He would like a word.
It’s time for another eagerly anticipated epistle from the Warren Buffett.
Berkshire Hathaway BRK.A, -1.02% BRK.B, -1.04% will release its annual report at around 8 a.m. Eastern Time on Saturday, but the main draw will be the annual letter to shareholders from Buffett, the firm’s chairman and chief executive.
This will mark the 51st year Buffett, 85, has written a letter to Berkshire investors. His track record — combined with his folksy ability to explain his investment philosophy, long-term strategic decisions and even his biggest regrets — have made the letters a must-read for investors and students of the market. He’s not called the “Oracle of Omaha” for nothing.
With that in mind, here’s a rundown of some of the things investors and other interested observers will be looking for Saturday morning:
1. Hunting elephantsBerkshire’s $37.2 billion acquisition of aerospace-and energy-equipment maker Precision Castparts Corp. in August — Buffett’s largest single acquisition ever — drove home something the billionaire was getting at in last year’s letter: For a company that has grown to the mammoth size of Berkshire, big takeovers are now preferable to picking stocks when it comes to building value.
Don’t expect Buffett to tip his hand on future acquisitions, but he may offer some further insight into how he sees the strategy playing out.Buffett told shareholders at Berkshire’s annual meeting last May that given the firm’s size and scope, making large acquisitions was a way to create “more enduring value” and that it had “moved into phase two.”
After the Precision Castparts deal, Buffett ruled out any major takeovers in the immediate future, citing the need to “reload” cash reserves before hunting more elephants.
The move reflects the notion that Berkshire’s size makes it difficult to find deals big enough to move the needle on earnings without overpaying. Don’t expect Buffett to tip his hand on future acquisitions, but he may offer some further insight into how he sees the strategy playing out.
2. ‘The float’“You’ve got to understand insurance to understand Berkshire Hathaway,” said Robert Miles, an author and speaker who has written three books on Buffett and his investing style.
Indeed, the “float” is often described as Berkshire’s not-so-secret sauce. Buffett has devoted large chunks of past letters to talk about the float and the unique role it has played in his investment success.
The float, simply put, is money collected from insurance premiums but not yet paid out to meet claims. It is a liability on an insurer’s books, but the lag between collecting the premiums and paying out claims provides an opportunity to invest the float — and that’s been a boon for Berkshire.
Other insurers have struggled to make hay from the float, in large part because they lack Buffett’s investing acumen, and that has forced them to park cash in low-yielding assets.
But some investors think too much attention is paid to the float. The real secret to Berkshire's success is “intelligent underwriting and intelligent investment over a long period,” which is “not normal for insurance companies,” wrote investor David Merkel wrote in a 2014 blog post.
3. Mistakes, he’s made a few…Buffett isn’t afraid to admit a mistake. At times, it seems as if he revels more in owning up to blunders than taking credit for his wins. Of course, that’s a trait shared with many successful investors, who often like to parade past mistakes as learning opportunities that often provide more useful wisdom than any easy success.
Here’s Buffett in his 1999 letter — marking a rare bad year for Berkshire:
|Even Inspector Clouseau could find last year’s guilty party: your Chairman. My performance reminds me of the quarterback whose report card showed four Fs and a D but who nonetheless had an understanding coach. “Son,” he drawled, “I think you’re spending too much time on that one subject.” |
My “one subject” is capital allocation, and my grade for 1999 most assuredly is a D. What most hurt us during the year was the inferior performance of Berkshire’s equity portfolio — and responsibility for that portfolio, leaving aside the small piece of it run by Lou Simpson of GEICO, is entirely mine. Several of our largest investees badly lagged the market in 1999 because they’ve had disappointing operating results. We still like these businesses and are content to have major investments in them. But their stumbles damaged our performance last year, and it’s no sure thing that they will quickly regain their stride.
4. Book value versus market valueBuffett surprised investors last year when, for the first time, he added a column to the usual front-page table (see below). It showed the firm’s change in market value (shares outstanding multiplied by market price) alongside his long-preferred measure of book value (the difference between a company’s total assets and total liabilities).
As Buffett explained in last year’s letter, he’s traditionally viewed book value as a “crude, but useful, tracking device” of the crucial but elusive “number that really counts: intrinsic business value.”
As Buffett explained in last year’s letter, he’s traditionally viewed book value as a ‘crude, but useful, tracking device’ of the crucial but elusive ‘number that really counts: intrinsic business value.’Buffett explained the change as further recognition of Berkshire’s shift from stock-picking machine to owner and operator of large businesses, many of which “are worth far more than their cost-based carrying value.”
The book value of those businesses are never revalued upward, he noted, no matter how much the value of the companies have increased.
But observers couldn’t help but note that the change last year followed Berkshire’s recent underperformance on book value-per-share relative to the S&P 500. It will be interesting to see if Buffett reverts to emphasizing book value, which is likely to be in line with the S&P 500 over the past year, while Berkshire’s stock price is down by around 10%, noted Miles.
5. SuccessionWho will take the helm when Buffett, 85, is gone? That has long been a mystery. Buffett last year stuck to his usual reassurance that Berkshire’s board had identified an unnamed successor to take the helm as chief executive (Buffett’s son Howard is slated to fill the post of nonexecutive chairman).
Vice Chairman Charlie Munger offered a bit more clarity, indicating that Ajit Jain, who Buffett has praised for his deft management of Berkshire’s insurance business, and Greg Abel, who’s also won kudos for his management of Berkshire’s energy operations, would both be strong candidates for the top job.
There’s little reason to think the situation has changed over the past year, but investors will undoubtedly parse the letter for further clues.