INSUBCONTINENT EXCLUSIVE:
Warren Buffett released his annual letter to Berkshire Hathaway shareholders on Saturday
Read the full text here:To the Shareholders of Berkshire Hathaway Inc.:
Berkshire earned $81.4 billion in 2019 according to generally
The components of that figure are $24 billion of operating earnings, $3.7 billion of realized capital gains and a $53.7 billion gain from an
increase in the amount of net unrealized capital gains that exist in the stocks we hold
Each of those components of earnings is stated on an after-tax basis
That $53.7 billion gain requires comment
It resulted from a new GAAP rule, imposed in 2018, that requires a company holding equity securities to include in earnings the net change
in the unrealized gains and losses of those securities
The adoption of the rule by the accounting profession, in fact, was a monumental shift in its own thinking
illustrate the argument we have with the new rule
In 2018, a down year for the stock market, our net unrealized gains decreased by $20.6 billion, and we therefore reported GAAP earnings of
In 2019, rising stock prices increased net unrealized gains by the aforementioned $53.7 billion, pushing GAAP earnings to the $81.4 billion
reported at the beginning of this letter
Those market gyrations led to a crazy 1,900% increase in GAAP earnings!
Meanwhile, in what we might call the real world, as opposed to
Our advising that in no way diminishes the importance of these investments to Berkshire
To see why we are optimistic, move on to the next discussion
The Power of Retained EarningsIn 1924, Edgar Lawrence Smith, an obscure economist and financial advisor, wrote Common Stocks as Long Term
Investments, a slim book that changed the investment world
Indeed, writing the book changed Smith himself, forcing him to reassess his own investment beliefs
Going in, he planned to argue that stocks would perform better than bonds during inflationary periods and that bonds would deliver superior
returns during deflationary times
That seemed sensible enough
Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits
In good years, if not in all years, they retain a part of their profits and put them back into the business
Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the
After all, it was no secret that mind-boggling wealth had earlier been amassed by such titans as Carnegie, Rockefeller and Ford, all of whom
had retained a huge portion of their business earnings to fund growth and produce
ever-greater profits
Throughout America, also, there had long been small-time capitalists who became rich following the same playbook.
Nevertheless, when
gamble on market movements
Even at their best, stocks were considered speculations
Gentlemen preferred bonds.
Though investors were slow to wise up, the math of retaining and reinvesting earnings is now well understood
have long focused on using retained earnings advantageously
In our deployment of the funds we retain, we first seek to invest in the many and diverse businesses we already own
plant and equipment have totaled $121 billion
Reinvestment in productive operational assets will forever remain our top priority.
In addition, we constantly seek to buy new businesses
First, they must earn good returns on the net tangible capital required in their operation
Second, they must be run by able and honest managers
Finally, they must be available at a sensible price
When we spot such businesses, our preference would be to buy 100% of them
But the opportunities to make major acquisitions possessing our required attributes are rare
Far more often, a fickle stock market serves up opportunities for us to buy large, but non-controlling, positions in publicly-traded
financial results from the commitment will in large part be determined by the future earnings of the business we have purchased
Nonetheless, there is between the two investment approaches a hugely important accounting difference,
essential for you to understand.
In
our controlled companies, (defined as those in which Berkshire owns more than 50% of the shares), the earnings of each business flow
directly into the operating earnings that we report to you
What you see is what you get
In the non-controlled companies, in which we own marketable stocks, only the dividends that Berkshire receives are recorded in the
operating earnings we report
For us, however, it is a standout omission, of a magnitude that we lay out for you below.
Here, we list our 10 largest stock-market holdings
Normally, those companies use
retained earnings to expand their business and increase its efficiency
Sometimes, alas, retentions produce nothing
(When we sell shares and realize gains, we will pay income tax on the gain at whatever rate then prevails
equity holdings, will manifest themselves in a highly irregular manner
Periodically, there will be losses, sometimes company-specific, sometimes linked to stock-market swoons
Smith got it right.
Non-Insurance OperationsTom Murphy, a valued director of Berkshire and an all-time great among business managers, long
proved disappointing; more than a few were outright disasters
A reasonable number, on the other hand, have exceeded my hopes
then reality tends to diverge from pre-nuptial expectations
In other cases, disillusionment is swift
Pursuing that analogy, I would say that our marital record remains largely acceptable, with all parties happy with the decisions they made
Some of our tie-ups have been positively idyllic
A meaningful number, however, have caused me all too quickly to wonder what I was thinking when I proposed.
Fortunately, the fallout from
employ only a tiny portion of our capital.
