reasonable price relative to earnings power. Its focus on enterprise computing creates switching costs that keep clients loyal.

Burlington Northern

Our railroad acquisition continues to exceed expectations. Carl Ice and his team have integrated operations smoothly, captured synergies, and maintained service quality that keeps customers coming back.

The railroad business is essentially a toll road: customers must ship goods, and BNSF is often the only practical option. This pricing power, combined with high barriers to entry, creates an attractive long-term business.

Insurance Operations

Our insurance float grew to $49 billion in 2011. This float—permanently available, no interest required—is the gift that keeps on giving.

Ajit Jain continued to demonstrate his unique ability to underwrite risks that others cannot even understand, let alone price. His reinsurance operations generate returns that would be impossible for less-capitalized competitors.

Looking Forward

Our philosophy is simple: own excellent businesses, hold them forever, and maintain the financial strength to wait for opportunities. This approach has worked for 47 years and will continue to work.

1. We don't need normal conditions — Our strength allows us to wait out any crisis
2. We think in decades — Quarterly noise is irrelevant to our analysis
3. We own essential businesses — What we own serves needs that don't disappear
4. We trust America — Our entire system depends on continued American prosperity

Warren E. Buffett February 2012