Warren Buffett’s annual letter to shareholders and the world is a bit unusual this year – a bit US centric, not unsurprising given the tone of the Presidential primary race, especially and the all important polls on November 8.
Buffett reiterated that he is bullish on America (he also criticised some presidential candidates talking down the health of the US economy), talked up the performance of various Berkshire businesses and individual managers, but didn’t elaborate any more on a succession plan at Berkshire, except to say he intends being around in 2030 when he will turn 100 to see a key insurance arm become the biggest of its kind in the US.
Buffett said that he and Charlie Munger, the firm’s vice chairman, “expect Berkshire’s normalized earning power to increase every year…In some years the normalized gains will be small; at other times they will be material. Last year was a good one.”
Buffett also said he and Vice Chairman Munger would continue to look out for potential deals, while Berkshire subsidiaries purse “bolt-on” acquisitions (well over 100 were done last year). In other words, one of Buffett’s famed ‘whale’ deals is not on the cards given the $US37 billion purchase of Precision Castparts (that includes $US5 billion in debt), but a lot of smaller deals are.
Buffett said that Berkshire will only pursue a friendly takeover, even if hostile deals may sometimes be justified for other investors. He said that at Berkshire, “we go only where we are welcome.”
But there was enough in his letter on markets and investors to satisfy his legion of fans around the world. For example the annual results showed the company had an OK year – but failed to outperform the S&P 500.
Book value, a measure of assets minus liabilities that Mr. Buffett has long used to measure performance, increased 6.4% per share in 2015, outperforming the S&P 500 stock index.
Mr Buffett has used to set himself the goal of beating the S&P on a five-year rolling basis, although he conceded it is becoming harder as Berkshire grown (this year will be made harder by the $US32 billion acquisition of Precision Castparts).
The S&P 500 was essentially flat last year when dividends are factored in (up 1.4%), but Berkshire’s shares slid 12.5% last year because trading was dominated by the performance of major tech stocks suck as Facebook, Apple, Amazon.
The report noted Buffett’s $US2.6 billion loss as of December 31 (the shares fell 14% last year) in his investment in IBM Corp, but he said Berkshire has no intention of selling its IBM shares.
Besides IBM, Berkshire’s “Big Four” stock investments include stakes in Well Fargo, Coca Cola and American Express (which also did badly in 2015, falling 24%). Berkshire increased its interest in all four during 2015.
Wells Fargo shares were down around 12% last year, even though it is the most profitable big bank in the country.
Mr Buffett said that Berkshire’s share of the Big Four’s 2015 earnings amounted to $US4.7 billion, but Berkshire only received dividends of $US1.8 billion.
To critics of these holdings, especially IBM and Amex, he said in the letter “At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business. It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone.”
Last year Buffett started telling shareholders and investors to look at the company’s longer term performance (over 5 years) against the performance of the S&P.
That’s because of the increasing size of the non-industrial side of the business which has a longer time frame than some of the insurance (apart from the long tail risks reinsurance and underwriting, much of the insurance business is yearly renewals, such as property and casualty and reinsurance deals).
Berkshire reported net profit climbed to $US24 billion for the year, with the increase driven by a one off investment gain of $US4.4 billion tied to the merger last year of Kraft Foods and H.J. Heinz. Berkshire owns 27% of the combined company, which has annual sales of $US27 billion.
Excluding the gain, Berkshire’s full-year profit was $US17.4 billion, up 5.4% from $US16.5 billion in 2014, on revenue of $US210.8 billion, up 8.3% from $US194.6 billion in 2014. Mr Buffett said the company’s net worth rose $US15.4 billion (up 6.4%) in 2015.
Berkshire’s non-insurance companies also include what Mr. Buffett called the “Powerhouse Five”: Berkshire Hathaway Energy, Marmon (an industrial holding company), Lubrizol (specialty chemicals), IMC (metalworking) and BNSF Railway, which together earned $US13.1 billion last year.
That was a rise of $US650 million from 2014 Buffett says the group will become the “Powerhouse Six” with the addition of Precision Castparts, an aerospace components maker and supplier.
A lower result from Berkshire’s large insurance operations — which earned $US4.9 billion in 2015 compared with $US5.2 billion in 2014 — put downward pressure on the results.
However, the insurance group’s float rose to $88 billion from $US41 billion at the end of 2014. The ‘float’ in these businesses (that’s premium income inflows and payments approved and waiting to be paid) can allow the company to fund investments.
Buffett reminded investors why insurance has been good for Berkshire over the five decades he’s run the company and have generated an underwriting profit of $US26 billion in the last 13 years alone!
In 2015, all of Berkshire’s other businesses — including a railroad, utilities and energy, financial products, manufacturing and retail — were more profitable than the previous year.
Buffett highlighted the turnaround in the company’s biggest industrial business, the BNSF railroad, which improved its service to customers after $US5.8 billion of capital spending which was forced on it by accidents and criticisms of a lack of investment to handle the shale oil boom which needs tens of thousands of tankers and railroad facilities to transport (pipelines were not sufficient to handle the surge of millions barrels a day in output or more in 2013-2015.
Don’t look for any mentions about oil, China, foreign currency exchange rates, or monetary policy in the Berkshire letter— they are not there, although there is a strong defence of the health of the American economy.
Buffett did emphasise that the domestic economy is strong, despite what politicians contend. He is typically upbeat on the long-term prospects of the US economy. And this year is no different, as the ultimate value investor highlighted “generational opportunities.”
“It’s an election year, and candidates can’t stop speaking about our country’s problems (which, of course, only they can solve). As a result of this negative drumbeat, many Americans now believe that their children will not live as well as they themselves to. That view is dead wrong: The babies being born in America today are the luckiest crop in history,” Buffett wrote in the letter.
He strongly defended the company’s manufactured homes group, Clayton Homes against media claims that it exploited some people and discriminated against others in selling mortgages to buy these homes. His defence was pretty robust and detailed, unlike many of the media claims.
And he rejected claims from one shareholder (a do-gooder group based in Nebraska which owns 1 share) that the company should make more disclosures about the impact of climate change on its insurance policy. The group and others like it claim insurance companies will be hurt by rising claims caused by climate change.
Buffett pointed out that except for some long tailed claims and insurance types, all insurance and reinsurance was repriced annually, so if there was a rise in claims caused by climate change from more floods, fires and storms, Berkshire’s companies would put up their premiums to reprice for the higher risk.
He pointed out that rising claims for insurers increased the value of insurance companies because of rising premiums and revenue (much of which is not paid out at all and falls to the company’s profit and loss account). "It’s understandable that the sponsor of the proxy proposal (for the annual meeting) believes Berkshire is especially threatened by climate change because we are a huge insurer, covering all sorts of risks.
The sponsor may worry that property losses will skyrocket because of weather changes. And such worries might, in fact, be warranted if we wrote ten- or twenty-year policies at fixed prices. But insurance policies are customarily written for one year and repriced annually to reflect changing exposures. Increased possibilities of loss translate promptly into increased premiums.
“Up to now, climate change has not produced more frequent nor more costly hurricanes nor other weather – related events covered by insurance. As a consequence, U.S. super-catastrophe rates have fallen steadily in recent years, which is why we have backed away from that business. If super-cats become costlier and more frequent, the likely – though far from certain – effect on Berkshire’s insurance business would be to make it larger and more profitable.
"As a citizen, you may understandably find climate change keeping you up nights. As a homeowner in a low-lying area, you may wish to consider moving. But when you are thinking only as a shareholder of a major insurer, climate change should not be on your list of worries,” Buffett wrote.
