Warren Buffett, at the young age of 90, once again did not disappoint with this year’s letter.

For 56 years, Warren has consistently told us what is happening within Berkshire Hathaway. Warren writes this letter as if he is speaking to his two sisters who have very little business or investment knowledge. He has a wonderful way of discussing investing in a business-like manner and turning complicated information into simple yet understandable concepts.

I think we can all learn from him and remember in essence we are all running our own Berkshire Hathaway.

If you haven’t read his letter, I still recommend you do. There were so many nuggets of information Warren covers and I won’t be able to cover them all here. I want to give a brief overview of his letter and then will circle back in future posts to discuss some important points in greater detail.

Berkshire Hathaway is a conglomerate and is a collection of fully or partially owned exceptional businesses as well as a collection of publicly held shares. Conglomerates can sometimes have a negative connotation to their name due to their acquisition of over-priced mediocre businesses. These conglomerates also strive to control these businesses which comes at a staggering cost.

Warren makes it clear that Berkshire Hathaway is like no other and sets itself apart from these poorly run conglomerates.  

Warren has succeeded at and continues to buy a diverse group of businesses with good economic characteristics and good managers at a reasonable price. Whether he has control of the businesses is unimportant as Warren remarks: “If that strategy requires little or no effort on our part, so much the better.” He also references a quote from Ronald Reagan:

“It’s said that hard work never killed anyone, but I say why take a chance?”  

Currently, Warren employs 360,000 employees across a diverse group of businesses. The 4 main categories of businesses are 1) Insurance, 2) Railroad Utilities and Energy, 3) Manufacturing, and 4) Service and Retailing.

Berkshire or in other words a collection of businesses earned a total of $42.5 Billion dollars in 2020. This amount encompasses $21.9 billion of operating earnings, $4.9 billion of realized capital gains, $26.7 billion gain from an increase in the amount of net unrealized capital gains that exist in stocks they hold as well as a $11 billion loss from a write down in the value of a few subsidiary and affiliate businesses they own.

Operating earnings from his companies are very important. Each year his goal is to increase this segment as well as add to it through the acquisition of “large and favorably-situated businesses.” Unfortunately, in 2020 those earnings fell 9% and they were unable to make any large acquisitions.

At year end, Berkshire Hathaway’s holding of publicly traded stocks or collection of businesses was worth $281 billion.

Warren discussed that the only thing Berkshire Hathaway can report on their financials pertaining to their publicly held shares is the dividend the companies pay them but discusses the importance of retained earnings.

Retained earnings is the net income left after paying out profit or dividends to shareholders. This does not go unnoticed by Berkshire and Warren comments:

 “What’s out of sight, however, should not be out of mind: Those unrecorded retained earnings are usually building value- lots of value - for Berkshire. Investees use the withheld funds to expand their business, make acquisitions, pay off debt and, often, to repurchase their stock (an act that increases our share of their future earnings).”

I think it is key Warren mentioned the decrease in earnings and how he failed to acquire any new large businesses. It was impressive that he crystalized capital gains and had $26.7 billion growth in unrealized capital gains, however capital gains will rise and fall. Longer term, there is no doubt there will be substantial gains but the key is growing cash flow which is earnings. If your earnings aren’t growing, you have lower retained earnings and can’t increase dividends to shareholders nor reinvest back into your business or buy back shares.

Within the categories of businesses Berkshire owns, there are four jewels that Warren describes as their most valuable assets. The first and largest is their property/casualty insurance operation. The second and third is their 100% ownership of Burlington Northern Railroad and their 5.4% ownership of Apple.  The fourth jewel, which they own 91% of, is Berkshire Hathaway Energy.

Warren has an advantage with his insurance operations. Berkshire currently has a float sitting at $138 billion. Warren is able to use this float at zero cost in any way he wants.

The insurance companies he competes with have to keep their funds in bonds with rates so low their return is negligible. In the past when companies reach for yield bad things happen. Berkshire has the ability to take cash flow from other companies under his structure and flow it through to his insurance operations if required, hence allowing him to stay with a heavy equity exposure in his insurance operations.Warren stated:

“And bonds are not the place to be these days. Can you believe that the income recently available from a 10-year U.S. Treasury bond- the yield was 0.93% at yearend- had fallen 94% from the 15.8% yield available in September 1981.”

Through Warren’s explanation of Berkshire’s ownership of Apple, he explained the significance of buybacks. In mid-2018, Berkshire owned 5.2% of Apple. Apple since has repurchased their shares, reduced the number of available shares, and consequently increased the of value of those remaining shares. Without having to buy a bigger stake in the company, Berkshire now owns 5.4% of Apple.       

Berkshire bought back 80,998 class “A” shares spending $24.7 billion dollars which thus increased shareholder ownership in all Berkshire’s businesses by 5.2% and as Warren says: “without requiring you to so much as touch your wallet.”

He does a wonderful job walking you through his purchase of See’s Candy, GEICO insurance, National Indemnity, Nebraska Furniture Mart, Clayton Homes and Pilot Travel Centers and shares some of the growth from their inception and these companies epitomize his quote:

 “Success stories abound throughout America. Since our country’s birth, individuals with an idea, ambition and often just a pittance of capital have succeeded beyond their dreams by creating something new or by improving the customer’s experience with something old.”

Warren did a wonderful job explaining why his conglomerate is different than others and he continues to leave me in awe.

Warren stated: “Although our form is corporate, our attitude is partnership.” This statement is really telling of his intentions and driving factors behind Berkshire Hathaway that ultimately sets them apart.

He has amassed a wonderful group of businesses over the past 56 years by following his three key mandates: 1. Invest in or purchase companies that have a strong competitive strength, 2. have excellent management and 3. paying the appropriate price for that company.

Warren has built a culture that allows companies to sell a portion or all of their business to Berkshire. They can stay and run the business the way they did to make it such a wonderful company with little interference from Omaha.

Warren has not only provided insight on his astounding conglomerate, he has provided priceless financial and business lessons. Each time I re-read his letter I gain a new perspective and take away something new. Although I haven’t touched on everything Warren mentioned, I hope that I have conveyed a few of his points to emphasize his immense wisdom.   

One point Warren mentioned that I think all investors should take away is:

“Productive assets such as farms, real estate, and yes, business ownership produce wealth – lots of it. Most owners of such properties will be rewarded. All that’s required is the passage of time, an inner calm, ample diversification and minimization of transactions and fees.”

I share a similar approach to investing where we continue to buy and hold wonderful companies that grow their earnings, which allows them to pay you a growing dividend. Share prices of great companies will continue to ebb and flow but immense wealth is created by being patient and continuing to save.

Please give us a call if you have any questions or would like to chat.

 

"How will you replace your current income in retirement?" - Jim Seyers