3 Key Takeaways From Buffett’s Annual Letter to Shareholders

Warren Buffett, the world’s most recognized stock market investor, addressed shareholders of his Berkshire Hathaway in an annual letter.

Much of the emphasis has been placed on the future of the company as Buffet, 89, and his close aid Charlie Munger, 96, prepare the company for what’s next when they are not around anymore.

Record earnings, operating profit disappoints

Berkshire Hathaway reported a decrease of 23% in quarterly operating profit to $4.42 billion from $5.72B a year earlier, mainly due to the poor performance of its insurance business.

“The big miss was on the insurance front, though energy and railroads were stronger. It will be interesting to see the impact of coronavirus on freight traffic in the first quarter and beyond,” said Cathy Seifert, an analyst at CFRA Research.

On the other hand, quarterly earnings smashed previous all-time record with net income reported at $81.42 billion, almost double compared to the previous record of $44.94 billion for 2017, mainly due to unrealized gains from its stock investments.

Such differences in the quarterly profit stem mainly from a different accounting approach Berkshire has been forced to take, which means that the company has to report paper gains and losses from its stock holdings with net income.

In his annual letter, Buffet used the opportunity to inform shareholders that the company is in good hands. Every year, investors and analysts wait for Buffett’s annual letter as they look for clues and financial wisdom from the world’s renowned investor.

Here’s a look at three key takeaways from Buffett’s latest letter.

Who’s next?

As Buffett and Munger have the combined age of 185 years, it’s not surprising that the media is so insistent to find out who Buffett picked to succeed him. His two top “generals” are Ajit Jain and Greg Abel.

Jain, 68, is Vice Chairman of Insurance Operations at Berkshire, and one of the most trusted people to Buffett. When asked about him, the legendary investor famously said that “I don’t know what his best deal was. I know what my best deal was: It was hiring him”.

Abel, 57, is Vice Chairman of Non-Insurance Operations and is known for building Berkshire’s energy empire. Abel and Jain are seen as two operating managers who are practically running Berkshire’s impressive portfolio on a daily basis.

Given their age, Buffett and Munger are open to giving more room to Jain and Abel in the future. Media has been speculating for a long time that either Abel or Jain will be hand-picked by Buffett to replace him at the top of Berkshire Hathaway.

“I’ve had suggestions from shareholders, media and board members that Ajit Jain and Greg Abel — our two key operating managers — be given more exposure at the meeting. That change makes great sense,” said Buffet in a letter.

“They are outstanding individuals, both as managers and as human beings, and you should hear more from them. Charlie and I long ago entered the urgent zone. That’s not exactly great news for us. But Berkshire shareholders need not worry: Your company is 100% prepared for our departure,” he added.

And it seems that investors and analysts are not worried.

“I’m comfortable with how Berkshire is moving up the next generation,” said Thomas Russo, a partner at Gardner, Russo & Gardner in Lancaster, Pennsylvania, a longtime Berkshire shareholder.

Strategy shift?

In 2016, Berkshire bought the aircraft parts maker Precision Castparts in a deal worth over $32 billion. The company is now entering its fifth year without a major acquisition, which in the investing industry, may look bad for the company.

The latest data shows that Berkshire finished the year with $128 billion in cash, which is a number similar to the one reported at the end of Q3. Many ask whether Buffett “still has it”, given his remarkable reputation for striking great deals.

Contrary to expectations that Buffett will use the “too expensive” excuse to defend his cash hoard, he simply referred to a difficult market.

“The opportunities to make major acquisitions possessing our required attributes are rare,” he wrote.

And what are the required attributes, as per Buffett?

“First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price,” he added in the letter.

Instead, Buffett prefers to have bigger stakes in well-run businesses, such as Apple.

“Far more often, a fickle stock market serves up opportunities for us to buy large, but non-controlling, positions in publicly traded companies that meet our standards,” he said.

Given how high the stock market is trading, many analysts believe that good and profitable businesses are simply too expensive now. Instead of multi-billion acquisitions, Buffett prefers smaller, non-controlling stake investments.

“I was expecting him to say the market was expensive. He didn’t even hint that,” said Stephen Dodson, who manages the Bretton Fund.

Continue to invest in stocks

Buffett has been one of the most vocal advocates for investing in the stock market in the last decade. As some investors prefer to channel their funds into bonds, Buffett is adamant that the stock market offers far more opportunities for profit than fixed-rate debt instruments.

“If something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments,” he wrote.

Berkshire owns a stake in such giants as Apple, Coca-Cola, Kraft Heinz, JP Morgan etc.

“That rosy prediction comes with a warning: Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater,” warns Buffett but adds that still equities are a “much better long-term choice” compared to other options.

Once again, Buffett doubled down on his long-known strategy: pour cash into equities.

Summary

Investors, media, and shareholders of Berkshire Hathaway finally got the opportunity to see the latest annual letter from the legendary investor Warren Buffet as his words are always closely followed.

Buffet used the opportunity to defend recent activities from his company, which instead of investing in multi-billion acquisitions prefers non-controlling stakes in well-run, publicly-trading business.

Moreover, Buffett said that his two top generals – Jain and Abel – will get more exposure in meetings and in front of shareholders. It is still unknown who will replace Buffett at the top, although it is almost certain that the successor will be either Jain or Abel.