EP48 2018 Berkshire Shareholder Letter By Warren Buffett
This is volume vesting. I'm your host June in this podcast. You'll learn everything related volume best. Hello, follow investors who welcome to another episode of folly investing on today's show. What I'm gonna talk about a two thousand eighteen annual later from Berkshire Hathaway, so Warren Buffett writes this letter every year, and he puts a lot of time into putting together this letter. So I thought that it be nice to go over this letter on today's episode. So there are five items that I'm going to touch up on on today's show, and I'm so excited to go over them because it is advice from legendary investor Warren buffet, so before we get started limiters, keep your creek. Disclaimer as always that this podcast is for entertainment purposes, only, and it is your responsibility to consult with your investment professional for any investment decisions. So without further ado, why don't we get started? So as I mentioned in the intro, we're gonna. Talk about five things in two thousand eighteen Berkshire Hathaway and your letter. So this is the shareholder letter. Warren buffet have rights every year to his shareholders. And what's quite interesting is that Warren Buffett dozen hold Cawley Kohl's in anything like that with Wall Street analysts. And that's what happens to a lot of companies on Wall Street, and that's not the case for Berkshire Hathaway, so instead what Warren Buffett does he writes, this Enya letter shareholder letter to show holders and hold. So he holds annual meeting in Omaha Nebraska, and a lot of people flocked to never sky in order to see Warren Buffett, and he answers, virtually all the questions that individuals shareholders have in their mind. So that's quite different from what other companies do for their quarterly, Kohl's and things. Like that. So why don't we get into the five topics that I wanted discuss on today's show. So let me just go over them briefly. And and let's get into the details. The first topic that I wanna talk about ease gap rule that requires companies to report their stock portfolio marked market, so warm befit complained about this new rule because it doesn't make sense to him and Charlie monger, some gonna get into later the second topic that I wanna talk about here is the practice of using the book value in order to measure Pirker, Hathaway's intrinsic value. So Warren buffet from this letter on started to abandon this practice, and he laid out he's rationale for that. The third thing that he talks about in. His letter is Berkshire Hathaway's intrinsic value calculation. Berkshire Hathaway holds a lot of companies. It's quite complicated to calculate injuries value of Porsche or Hathaway, but he said that it's not that bad if you group them together. So that's what I want to talk about on today's show as well. The fourth thing that I wanna talk upon is funding sources for Berkshire Hathaway, Berkshire Hathaway has traditional funding sources like other companies, and but it also has untraditional funding sources that do not exist in other companies. So that's something fight interesting to talk about. And lastly, you're going to talk about American tailwind. So this is economic power that American companies have and warmth of basically have very positive view about the future prospects of America. So those are the five things that we're going to touch upon on today's show, and let's just get into each topic. And. Talk about the details. So the first pick is the new caporal. So this new gap rule requires companies public companies to report their stock portfolio marked market every quarter. So this is particularly produce interesting results for Berkshire Hathaway because as you know, Warren Buffett has a huge stock per folio for Parker Hathaway this produces wild swings in the bottom line. You'd actually goes down to Berkshire Hathaway's income statement every quarter and warm at things that this doesn't make any sense to him. Well, he laid out some examples in two thousand eighteen the first quarter berkshire-hathaway reported one point one billion dollars loss. Second quarter twelve billion dollar profit third quarter eighteen billion dollar profit and fourth. Quarter twenty five billion dollar loss. So it's a huge swing Potter over quarter. While many businesses on the Berkshire Hathaway umbrella had produced consistent and satisfactory operating earnings in all quarters. It's not just one quarter an old quarters. So if you look at financial statement, then you have gotten the impression that Berkshire Hathaway business is not you know, in a stable condition. It actually produces wild swings in profits and losses every quarter. But that's not necessarily a case. If you look at a lot of businesses warm of purchase over the course of his career day produce very consistent earnings quarter over quarter. And if you look at financial statement, you probably wouldn't be able to calculate intrinsic value in a correct manner. So focused on off rating earnings while Warren Buffett. Said and pay little attention to gains and losses of stock portfolio. So that's the first topic. I agree with Warren buffet, and it actually makes the analysts job hotter because they have to carve out this stop per folio. And try to see how they can look at the operating earnings standing, and it actually makes hard for us to evaluate a company like Berkshire Hathaway because it has a lot of stocks in its book, the second topic that I wanna talk about here is the practice to use boop value as a measure to evaluate the interest. Value perks Hatheway so warm it decided to abandon this practice going forward because of the following reasons. First Berkshire Hathaway has gradually more from a company whose assets are concentrated in marketable stocks into the one whose market value resides in operating businesses. And second while equity holdings are volleyed at market prices operating companies are reported at boop value that he's far below their current Bali. And lastly over time pressure Hathaway will be a significant repurchase of its shares transactions that will pay place at prices above Pook folly, but below two of intrinsic value. So each transaction makes per share intrinsic value up whenever this type of stock repurchase happens. But it actually makes the per share value go down. So this combination causes the boop value scorecard to become increasingly out of touch with economic reality. So he laid out three reasons as I just mentioned, and he decided not to make use of boot value as yardstick in order. Assess intrinsic value of the company. So if you look at Warren Buffett's annual laters always he looked at the changing McFaul you from year to year. And then that he started his annual later from that change, but he is not going to do that anymore because of these reasons so that was the second topic and third topic. He's talking about in his annual letter is with respect to intrinsic value calculation. So here he said that a lot of analysts focus on the details instead of looking at the overall picture, so since Berkshire Hathaway has a lot of businesses on the one roof. It's extremely hard for anyone to assess you know, with certain accuracy, interesting folly of the company warmth of gave out some useful advice here. He said that focus on the forest and forget the trees, so what he's saying is, basically. Just look at the things in groups instead of looking at the details of each company that Berkshire owns so he said that there are five groups that you can focus