Warren Buffett's Letter to Shareholders -- Viewed as a Series of Charts
You read what Warren Buffett said in his letter to shareholders this weekend, now let’s go to the charts. Over the last 47 years, Berkshire Hathaway (BRK.A) has produced growth in book value per share from $19 to $99,860, a rate of 19.8% compounded annually. Amazing.
Buffett likes the insurance business, which provides costless capital to fund other investment opportunities for Berkshire. Insurance premiums become “float” which is invested for Berkshire’s benefit. The Berkshire insurance operations have had nine consecutive years of underwriting profits, totaling about $17 billion. Over the same nine years float increased from $41 billion to its current record of $70 billion.
Berkshire has used the capital to build up large ownership interests in the "big four": 13.0% of American Express (AXP), 8.8% of Coca-Cola (KO), 5.5% of International Business Machines (IBM) and 7.6% of Wells Fargo (WFC).
In addition to the "big four", Warren and Charlie had Berkshire buying its own stock last September. Berkshire said it would repurchase its shares at a price of up to 110% of book value, so it bought $67 million of stock over a couple days and stopped once the stock rose over the limit. A Berkshire director compares this to "shooting fish in a barrel, after the barrel has been drained and the fish have quit flopping". The chart below shows the dip Buffett bought into.
Berkshire operating businesses did well. The five largest non-insurance companies – BNSF, Iscar, Lubrizol, Marmon Group and MidAmerican Energy – delivered record operating earnings. "Unless the economy weakens in 2012, each of our fabulous five should again set a record, with aggregate earnings comfortably topping $10 billion", said Buffett.
There were a couple negatives. Real estate-related investments and Energy Future Holdings were challenging. Last year Buffett said “a housing recovery will probably begin within a year or so.” He now acknowledges that was overly optimistic. Berkshire has five businesses tied to housing activity, with aggragate pre-tax profits of $513 million in 2011, down from $1.8 billion in 2006. In Buffett's view, the employment situation in the U.S. will recover with the housing market.
Buffet also discussed his philosophy of investing - "forgoing consumption now in order to have the ability to consume more at a later date." He breaks investments into three categories. First, investments that are denominated in a given currency (interest-rate products): money-market funds, bonds, mortgages, bank deposits, and other instruments. He calls these some of the most dangerous assets. "Their beta may be zero, but their risk is huge." As the Fed continues to print money, the dollar continues to lose value. Thus the high risk of holding dollar-denominated assets.
Given that he already has buckets of it, the Old Man abhors easy money: "Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965 . . . For tax-paying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It’s noteworthy that the implicit inflation “tax” was more than triple the explicit income tax that our investor probably thought of as his main burden. “In God We Trust” may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human."
The second major includes assets like gold. "What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” of investors join any party, they create their own truth – for a while". The "bandwagon" has enjoyed an amazing run as you can see below.
The third category, Buffett's favorite, is investments in productive assets like businesses, farms, and real estate. These have the ability to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.
If you’re a believer in Buffett's approach, you can buy shares of Berkshire, which will also get you into the annual meeting May 5th. To find examples of his approach, follow the Buffett Portfolio Strategy in YCharts Pro which aims to select stocks that fit Buffett's strategy: solid ROE, increasing book value and wide “moats” that serve as barriers to competitors.