Berkshire Hathaway’s earnings is a quarterly event. Warren Buffett’s reputation as the greatest investor of the modern age, and the company’s wide shareholder base and status as one of the biggest companies in the world make it a closely watched event.
The Q1 and Q4 earnings are heightened. Q1 because it is timed for Berkshire’s annual shareholder meeting in Omaha, the Woodstock of Capitalism. Q4 because it comes with Warren Buffett’s annual letter to shareholders.
I broke down Berkshire’s annual report in a separate post, as I think there’s a lot we can learn about investing and the state of the economy. In this post, I want to do a close read of Buffett’s shareholder letter. It’s an entertaining and valuable read, and I want to share what I see.
I am no Buffettologist; I own Berkshire shares and admire Buffett’s investment career and wisdom. He’s also a human, and makes as many mistakes as we all do. I don’t intend to criticize him as a person, but to just read his letter closely.
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The Charlie Tribute
Warren Buffett’s annual letter starts with an added tribute to the late great Charlie Munger. Munger was Berkshire’s Vice-Chairman, and Buffett’s longtime partner, and died last November at the age of 99. It’s no surprise that this is how the letter starts (though the different font is certainly curious).
“Charlie was the “architect” of the present Berkshire,” Buffett insisted, citing Charlie’s insistence on buying wonderful businesses at fair prices rather than the reverse. This is the “quality” vs. “value” debate in investing, and Buffett says Munger was decisive in tilting Berkshire, given its growing size, towards “quality”.
Buffett humbly credited Charlie for willing to be in the background, which is its own way humble.
While Charlie’s fame rose considerably in the past couple decades, Buffett is eager to add to it.
A Bigger Audience than he Admits
Buffett starts, like any good writer, thinking of who his reader is. While he claims his audience is select, and envisions his sister Bertie – a shareholder, knowledgeable without being expert, and looking for just the facts, ma’am – as the ideal reader.
I think it’s worth remembering that Buffett’s audience is much larger than that, and he knows it. Buffett has been called the Oracle of Omaha for years. His annual letters are his largest platform, along with the annual shareholder meeting, for spreading his gospel. The investing public and financial media is sure to read this. Which is where he likes to underline investing lessons.
The political class is also paying attention. Buffett is 93 and hardly the most powerful figure in politics, but he also is no shrinking violet. When he makes a point, whether it’s about the uselessness of incorporating unrealized gains into GAAP earnings, as he did again this year, or the value of share buybacks, as he has done in the past, it’s meant to score with a wider audience.
Size Does Matter, but Bigger isn’t always Better
There’s a bit of a victory lap and lament next. Berkshire Hathaway’s book value makes up 6% of the S&P 500’s book value, he points out. Impressive, but hard to grow fast. “We have no possibility of eye-popping performance,” he concludes. He says only that the company “should do a bit better than the average corporation.”
This is the reality of owning Berkshire shares, and why you can’t think of it as a crazy alpha position. He then reminds us that Berkshire avoids risking permanent loss of capital, which is a truism – they could still get an investment wrong. But the focus on doing slightly better and avoiding a major loss can get you big results due to the power of compounding.
If my calculations are right, Berkshire is lagging the S&P 500 for the last 5 and 10 completed years, and everything depends on your starting point1. But the relative confidence you have that things won’t go bad makes an investment more valuable in its way.
Defending the Oil Patch, and Charging American Express
Buffett talked up a few of Berkshire’s investment positions. Berkshire owns shares in five Japanese companies, and Buffett’s remark that in certain ways, the five are much more shareholder-friendly than U.S. companies, is interesting. Japan is considered notoriously not shareholder-friendly. Buffett’s pointing out that executive compensation is a key part of that puzzle along with shareholder returns is welcome.
Buffett talked about Berkshire’s continuing growing ownership in Occidental Petroleum, and the value that the shale oil boom has brought to the U.S. in reducing dependency on other countries for oil. What’s more interesting is Buffett saying Berkshire has no interest in purchasing or managing Occidental. Berkshire is famously hands off in management of its portfolio companies. I’ll comment on the political aspect of Buffett’s letter later, but it’s curious to know what would make Occidental different except, maybe, the doubt around oil companies in a changing climate world. Though, his forceful support for the business here would seem to dispel that argument.
