A Nice "Subpar" Year for Berkshire
Board: Berkshire Hathaway
What a choice of words at the start of the annual letter! Book value actually increased more than I anticipated (my guess was $113K) because the derivatives portfolio, that mysterious black box, posted gains in Q4 that I didn't attempt to estimate. At $114,214, Berkshire's book value per share has grown a cumulative 46.4% over the past five years, or 7.9% annualized. Over the past ten years, Berkshire's book value per share has grown at 10.6% annualized ... from $41,727 to $114,214 per share. Based on YTD changes in the equities portfolio and an assumption of $2.2 billion in net income for the first two months of the year, my guess is that Berkshire's current book value per share is probably closing in on $118K by the end of Q1 meaning that we are barely above 1.3x current book.
Some thoughts on the annual letter:
* Warren and Charlie believe that Berkshire's gain in intrinsic value will over time "likely surpass the S&P returns by a small margin". Hmmm, does that mean 1%, 2%, or 5%? My interpretation is that he means low single digit outperformance over time. With shareholders equity pushing $200 billion, even a low single digit level of outperformance is nothing to sneeze at.
* Heinz preferred will at some point be redeemed "at a significant premium price" and the warrants permit Berkshire to buy 5% of the holding company's common stock for "a nominal sum". So, in addition to a 9% dividend, at some point our preferred gets redeemed at a significant premium ... and we get 5% of the common stock for a nominal sum? Will someone explain to me exactly what's in this deal for Jorge Paulo Lemann? Not a heck of a lot unless he finds lots of ways to "optimize" Heinz ... This isn't a typical Berkshire acquisition but the way I see it we get to have someone else restructure the business (leaving Berkshire's reputation for not interfering intact) and eventually we will get a controlling interest in the improved business. Heads Berkshire wins very big, Tails Berkshire still wins but not as big. I like the deal.
* GEICO has 9.7% market share and "much more growth lies ahead". Eventually I see GEICO and Progressive dominating auto insurance as the #1 and #2 players, hopefully in that order.
* Combs and Weschler managing $5 billion each including pension fund assets as discussed here a couple of weeks ago. Note that even though Berkshire owns more than $1 billion of DVA, the company does not appear in the table of investments worth over $1 billion because so many shares are in the pensions.
* IBM: An "Inevitable"? Now lumped in with Amex, Coca Cola, and Wells Fargo as one of the "big four"...
* $2.8 billion of "look through earnings" from the "big four" last year. That's $1,700/share of look through earnings. And just from the "big four".
* Per share investments increased to $113,786 (note: Buffett is apparently including rail/utility/finance cash+investments in this per-share figure and I don't think he used to ... ). Per share pre-tax earnings from non-insurance businesses was $8,085. Two column valuation using 8x multiple would be 113,786+8*8,085 = ~$178K.
* Float is $73.125 billion and any decline in float will be "very gradual" ... no more than 2% per year. Although GEICO's float will grow, many of National Indemnity's runoff contracts will cause downward pressure on float.
* Ten years in a row of underwriting profits. Cumulative total: $18.6 billion pre-tax. Buffett sees continued underwriting profits in "most years". Yet we don't include any of this in the two column valuation. Maybe Whitney Tilson's model is correct to incorporate at least some underwriting profits into the two column model. But I'm too conservative to do that myself.
* If we have a $250 billion insured mega-cat Berkshire would still record a profit for the year. This is an amazing statement. Just think of the hard market that would develop and Berkshire's capacity to write premiums the year after such a mega cat (not that I would hope for such an event of course).
* GEICO insured 46,906 vehicles destroyed or damaged in Hurricane Sandy. (I'd glad he called it a HURRICANE which it was and not "Storm Sandy" like the politically correct who have attempted to claim that hurricane deductibles don't apply)...
* Credit derivatives portfolio winding down with profit of $1 billion pre-tax being "almost certain". I wonder whether he would do this again however ... there are probably less stressful methods of making a billion.
* 28 Daily papers purchased over the past fifteen months at a cost of $344 million. I did appreciate the essay on the economics of newspapers. I hope we don't look back at newspapers as the "textile investment" of the 21st century. I'm not sold on local communities looking to newspapers as a source of information either and I am not at all sure that local papers can put in paywalls. But the size of this investment is totally meaningless to shareholders one way or another.
* Long essay on dividends ... the math makes sense, the logic makes sense, but I guarantee that charges of "hypocrisy" will continue regardless. This seemed like a part of the letter directed to Buffett's personal friends and longtime investors who are 80 or 90 years old and want income.
* One key item to note buried in the dividend essay: The example on repurchases being "hard to go wrong when you're buying dollar bills for 80 cents of less". Berkshire's buyback limit is 120% of book. This means that Buffett views Berkshire as worth at least 150% of book (120/.8). That's in the neighborhood of $175K at what I think book value is today.
Interesting random factoid of the evening: Over $100 billion, or 81%, of Berkshire's $124.3 billion in retained earnings were earned over the past ten years.
I thought it was a pretty good subpar year overall.