Warren Buffett, the Chairman and CEO of Berkshire Hathaway Inc (BRK.A) and (BRK.B) published his annual letter for 2019 this past week. As usual Warren Buffett’s Annual shareholder letter makes for good reading. Below are some highlights that I view as important or at least interesting from the newsletter.
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Warren Buffett’s Returns Crushes That of The S&P 500
The annual letter leads with a list of annual gains for Berkshire Hathaway compared to the S&P 500 (SPY) since 1965. An investment in 1965 in Berkshire Hathaway would have returned a compounded annual gain of 20.3% and an overall gain of 2,744,062%. Pretty much anyone who started investing with Buffett in 1965 would be very wealthy by this point. Over the same time period, the S&P 500 had a compound annual gain of 10.0% and an overall gain of 19,784% with dividends included. Notably, not all years were gains for Berkshire Hathaway. There were 10 down years and the worst year was a (48.7%) decline in 1975. Interestingly, the S&P 500 did much better in 1975 with a loss of only (26.4%). But in most years Warren Buffett’s Berkshire Hathaway outperformed the S&P 500 by a wide margin. In turn this has led to outsized total returns.
The S&P 500 did much better than Buffett in 2019 with a gain of 31.5% versus 11.0% for Berkshire. But with that said, Berkshire Hathaway earned $81.4 billion in 2019. This is more than the market capitalization of most companies. This amount was comprised of $24 billion in operating earnings, $3.7 billion in realized capital gains, and $53.7 billion from an increase in the net unrealized capital gains of stock holdings. The $53.7 billion resulted from a new generally accepted accounting principles (aka ‘GAAP’) rule that requires including net change in unrealized gains and losses of stock holdings. Note that Buffett or his partner Charlie Munger disagree with that rule. But nonetheless, they are now reporting it.
Did Warren Buffett Recommend Two Books
There were two books that Buffett wrote about in Warren Buffett’s Annual Letter. The first is Common Stocks as Long Term Investments, which I have not yet read. This book was written by Edgar Lawrence Smith in 1924. According to Buffett, Smith planned on arguing that stocks would perform better than bonds during inflationary periods and that bonds would deliver superior returns during deflationary times. However, Smith’s initial thesis was proven wrong. The main point of his book is that well-managed industrial companies do not distribute all their profits to shareholders as dividends. Instead they retain a part of it to reinvest in the business to drive future growth. This really is he power of retained earnings for well managed companies. Most businesses reinvest a portion of their earnings to drive future growth. This in effect is compounding of a business’ earnings power.
The second book mentioned by Warren Buffett was Margin of Trust, a new book by Larry Cunningham and Stephanie Cuba. I have not yet read this book either. But it is on my ever-growing list. This book is about Berkshire Hathaway’s business model and Warren Buffett’s approach to management and corporate life.
Berkshire Hathaway’s Stock Holdings
Berkshire Hathaway’s stock holdings continue to grow in value over time. There are down years but the general long-term trend is upward. The current value of company’s stocks was $248,027 million with a cost basis of $110,340 million. Note that Berkshire Hathaway’s stock holdings have a market value greater than almost all US companies except a handful. Berkshire is a major shareholder in some of these companies. For instance, it owns over 18% of American Express Company (AXP) as well as significant percentages of Bank of America Corp (BAC), Delta Air Lines Inc (DAL), and Moody’s Corporation (MCO). The top 10 largest holdings distributed $3,798M in dividends to Berkshire.
Note that Berkshire’s ownership percentage tends to rise each year due to share buybacks by the individual companies. Ten years ago, at end of 2010 Berkshire owned only 12.6% of American Express. The ownership stake is about 50% greater since then and is now 18.7%.
Berkshire’s Wholly Owned Companies
Besides the stock holdings, Buffett discussed Berkshire’s growing list of wholly or almost wholly owned non-insurance companies continue to generate growing operating earnings for Berkshire Hathaway. These business are run by Greg Abel. The two most profitable companies were Burlington Northern Santa Fe (BNSF) railroad and Berkshire Hathaway Energy, which combined earned $8.3 billion. The next five companies, which are Clayton Homes, International Metalworking, Lubrizol, Marmon, and Precision Castparts earned $4.8 billion in 2019.
The five after that, which are Berkshire Hathaway Automotive, Johns Manville, NetJets, Shaw, and TTI earned $1.9B in 2019. The remaining business earned $2.7 billion in 2019 for a total of $17.7 billion. Since Berkshire does not pay a dividend and only started buying back shares recently much of this goes into Berkshire Hathaway’s growing war chest. This is in effect retained earnings. The company has over $124 billion in cash, equivalents, and short-term investments at end of 2019. A number that grew from over $109 billion at end of 2018. Eventually this money will be used for an acquisition.
Berkshire’s Insurance Operations
Berkshire’s Insurance operations continue to be profitable, which is the 16th time in the past 17 years. This business is run by Ajit Jain. The insurance operations only lost money in 2017 when pre-tax losses totaled $3.2 billion. Berkshire Hathaway’s insurance float continues to grow and was over $129 billion at end of 2019 growing from $39 million at end of 1970. This is money that is invested and earns essentially a very safe return for the insurance operations.
Final Thoughts on Warren Buffett’s Annual Letter 2019
Warren Buffett concludes the letter by spending a significant time talking about the future of Berkshire Hathaway. Buffett discusses his will and writes about the future plans for his Berkshire stock holdings. Warren Buffett also wrote about the Board of Directors as he and vice chairman Charlie Munger have planned it out. If you have not had an opportunity to read Warren Buffett’s annual letter, it is always worth a read for small investors. Warren Buffett and Charlie Manager are some the best money managers of all-time. As a final note, I periodically write about Warren Buffett. My last article was entitled Warren Buffett’s Top 10 Stocks in 2019.
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.
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