Warren Buffet’s Letter:

Kraft/Heinz, Big Stock

Losses, the US Budget Deficit.
Image

Warren Buffett, in his letter to Berkshire Hathaway investors on Saturday, said he continued “to
hope for an elephant-sized acquisition.”CreditCreditRick Wilking/Reuters
By Peter Eavis, Stephen Grocer and Jaime Condliffe
 Feb. 23, 2019

The stock market rout that occurred at the end of last year hurt Berkshire
Hathaway’s 2018 profits, at least on paper.

The conglomerate controlled by Warren E. Buffett suffered losses of $25.4

billion in the fourth quarter, according to Berkshire’s annual report that
was released on Saturday. The company owns $173 billion of stocks and the
market’s swoon in the fourth quarter helped cause losses of $22.7 billion on
those securities. Berkshire also recorded a $3 billion noncash loss related to
its large stake in Kraft Heinz, the struggling food company. (Stocks, of
course, have recovered this year, and Berkshire’s losses may now be
smaller.)

In his annual letter to Berkshire’s shareholders that accompanied its

results, Mr. Buffett urged investors to focus on the performance of
Berkshire Hathaway’s broad array of companies, which includes insurers,
energy firms, railways and manufacturers. These firms did well last year,
posting a 36 percent increase in earnings.
Before 2018, Berkshire did not include the performance of its stock
holdings in its income statement, unless it sold the shares. But a new
accounting rule requires that the company include the paper gains and
losses. That is something Mr. Buffett has criticized, saying the rule would
cause “wild and capricious” swings in Berkshire’s bottom line. In this year’s
letter, he wrote, “Indeed, in the fourth quarter, a period of high volatility in
stock prices, we experienced several days with a ‘profit’ or ‘loss’ of more
than $4 billion.”
ADVE RT ISEMENT

Problems at Kraft Heinz, which on Thursday reported weak fourth-quarter

earnings and a $15.4 billion write-down, also weighed on Berkshire, which
owns a nearly 27 percent stake in the food company.

If Kraft, among Berkshire’s biggest holdings, fails to revive its business, Mr.
Buffett’s reputation as a savvy investor could take a hit. His partner in the
food maker, a Brazilian investment firm called 3G Capital, has pursued a
strict cost-cutting strategy that may now be showing diminishing returns.
Here’s a look at some of the other highlights from the letter:

What to do with all its cash? Buybacks

Berkshire joined the buyback boom last year, modestly.

The company bought back $418 million of its own shares during the final
three months of 2018, bringing its total for the year to just over $1.3 billion.

That activity will probably continue. “It is likely that — over time —
Berkshire will be a significant repurchaser of its shares,” Mr. Buffett wrote
in his letter to shareholders.

Flush with cash from the $1.5 trillion tax cut, American companies bought
back almost $800 billion of their own stock last year, a record amount. By
reducing the number of shares outstanding, the buybacks can help boost
the companies’ stock prices. And companies often buy back their shares
when they believe they have nothing better to do with their money than
return capital to shareholders.

There are signs of that at Berkshire. Over the years, Mr. Buffett has mostly
avoided repurchasing Berkshire’s shares, arguing that he could generate
better returns for shareholders through investments.

But as the price to acquire big companies has risen in recent years,
Berkshire hasn’t made any big deals. That has led Mr. Buffett, who in the
past has disparaged corporate buybacks, to consider repurchasing
Berkshire’s stock.
This summer, Berkshire lifted its restrictions on the price at which price
Mr. Buffett could buy back shares. In the third quarter, it bought back $928
million worth.

So far, Berkshire’s buyback spending has been fairly modest, and in his
letter, Mr. Buffett warned of caution in the future.

“Obviously, repurchases should be price-sensitive: Blindly buying an

overpriced stock is value destructive, a fact lost on many promotional or
ever-optimistic C.E.O.s,” Mr. Buffett wrote.

Berkshire vs. the S&P 500

One of Mr. Buffett’s goals each year is to beat the S&P 500 stock market
index. Last year, Berkshire did.
In 2018, the company’s book value rose 0.4 percent and its stock price
climbed 2.8 percent. By comparison, the S&P 500 lost 4.4 percent, counting
dividends.

For years, Mr. Buffett’s preferred measure of Berkshire’s performance was

the company’s book value as compared with the S&P 500, and he would
highlight the annual rise and fall of both on a table in the letter.

But beating the S&P 500 became more difficult as Berkshire grew and
shifted to buying whole companies. In 2014, Mr. Buffett added the annual
performance of Berkshire’s stock price to the table.