He also talked up Coca Cola and American Express, lasting positions for Berkshire. He often does, even though as far as I’ve been able to tell, they haven’t been huge outperformers for him. This might re-make my point from earlier. If you can own a stock without thinking about it much, it might be relatively more valuable.
American Express is interesting to me because Buffett also owns Capital One, which just announced a deal to buy Discover Financial. Were that to be approved, Capital One would be a bulked-up competitor to American Express (and Mastercard and Visa). I own Discover shares, and would welcome Buffett as a fellow shareholder in the combined company.
Buffett’s Political Voice on Railroads and Utilities
Buffett is not a sugarcoater in these letters, and he calls out the railroad units and the utilities businesses as Berkshire’s disappointments for the year. I would argue, though, he’s pointing the finger elsewhere.
Trouble Down the Railroad Line (but not so bad)
In railroads, Burlington Northern Santa Fe is Berkshire’s business. Buffett is somewhat two-sided in his commentary: BNSF is a tough business because it costs so much to maintain. It’s so great because it would be hard for a competitor to replace it. He refers to the returns on the investment as ‘acceptable’, though not as great as they seem. There’s also some passive-aggressive mumbling about how the government gets involved in wage negotiations, which rose faster than inflation.
I’ll give Buffett the benefit of the doubt – perhaps the wage rises will become more evident in 2024, as they seemed to jump a little more in Q4 than other quarters. But wages and compensation rose 4.7%. A jump but not a big difference. The issue with BNSF seems to be more around losing business to a competitor, while maintaining their prices as more or less flat. These are things within a business’s control.
And as far as returns, I haven’t pulled all the numbers, but BNSF has paid $51.7B back to Berkshire since 2010, not counting Q4 of 2023. Berkshire bought BNSF for $34B at the time, though admittedly 40% or so of that purchase price was in stock, so the price has risen. It seems like the business is producing well for Berkshire, and Berkshire has been a proud owner.
A Challenging Environment for Power
The picture is starker and grimmer for utilities. The business’s pre-tax earnings dropped 70%, and its after-tax income dropped 40%. Income tax credits make up some of that difference, but that’s a reminder how entwined utilities are with government.
Buffett snipes that governments are violating the old pact that allows utilities to earn a reasonable return, by raising prices. I don’t know the details here, but the cause may be more basic. Buffett mentions forest fires are likely to increase, and climate change adds to investors’ worries. The utility business is a tough spot, however the political winds blow.
Father Time is Undefeated
Buffett praised Ajit Jain and Greg Abel, his two chief lieutenants, in his letter. He’s done this in the past – Ajit, who runs the insurance business, got a nearly identical mention two years ago. But I thought it was notable in the context of how the letter started.
Buffett added a page of praise about Munger before the official letter. And then concluded the letter wondering about what’s in the water in Omaha, where he and Munger were born, where Greg Abel and Ajit Jain each spent time in the 80s or 90s. In doing it, Buffett underlined that he’s lived in the same house since 1958, bolstering his folkie reputation. But he also specifically called out how Greg is ready to be CEO of Berkshire tomorrow.
Abel has been named as the eventual successor. But with Charlie Munger dying and with Warren Buffett 93 years old, his thoughts of mortality must be coming more frequently. These mentions, in conjunction with a nod to Berkshire’s Hall of fame lineup of managers, and the reality that Berkshire can’t make many homerun investments, set expectations for the future. Those expectations? Stable, more of the same, but not likely to knock your socks off.
I suspect for Berkshire investors, those sentiments are not surprising. But they are notable, and worth our consideration as investors more broadly.
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Disclosure: Middle Coast Investing clients and portfolios have long positions in BRK.B and DFS. Positions may change at any time without notice. Nothing in this post is investment advice.
- If you measure the last 5 and 10 years as of Friday, February 23, 2024, instead of December 31st, Berkshire outperforms. The power of picking a starting point. ↩︎