Today, we have most of your money deployed in controlled businesses that achieve
good-to-excellent returns on the net tangible assets each requires for its operations
Our insurance business has been the superstar
That operation has special characteristics that give it a unique metric for calibrating success, one unfamiliar to many investors
We will save that discussion for the next section.
In the paragraphs that follow, we group our wide array of non-insurance businesses by
costs that CEOs and Wall Street sometimes urge investors to ignore
billion in 2019 (including only our 91% share of BHE), an increase of 6% from 2018.
Our next five non-insurance subsidiaries, as ranked by
earnings (but presented here alphabetically), Clayton Homes, International Metalworking, Lubrizol, Marmon and Precision Castparts, had
aggregate earnings in 2019 of $4.8 billion, little changed from what these companies earned in 2018
The next five, similarly ranked and listed (Berkshire Hathaway Automotive, Johns Manville, NetJets, Shaw and TTI) earned $1.9 billion last
Our total net income in 2019 from the non-insurance businesses we control amounted to $17.7 billion, an increase of 3% from the $17.2
billion this group earned in 2018
Acquisitions and dispositions had almost no net effect on these results.
I must add one final item that underscores the wide scope of
Since 2011, we have owned Lubrizol, an Ohio-based company that produces and markets oil additives throughout the world
On September 26, 2019, a fire originating at a small next-door operation spread to a large French plant owned by Lubrizol
largest insurers of Lubrizol was a company owned by
the year we acquired National Indemnity and its sister company, National Fire - Marine, for $8.6 million
Today, National Indemnity is the largest P/C company in the world as measured by net worth
In extreme cases, such as claims arising from exposure to asbestos, or severe workplace accidents, payments can stretch over many
Meanwhile, insurers get to invest this float for their own benefit
Though individual policies and claims come and go, the amount of float an insurer holds usually remains fairly stable in relation to premium
Consequently, as our business grows, so does our float
And how it has grown, as the following table shows:
We may in time experience a decline in float
The nature of our insurance contracts is such that we can never be subject to immediate or nearterm demands for sums that are of
significance to our cash resources
That structure is by design and is a key component in the unequaled financial strength of our insurance companies
That strength will never be compromised.
If our premiums exceed the total of our expenses and eventual losses, our insurance operation
registers an underwriting profit that adds to the investment income the float produces
For the P/C industry as a whole, the financial value of float is now far less than it was for many years
Changes in interest rates therefore matter enormously to these companies, and during the last decade the bond market has offered
Where once these insurers could safely earn 5 cents or 6 cents on each dollar of float, they now take in only 2 cents or 3 cents (or even
less if their operations are concentrated in countries mired in the never-never land of negative rates).
Some insurers may try to mitigate
But those are dangerous games and activities that most institutions are ill-equipped to play
Most important, our unrivaled mountain of capital, abundance of cash and a huge and diverse stream of non-insurance earnings allow us far
more investment flexibility than is generally available to other companies in the industry
Our P/C companies have meanwhile had an excellent underwriting record
Berkshire has now operated at an underwriting profit for 16 of the last 17 years, the exception being 2017, when our pre-tax loss was a
For the entire 17-year span, our pre-tax gain totaled $27.5 billion, of which $400 million was recorded in 2019.
That record is no accident:
Disciplined risk evaluation is the daily focus of our insurance managers, who know that the rewards of float can be drowned by poor
All insurers give that message lip service
At Berkshire it is a religion, Old Testament style
As I have repeatedly done in the past, I will emphasize now that happy outcomes in insurance are far from a sure thing: We will most
certainly not have an underwriting profit in 16 of the next 17 years
having disastrous consequences beyond anything insurers now contemplate
Unlike many other insurers, however, handling the loss will not come close to straining our resources, and we will be eager to add to our
business the next day.
Close your eyes for a moment and try to envision a locale that might spawn a dynamic P/C insurer
New York? London? Silicon Valley? How about Wilkes-Barre?
Late in 2012, Ajit Jain, the invaluable manager of our insurance operations,
Both GUARD and Sy were new names to me
Bingo and bingo: In 2019, GUARD had premium volume of $1.9 billion, up 379% since 2012, and also delivered a satisfactory underwriting
In 1967, Omaha seemed an unlikely launching pad for a P/C giant
Wilkes-Barre may well deliver a similar surprise.
Berkshire Hathaway EnergyBerkshire Hathaway Energy is now celebrating its 20th year under
8.8 cents per kilowatt-hour (kWh)
Prices for residential customers have since risen less than 1% a year, and we have promised that there will be no base rate price increases
Recently, that utility received a rate increase that will widen the gap to 70%.
