Learning points from Warren Buffett’s 2018 Berkshire Hathaway annual letter. Focus on the forest and not the trees.
Berkshire 2018 Earnings
- Operating Earnings: $24.8b
- Non-Cash Loss (Kraft Heinz): -$3.0b
- Capital Gains Investment Securities: $2.8b
- Unrealized Capital Losses Investment Holdings: -$20.6b
Buffett admitted to overpaid for Kraft Heinz by buying the stock at a premium with 3G Capital operating the business in 2015. The brand took a massive write-down for their brand and intangible assets. Kraft Heinz is also facing lowered profitability, changing customer preferences, and a SEC investigation into accounting practices. However, Buffett is continuing to hold on to the stock (although he won’t be buying more).
GAAP or Generally Accepted Accounting Principles is described by Buffett as causing “wild and capricious swings” as equities must be valued at market prices. Being marked to market results in vast swings and high volatility.
- 2018 1Q: -$1.1b
- 2018 2Q: $12.0
- 2018 3Q: $18.5b
- 2018 4Q: -$25.4b
“As I emphasized in the 2017 annual report, neither Berkshire’s Vice Chairman, Charlie Munger, nor I believe that rule to be sensible.” ~Warren Buffett
Goodbye Per-Share Book Value
Per-Share Book Value indicates the book value (aka accounting value) of every 1 share. Buffett has finally decided to no longer report per share book value after reporting it since 1986. Previously per share book value had grown 1,091,899% or 18.7% annually. The following reasons are given:-
- Berkshire has changed from company focused on marketable stocks to one whose value is in operating businesses.
- Accounting rules require Berkshire’s operating companies to be valued at book value which is far below current value.
- Berkshire will over time become a significant repurchaser of shares which reduces per-share book value.
“For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s
now time to abandon that practice.”
Buffett has relaxed guidelines on buying back shares of Berkshire to buy at a discount to Berkshire’s intrinsic value. Previously, the rule was of buying back shares only when the stock was trading below 1.2 times book value. Overall Berkshire bought back $1 billion of its own shares in 2018.
Buffett has over the years talked much about intrinsic value which is difficult to measure. Cash generation is projected into the future while applying a discount rate such as the long-term government rate.
“Intrinsic value is the present value of the stream of cash that’s going to be generated by any financial asset between now and doomsday.”
“The value of any stock, bond or business today is determined by the cash inflows and outflows — discounted at an appropriate interest rate — that can be expected to occur during the remaining life of the asset.” ~The Theory of Investment Value, John Burr Williams
Buffett describes Berkshire’s intrinsic value can be approximated by summing the values of all their assets and then subtracting taxes which are eventually payable for the sale of marketable securities.
Focus on the Forest – Forget the Trees
Buffett advocates to focus on the five “groves” that is Berkshire instead of trying to count all the “trees”.
“A few of our trees are diseased and unlikely to be around a decade from now. Many others, though, are destined to grow in size and beauty.”
Buffett’s Five Groves
- Businesses that are 80%-100% owned by Berkshire such as BNSF Railroad and Mid-American Energy.
- Publicly traded equities which Buffett owns large 5-10% such as Apple, Coca-Cola, Bank of America, and American Express.
- Shared control companies such as Kraft Heinz, Berkadia, and Pilot Flying J.
- Fixed income securities such as treasury bonds to the tune of $130b.
- Insurance operations and the magic of “insurance float”.
Berkshire Succession Planning
Shareholders of Berkshire are still concerned on the future when Buffett (age 88) and Munger (age 95!) are no longer running Berkshire. Management changes in 2018 at Berkshire saw Ajit Jain overseeing all insurance activities and Greg Abel over all other operations.
Berkshire looks to be indeed a rare one of a kind mature forest for now and into the future despite challenges ahead whether from companies future performance (Kraft Heinz, Apple, etc), changes to the world, and the inevitability of time. It is good to see that Buffett has shown his ability to change such as investing in airlines which he previously would not touch.