At the Berkshire Hathaway Annual Meeting on April 30 with 40,000 in attendance and webcast available for the first time, Warren Buffett age 85 and Charlie Munger age 92 were at the top of their game.
Buy good companies, let their managers run them and invest the capital they generate has been their mantra from the outset, and we believe it is still working. Berkshire’s annual percentage change in book value (its preferred measurement of performance) was up 6.4% for 2015 compared to the S&P 500 Index which was up 1.4% including the reinvestment of dividends. Berkshire’s net earnings attributable to shareholders for the year were up 21.0% compared to 2014. But that’s not to say that Berkshire only had smooth sailing during the year. Berkshire’s stock was down 12.5% in 2015 but is up 11.3% so far this year, as of today, May 2, 2016.
In 2015, Berkshire’s reinsurance companies encountered increasing competition from others and continuing low interest rates which adversely impacted earnings on the fixed income investment portion of their reserves for claims. GEICO suffered a significant decrease in profits as increased accidents caused by greater automobile mileage and higher accident rates resulted in rising claims. BNSF encountered diminishing coal and oil railroad car shipments. Even so, BNSF’s net earnings rose due to improved service and cost control, and we believe the overall performance of Berkshire for the year was laudatory.
To comprehend the intrinsic (true) value of Berkshire Hathaway, it is necessary to understand its three components. First is the ownership of 78 non-insurance operating companies led by railroad BNSF and public utility Berkshire Hathaway Energy. These operating companies account for 36% of Berkshire’s pre-tax net earnings.
Second is Berkshire’s insurance business consisting of 11 insurance companies with their $88 billion of reserve “float” funds available for investment pending future insurance claims. $59 million of these funds are invested in stocks, the largest 4 of which are Wells Fargo, Coca-Cola, IBM and American Express. Profits from Berkshire’s stock portfolio are understated since only dividends received by Berkshire are reported as income, not the share in earnings these stock holdings represent. Moreover, the market value of Berkshire’s stock portfolio was $112 billion at year-end 2015 versus its cost of $59 billion, a 90% unrealized gain of $53 billion which under GAAP is reflected on Berkshire’s balance sheet but has not been recorded on Berkshire’s income statement.
The third value component is the future earnings potential of Berkshire’s retained earnings. This has been the hallmark of Berkshire’s success and the reason it does not pay a dividend. Warren and Charlie believe they can invest their stockholders share of Berkshire’s earnings better than their shareholders could invest their dividends if Berkshire paid them.
In Warren and Charlie’s view, Berkshire’s book value significantly understates the intrinsic value of the company. Warren is so confident of this that Berkshire is committed to aggressively repurchase its shares if they ever fall to 120% of book value. He also believes that Berkshire’s current market price of 144% of book value is well below its intrinsic value.
Here are some interesting take-aways from the meeting:
- Warren said Berkshire Hathaway will do just fine no matter who becomes our next president. He is a supporter of Hilary Clinton, but is not worried if Donald Trump should win.
- According to Warren, an important reason why the managers of Berkshire Hathaway’s operating companies perform so well is that they can fully concentrate on their businesses and don’t have to be concerned about investor relations since Berkshire is their stockholder.
- A succession plan for Warren and Charlie is in place but not disclosed, because to announce it would be premature and cause undue attention. Warren firmly believes that the culture and investment philosophy of Berkshire Hathaway will not change after he and Charlie are gone. He thinks Berkshire’s board, management and stockholders are too committed to Berkshire’s way of doing things to allow that to happen.
- Warren views Amazon as a competitive force for change in the marketplace, and it is a company Berkshire follows closely. On the subject of competition, Charlie said it is Berkshire’s culture to “Win fairly and use (spend) wisely.” Warren stressed that treating all constituents fairly is important including both customers and vendors. Pressing to win every aspect of a negotiation can be counter-productive.
All in all, it was another worthwhile Berkshire Hathaway annual meeting to attend in person or to view by webcast.
Past performance is not indicative of future results. The information provided in this commentary should not be considered financial advice or a recommendation to buy or sell a particular security. You should not assume that any of the investment strategies or securities discussed herein are or will be profitable. The opinions expressed herein are those of Edgemoor Investment Advisers, Inc. (Edgemoor) and are subject to change without notice. You should always obtain current information and perform due diligence before investing.
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