The extraordinary differential between our rates and theirs
is largely the result of our huge accomplishments in converting wind into electricity
That output will totally cover the
annual needs of its Iowa customers, which run to about 24.6 million MWh
In other words, our utility will have attained wind self-sufficiency in the state of Iowa.
In still another contrast, that other Iowa
utility generates less than 10% of its power from wind
Furthermore, we know of no other investor-owned utility, wherever located, that by 2021 will have achieved a position of wind
In 2000, BHE was serving an agricultural-based economy; today, three of its five largest customers are high-tech giants
wind is intermittent, and our blades in Iowa turn only part of the time
In certain periods, when the air is still, we look to our non-wind generating capacity to secure the electricity we need
Berkshire Hathaway now owns 91% of BHE in partnership with Walter Scott, Jr
BHE has never paid Berkshire Hathaway a dividend since our purchase and has, as the years have passed, retained $28 billion of earnings
Our view: The more we can invest, the more we like it.
Today, BHE has the operating talent and experience to manage truly huge utility
We stand ready, willing and able to take on such opportunities.
InvestmentsBelow we list our fifteen common stock investments that at
yearend had the largest market value
share of the audited net worth of Kraft Heinz at December 31, 2019
Please note, though, that the market value of our shares on that date was only $10.5 billion.
Charlie and I do not view the $248 billion
What we see in our holdings, rather, is an assembly of companies that we partly own and that, on a weighted basis, are earning more than 20%
on the net tangible equity capital required to run their businesses
These companies, also, earn their profits without employing excessive levels of debt.
Returns of that order by large, established and
understandable businesses are remarkable under any circumstances
Treasury bonds, for example.
Forecasting interest rates has never been our game, and Charlie and I have no idea what rates will average over
the next year, or ten or thirty years
Our perhaps jaundiced view is that the pundits who opine on these subjects reveal, by that very behavior, far more about themselves than
they reveal about the future
What we can say is that if something close to current rates should prevail over the coming decades and if corporate tax rates also remain
near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate
debt instruments.
That rosy prediction comes with a warning: Anything can happen to stock prices tomorrow
Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater
But the combination of The American Tailwind, about which I wrote last year, and the compounding wonders described by Mr
Smith, 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
Others? Beware!
The Road AheadThree decades ago, my Midwestern friend, Joe Rosenfield, then in his 80s, received an irritating letter from
But Berkshire shareholders need not worry: Your company is 100% prepared for our departure
The two of us base our optimism upon five factors
returns on the capital they use
Fourth, we possess skilled and devoted top managers for whom running Berkshire is far more than simply having a high-paying and/or
is rare among giant corporations
(The value of this culture is explored in Margin of Trust, a new book by Larry Cunningham and Stephanie Cuba that will be available at our
I have never sold any shares and have no plans to do so
My only disposal of Berkshire shares, aside from charitable donations and minor personal gifts, took place in 1980, when I, along with other
Berkshire stockholders who elected to participate, exchanged some of our Berkshire shares for the shares of an Illinois bank that Berkshire
had purchased in 1969 and that, in 1980, needed to be offloaded because of changes in the bank holding company law.
Today, my will
to sell any Berkshire shares
My will also absolves both the executors and the trustees from liability for maintaining what obviously will be an extreme concentration of
then distribute the Bs to various foundations
Those foundations will be required to deploy their grants promptly
In all, I estimate that it will take 12 to 15 years for the entirety of the Berkshire shares I hold at my death to move into the
for both my executors and trustees would be to sell the Berkshire shares under their temporary control and reinvest the proceeds in U.S
Treasury bonds with maturities matching the scheduled dates for distributions
That strategy would leave the fiduciaries immune from both public criticism and the possibility of personal liability for failure to act in
during the disposal period
I believe, however, that there is a high probability that my directive will deliver substantially greater resources to society than would
result from a conventional course of action
They will regularly be tested by Wall Streeters bearing fees
At many companies, these super-salesmen might win
I do not, however, expect that to happen at Berkshire
Boards of Directors In recent years, both the composition of corporate boards and their purpose have become hot topics
Once, debate about the responsibilities of boards was largely limited to lawyers; today, institutional investors and politicians have
My credentials for discussing corporate governance include the fact that, over the last 62 years, I have served as a director of 21
publicly-owned companies (listed below)
In all but two of them, I have represented a substantial holding of stock
In a few cases, I have tried to implement important change
During the first 30 or so years of my services, it was rare to find a woman in the room unless she represented a family controlling the
This year, it should be noted, marks the 100th anniversary of the 19th Amendment, which guaranteed American women the right to have their
voices heard in a voting booth
Their attaining similar statusin a board room remains a work in progress.
