Early Saturday morning, the world’s best investor released the most widely read shareholder letter. I woke up before the kids and headed into my home office with a cup of coffee to read the latest dispatch from Warren Buffett.
The Berkshire Hathaway (NYSE: BRK-B) chairman has been writing these lengthy shareholder letters since 1965 when he took over the company. I look forward to reading this letter every year.
I’ve been a Berkshire Hathaway shareholder since 2011, and the stock is one of my biggest personal holdings.
[ad#Google Adsense 336×280-IA]The diversified operations of the company – insurance, railroads, consumer goods – make Berkshire stock similar to owning a mutual fund.
Unlike mutual funds, Berkshire has a long history of beating the market and doesn’t charge investors any expenses.
If you don’t already own shares of Berkshire Hathaway, I recommend you buy the stock and put it away for 10 or 20 years.
I think you’ll find that this is one of the best investments you could make.
Even after Buffett (who is 83 years old) is gone, Berkshire will continue to thrive.
In today’s issue of Daily Profit, I’m going to highlight some key aspects of Buffett’s 24-page shareholder letter. I believe that every investor can learn from the world’s most successful investor.
And if you don’t already own Berkshire shares, I hope that this will convince you to buy the stock. While the A-shares are prohibitively expensive (trading at $173,500 this morning), the B-shares are more affordable. Each class B-share represents 1/1,500 of an A-share, and trade accordingly around $115.
Berkshire’s Record Year
Berkshire had an amazing year in 2013, with sales growing by 12%. Meanwhile, net income soared 32% and reached a staggering $19.5 billion. That means the company’s profits stand at $1.6 billion per month! Meanwhile, the company’s investments per share increased nearly 14% and now stands at $129,253.
Berkshire vs. the S&P 500
Buffett tracks the performance of Berkshire based on one primary metric: growth in book value per share. This simply measures the value of the assets on the company’s balance sheet. In 2013, Berkshire’s book value increased at 19.7% versus a 32.4% gain for the S&P 500 (including dividends).
Charlie Munger, Berkshire’s vice chairman and my partner, and I believe both Berkshire’s book value and intrinsic value will outperform the S&P in years when the market is down or moderately up. We expect to fall short, though, in years when the market is strong – as we did in 2013. We have underperformed in ten of our 49 years, with all but one of our shortfalls occurring when the S&P gain exceeded 15%.”
With stocks soaring since the crash of 2009, Berkshire’s book value growth has struggled to keep up. But the reason to own Berkshire is because of the strong performance in years when stocks struggle. For example, in 2007 the S&P 500 fell 37%. In comparison, Berkshire’s 9.6% decline in book value was quite muted. And the same thing happened in 2001 and 2002.
Despite having its book value gains lag the S&P, Berkshire stock performed well last year, with shares gaining 32.7%.
Buffett has been aggressively looking to make big acquisitions, which he describes as elephants. Because Berkshire has gotten so big, the company needs big acquisitions in order to have a meaningful financial impact.
This year, Berkshire closed two such transactions. The company bought a 50% stake in H.J. Heinz for $12 billion. The other major transaction was the purchase of utility NV Energy for $5.6 billion.
In last year’s shareholder letter, Buffett said “[After buying 50% of Heinz], we still have plenty of cash and are generating more at a good clip. So it’s back to work; Charlie and I have again donned our safari outfits and resumed our search for elephants.”
Buffett says that he may look to make additional acquisitions similar to Heinz. “We created a partnership template that may be used by Berkshire in future acquisitions of size. Here, we teamed up with investors at 3G Capital, [who] are responsible for operations…Berkshire is the financing partner…Though the Heinz acquisition has some similarities to a “private equity” transaction, there is a crucial difference: Berkshire never intends to sell a share of the company. What we would like, rather, is to buy more…”
Berkshire has been on a buying spree, including the outright ownership of huge companies. As Buffett said in this year’s letter, “With Heinz, Berkshire now owns 81⁄2 companies that, were they stand-alone businesses, would be in the Fortune 500. Only 491 ½ to go.”
Insurance Business = “Free Money”
Berkshire got into the insurance business in 1967. And that business has been a huge contributor to the growth.
One of the reasons that Buffett loves the insurance business is because of the “float.” These are the premiums that the insurance company collects up front, and holds to pay for future claims. As Buffett says, “If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit is earned, we enjoy the use of free money – and, better yet, get paid for holding it.”
Since 1970, Berkshire’s insurance “float” has grown from $39 million to $77.2 billion. Not only has the float grown, but Berkshire has also operated with an operating profit for 11 years in a row. During that time, pre-tax profits were an astounding $22 billion.
That type of performance isn’t the norm in the insurance business, with many companies operating at a loss. As an example, Buffett points to State Farm. In nine of the last 12 years, State Farm has operated with an underwriting loss.
Investing in America
“Though we invest abroad as well, the mother lode of opportunity resides in America.”
Last year, Berkshire companies spent $11 billion on plant and equipment. 89% of that investment happened in the U.S.
“Charlie and I have always considered a “bet” on ever-rising U.S. prosperity to be very close to a sure thing. Indeed, who has ever benefited during the past 237 years by betting against America? If you compare our country’s present condition to that existing in 1776, you have to rub your eyes in wonder. And the dynamism embedded in our market economy will continue to work its magic. America’s best days lie ahead.
With this tailwind working for us, Charlie and I hope to build Berkshire’s per-share intrinsic value by (1) constantly improving the basic earning power of our many subsidiaries; (2) further increasing their earnings through bolt-on acquisitions; (3) benefiting from the growth of our investees; (4) repurchasing Berkshire shares when they are available at a meaningful discount from intrinsic value; and (5) making an occasional large acquisition. We will also try to maximize results for you by rarely, if ever, issuing Berkshire shares.”
Berkshire’s investments are having a positive material impact on the U.S. economy. The company’s employee headcount also increased considerably last year. Berkshire now employs 330,745 people – an increase of 42k from last year. While Berkshire continues to grow at a rapid clip, just 24 people staff the company’s home office.
The World’s Best Investor
Buffett has continued to transition investment management to Todd Combs and Ted Weschler. According to this year’s letter, each now manage a portfolio of more than $7 billion. This transition is an important part of Berkshire’s succession plan, and gives these two talented investment managers sizable stakes of the company’s investment portfolio.
Berkshire has investments of more than $1 billion in 16 different companies. The largest of these investments include Wells Fargo (NYSE: WFC) at $19.9 billion, The Coca-Cola Company (NYSE: KO) at $16.5 billion, American Express (NYSE: AXP) at $13.8 billion, International Business Machines (NYSE: IBM) at $12.8 billion, and Bank of America (NYSE: BAC) at $10.9 billion.
— Ian Wyatt
Source: Wyatt Investment Research