Last week I made my annual pilgrimage to Omaha, NE for Berkshire Hathaway’s Annual Meeting. Amazingly, Chairman/CEO Warren Buffett, age 87, and Vice Chairman Charlie Munger, age 94, are as astute as ever.
Management Succession
Most importantly, Buffett and Munger have provided for their management succession with long time Berkshire Hathaway executives Ajit Jain and Greg Abel each appointed as Vice Chairman and elected as Board Directors. They are responsible for Berkshire’s insurance operations and the rest of Berkshire’s other businesses, respectively. For Berkshire’s $170 billion portfolio of publicly traded common stocks, Buffett works with Todd Combs and Ted Weschler, who each now manage more than $12 billion independently of Buffett, with recent performance records better than Buffett himself. Management succession to Buffett and Munger seems to be well in place.
Increase in Book Value
During 2017, Berkshire’s book value per share increased by $65 billion, a whopping 23% in a single year. $36 billion came from Berkshire’s operations and the rest came from tax code changes. The latter was the result of the federal corporate tax rate reduction from 35% to 21%, which resulted in a $29 billion reduction in deferred taxes on appreciated publicly held stocks in Berkshire’s investment portfolio and an increase in Berkshire’s net worth by the same amount.
First Quarter 2018 Earnings
Buffett reported that Berkshire’s first quarter 2018 operating earnings, excluding gains and losses on publicly owned securities, were $5.29 billion, the highest quarterly operating earnings in its history and a good measure of Berkshire’s quarterly operating earnings for the rest of 2018. Buffett said Generally Accepted Accounting Principles (“GAAP”) now require security gains and losses be a component of reported quarterly earnings. However, he believes that the amount of gains and losses of Berkshire’s investment portfolio in any given quarter is usually meaningless because prices of the underlying stocks can fluctuate so widely up and down without regard to their intrinsic values.
Berkshire’s Building Blocks for the Future
1) Sizable Stand-Alone Acquisitions
Berkshire seeks to purchase businesses with durable competitive strengths, good returns on net tangible assets, able and high-grade management to operate the business, opportunities for internal growth at attractive returns, and sensible purchase prices. Berkshire has achieved this goal with patience throughout the years.
Sizable acquisitions in recent years have included Precision Castparts and Duracell in 2016, Van Tuyl Group (now Berkshire Hathaway Automotive) in 2015, NV Energy and 50% of H.J. Heinz in 2013, and Lubrizol in 2011.
In 2017, the lack of sensible prices proved to be a barrier to the deals Berkshire reviewed, and none were made. Both Buffett and Munger believe that in the future, there will be opportunities to make more very large purchases at reasonable prices, just as there have been in the past.
2) Bolt-On Acquisitions
These are acquisitions that fit with businesses Berkshire already owns. In 2017, subsidiary Clayton Homes acquired two builders of conventional homes, subsidiary HomeServices acquired Long and Foster and two other home brokerage operations, and subsidiary Precision Castparts acquired German industrial components manufacturer Wilhelm Schulz GmbH.
3) Internal Sales Growth and Margin Improvement of Owned Businesses
Insurance has been the primary basis of Berkshire Hathaway’s success, producing a cash reserve or “float” available for investment without cost since over time Berkshire’s insurance premiums have exceeded its insurance losses. Berkshire’s float has grown amazingly over the years, from $39 million in 1970 to $115 billion in 2017.
Berkshire’s non-insurance businesses have also continued to make progress. Viewed as a group, in 2017 they delivered pre-tax income of $20 billion, an increase of $950 million over the prior year.
4) Investments
At year-end 2017, excluding Kraft Heinz recorded separately, Berkshire’s investments in publicly traded companies aggregated $170 billion with the five largest being Wells Fargo, Apple, Bank of America, Coca-Cola, and American Express. The cost basis for this $170 billion investment portfolio is just $70 billion. The recent investment in Apple is now Berkshire’s largest investment portfolio asset which gained over $1 billion in market value last week alone.
A question was raised as to why Berkshire still owns such a large amount of Wells Fargo stock in light of the banking company’s fraudulent account openings and other customer abuses. Buffett replied that in his opinion Wells Fargo was righting its wrongs and would resume being a good investment growing in value. As examples of similar investments in the past, he pointed out two excellent historical stock investments in companies which engaged in fraud but subsequently righted themselves, American Express after its salad oil scandal and Salomon Brothers after its submission of false bids for treasury bonds.
Edgemoor Investment Advisor’s Investment in Berkshire Hathaway
Berkshire Hathaway currently remains on our investment buy list and is our largest single individual holding.