Over the years, many new rules and guidelines pertaining to board
composition and duties have come into being
will be devoted to the company for his/her business lifetime
When directors get it right, though, they need to do little else
But when they mess it up,
Audit committees now work much harder than they once did and almost always view the job with appropriate
Nevertheless, these committees remain no match for managers who wish to game numbers, an offense that has been encouraged by the scourge of
much more heavily on consultants than they used to
remain a particularly vexing problem for board members
The legal orchestration for deals has been refined and expanded (a word aptly describing attendant costs as well)
But I have yet to see a CEO who craves an acquisition bring in an informed and articulate critic to argue against it
and the many advisors and other professionals who feast on deals
One key point relating to this topic, though, is almost invariably overlooked: Director compensation has now soared to a level that
inevitably makes pay a subconscious factor affecting the behavior of many non-wealthy members
Think, for a moment, of the director earning $250,000-300,000 for board meetings consuming a pleasant couple of days six or so times a year
Frequently, the possession of one such directorship bestows on its holder three to four times the annual median income of U.S.
households
(I missed much of this gravy train: As a director of Portland Gas Light in the early 1960s, I received $100 annually for my service
Board members may get politely ignored, but they seldom get fired
the $500,000-600,000 class? To achieve this goal, the NWD will need help
corporation are deemed lacking in independence
Not long ago, I looked at the proxy material of a large American company and found that eight directors had never purchased a share of the
This particular company had long been a laggard, but the directors were doing wonderfully
Paid-with-my-own-money ownership, of course, does not create wisdom or ensure business smarts
Nevertheless, I feel better when directors of our portfolio companies have had the experience of purchasing shares with their savings,
met over the years have been decent, likable and intelligent
They dressed well, made good neighbors and were fine citizens
Among the group are some men and women that I would not have met except for our mutual board service
and who have become close friends
Nevertheless, many of these good souls are people whom I would never have chosen to handle money or business matters
It simply was not their game
They, in turn, would never have asked me for help in removing a tooth, decorating their home or improving their golf swing
Moreover, if I were ever scheduled to appear on Dancing With the Stars, I would immediately seek refuge in the Witness Protection Program
We are all duds at one thing or another
For most of us, the list is long
The
important point to recognize is that if you are Bobby Fischer, you must play only chess for money.
At Berkshire, we will continue to
look for business-savvy directors who are owner-oriented and arrive with a strong specific interest in our company
In representing your interests, they will, of course, seek managers whose goals include delighting their customers, cherishing their
associates and acting as good citizens of both their communities and our country.
Those objectives are not new
They were the goals of able CEOs sixty years ago and remain so
Our thinking, boiled down: Berkshire will buy back its stock only if a) Charlie and I believe that it is selling for less than it is worth
and b) the company, upon completing the repurchase, is left with ample cash.
Calculations of intrinsic value are far from precise
Consequently, neither of us feels any urgency to buy an estimated $1 of value for a very real 95 cents
In 2019, the Berkshire price/value equation was modestly favorable at times, and we spent $5 billion in repurchasing about 1% of the
If the price-to-value discount (as we estimate it) widens, we will likely become more aggressive in purchasing shares
We will not, however, prop the stock at any level.
Shareholders having at least $20 million in value of A or B shares and an inclination to
We request that you phone Mark between 8:00-8:30 a.m
Central Time, calling only if you are ready to sell.
In 2019, Berkshire sent $3.6 billion to the U.S
Treasury to pay its current income tax
government collected $243 billion from corporate income tax payments during the same period
From these statistics, you can take pride that your company delivered 11/2% of the federal income taxes paid by all of corporate America
Fifty-five years ago, when Berkshire entered its current incarnation, the company paid nothing in federal income tax
(For good reason, too: Over the previous decade, the struggling business had recorded a net loss.) Since then, as Berkshire retained nearly
annual meeting, which will be held on May 2, 2020
Yahoo, as usual, will be streaming the event worldwide
That change makes great sense
They are outstanding individuals, both as managers and as human beings, and you should hear more from them.
Shareholders who this year send
a question to be asked by our three long-serving journalists may specify that it be posed to Ajit or Greg
They, like Charlie and me, will not have even a hint of what the questions will be.
The journalists will alternate questions with those from
the audience, who also can direct questions to any of the four of us
So polish up your zingers.
On May 2nd, come to Omaha
Meet your fellow capitalists
Buy some Berkshire products