“The fact is that the annual change in Berkshire’s book value — which
makes its farewell appearance on page 2 — is a metric that has lost the
relevance it once had,” Mr. Buffett wrote in this year’s letter.

Why no deal making?

Berkshire has grown by spending large chunks of money to acquire other
companies. That remains part of its long-term plan, according to Mr.
Buffett’s letter, but the current business climate means that it’s temporarily
on hiatus.

“In the years ahead,” he wrote, “we hope to move much of our excess
liquidity into businesses that Berkshire will permanently own. The
immediate prospects for that, however, are not good: Prices are sky-high
for businesses possessing decent long-term prospects.

And if you were in any doubt about Mr. Buffett’s appetite for huge deals, he
paints a vivid picture about just how much he’d like to bag one.
“We continue, nevertheless, to hope for an elephant-sized acquisition,” he
wrote. “Even at our ages of 88 and 95 — I’m the young one — that prospect
is what causes my heart and Charlie’s to beat faster. (Just writing about the
possibility of a huge purchase has caused my pulse rate to soar.)”
ADVE RT ISEMENT

Don’t fret the United States’ budget deficit

Mr. Buffett also seems to have become more relaxed about the federal
budget deficit, which has recently been getting bigger.

In the 2018 annual report, he wrote: “Those who regularly preach doom
because of government budget deficits (as I regularly did myself for many
years) might note that our country’s national debt has increased roughly
400-fold during the last of my 77-year periods.”

Investors buying gold to try and protect themselves from the rising debt
and the prospect of ballooning deficits would have made a mere fraction of
what they would have earned in the United States stock market over the 77
year period, Mr. Buffett noted. (Mr. Buffett first invested in an American
business 77 years ago.)

“The magical metal was no match for the American mettle,” he said in the
report.

Succession plans remain a secret

Every year, investors carefully read Mr. Buffett’s letter for clues about
Berkshire’s succession plans. They didn’t get any on Saturday.

Mr. Buffett did, however, champion his two most senior lieutenants. At the
start of 2018, Berkshire Hathaway promoted two of its longtime executives,
Gregory E. Abel and Ajit Jain, to oversee the company’s businesses. Mr.
Abel became vice chairman of the conglomerate’s non-insurance
businesses; Mr. Jain is vice chairman of Berkshire’s insurance operations.

In his letter on Saturday, Mr. Buffett said this: “I want to give you some
good news — really good news — that is not reflected in our financial
statements. It concerns the management changes we made in early 2018,
when Ajit Jain was put in charge of all insurance activities and Greg Abel
was given authority over all other operations. These moves were overdue.
Berkshire is now far better managed than when I alone was supervising
operations. Ajit and Greg have rare talents, and Berkshire blood flows
through their veins.”

Quips and quotes

Mr. Buffett’s annual letter has become known for its investment advice and
folksy wisdom as well as a few corny jokes. Here are some of the best lines
from this year’s. (The Charlie they mention is Charles T. Munger, Mr.
Buffett’s vice-chairman at Berkshire Hathaway.)

On accounting fraud: “Over the years, Charlie and I have seen all sorts
of bad corporate behavior, both accounting and operational, induced by the
desire of management to meet Wall Street expectations. What starts as an
‘innocent’ fudge in order to not disappoint ‘the Street’ — say, trade-loading
at quarter-end, turning a blind eye to rising insurance losses, or drawing
down a ‘cookie-jar’ reserve — can become the first step toward full-fledged
fraud. Playing with the numbers ‘just this once’ may well be the C.E.O.’s
intent; it’s seldom the end result.”
On paying tax: “Begin with an economic reality: Like it or not, the U.S.
Government ‘owns’ an interest in Berkshire’s earnings of a size determined
by Congress. In effect, our country’s Treasury Department holds a special
class of our stock — call this holding the AA shares — that receives large
‘dividends’ (that is, tax payments) from Berkshire. In 2017, as in many
years before, the corporate tax rate was 35 percent, which meant that the
Treasury was doing very well with its AA shares.”

On using debt: “Many managers, it should be noted, will disagree with

this policy, arguing that significant debt juices the returns for equity
owners. And these more venturesome C.E.O.s will be right most of the time.
At rare and unpredictable intervals, however, credit vanishes and debt
becomes financially fatal. A Russian roulette equation — usually win,
occasionally die — may make financial sense for someone who gets a piece
of a company’s upside but does not share in its downside. But that strategy
would be madness for Berkshire. Rational people don’t risk what they have
and need for what they don’t have and don’t need.”