on and whenever you value at the Berkshire Hathaway stock you have to Gupta in five goofs, and that's gonna help you come up with insurance value. The first group is non insurance businesses that Berkshire controls these subsidiaries earned sixteen point eight billion dollars last year. And it's pretty much like everything because Berkshire Hathaway owns a lot of different kinds of businesses. And he wants to group them together here in one group. The second group is a collection of marketable equities. So Berkshire Hathaway owns a lot of stocks like americ- spreads apple BankAmerica. Coca Cola and Wells Fargo, and these are the companies that are reported. At market value marked market, so you can evaluate his company easily because you can just look at the market value. Warren buffet mentioned share purchases that these companies make and one example is American Express because American Express ownership was toll point six percent for Berkshire Hathaway eight years ago. But now it actually went up to almost eighteen percent. We doubt berkshire-hathaway buying a single share during that time period that kind of ownership increase happened because a stock repurchases by American Express, so style repurchases actually benefit quite a lot for existing shareholders. And since Warren buffet, and Berkshire Hathaway are usually long-term holder of a lot of stocks. They actually benefit quite a log from ownership perspective. The third group that he mentioned here is the companies in which Berkshire share control with other parties. So one good example is craft Hanes and Berkshire Hathaway owns twenty six point seven percent of Hanes along with three g capital. So if you combine the ownership of three g capital imperfect Hathaway, I think they're little bit above fifty percent. So they actually have controlling share of the company the fourth group that he mentioned is the treasury bills and other cash equivalence if you look at Berkshire Hathaway's balance-sheet warm buff as said that it wants to own enough amount of cash because Berkshire Hathaway's kind of in the business of insurance and wants to make sure that at least berkshire-hathaway on twenty billion dollars. But if you look at the kerm balance it it's about one hundred twelve billion dollar tree. Treasury bills and other Cachique Evelyn's, and he wants to deploy this cash to somewhere more productive because right now if you look at treasury bills, there don't really produce a high interest, and that's not Warren buffet likes. But he cannot find really large acquisitions to each warm of can invest this money. The last group is insurance. But before we get to the insurance. I let me reiterate the four groups that I just mentioned the first group is non insurance businesses. And the second group is a collection of market of equities and third groupies companies in which Berkshire share control with all their parties and fourth group is treasury bills and other cash equivalence. Warren buffet said that at the first four Gouves that I just mentioned and subtract an appropriate amount of taxes eventually payable on the sale of marketable securities. And that's how you derive intrinsic value for the first four groups the final group is very unique. And it actually is very important and crucial for Parker Hathaway, which is insurance businesses and much of the ownership of the I four segments, and I for groups is financed by funds generated from a collection of exceptional insurance companies that Berkshire Hathaway owns and if you look at the secret of how warm buffet has made tons of money for he's shareholders this secret is insurance businesses because insurance business has something called float so flow. This the money that insurance companies has. Right now, and it's not insurance companies money, but it's just the money. They insurance company holds for its policyholders. A later insurance companies has to pay out these money to policyholders in case of certain accidents or certain events stipulated in the contract. So the beauty of this business model is the fact that insurance company can hold his money for a long time. And it's quite good for someone like Warren Buffett because warmth of can make tons of money. If you look at the first page of annual letter that you'll see that Warren Buffett was able to produce approximately twenty percent annualized rate of return over forty years time, period. I don't even know if forty or fifty year time years time period and such money that you don't have to pay to policyholders cold float can be used to invest. In various companies for such a long time and warm buff Ed is perfect person to utilize this type of cash and money and make tons of money for he's shareholders. So that's the float that insurance company holds and as long as there's underwriting profit for insurance companies it actually is Haas free. The fourth item that I want to talk about as you released two thousand eighteen annual litter is funding sources that per Hatheway has so if you look at traditional companies, usually they have to funding sources the fronts funding sources that and the other one is equity so those are the two traditional funding sources, but if you look at Berkshire Hathaway there are two additional funding sources that Berkshire Hathaway uses and that is actually quite advantages for ratio holders. So the first funding source has mentioned that that, and this is quite typical lot of companies issued that and bonds in order to finance some activities that they're engaged in the second one is equity capital and a lot of companies are retain certain earnings in order to maintain their business or you not to go there. Businesses into different areas and things like that. And those are the quite common sources for a lot of American companies and also international companies just tell you to additional sources of money for Parker Hathaway, the first one is a float that I just mentioned so float is reported as a huge net liability on the balance sheet if you to accounting class before they you'd consider liability the bad thing for shareholders and for the company, but even though the float is reported as a net liability on the balance sheet actually has more utility to Berkshire Hathaway than an equal amount of equity. What I mean by that is since the flood is cost free because most of the insurance businesses on the Pirker Hatheway generate underwriting profit, which me. Means berkshire-hathaway doesn't have to pay any interest on this float to policyholders and to anyone else. If there's on the writing prophets for the flow that it means that Berkshire Hathaway east getting paid to hold the money. So that's a huge win for Warren Buffett because Warren Buffett has a special ability to generate compound interest on this float, and that's how he got so rich and how he made Berkshire Hathaway shareholder, so rich. So that's the third funding source that other companies do not have and the final funding source that Berkshire Hathaway has and other company. Do not have is deferred income taxes as of this quarter. Berkshire Hathaway has above fifty billion dollars defer income taxes, and this is the lions. Ability that you will eventually pay to the government. But in the meantime, it is interest free. So you don't have to pay any interest. This is also recorded as liability, but it's actually better than liability put because you don't have to pay interest. Just like float. And approximately fifteen billion dollar is coming from on realized gains in the equity holdings and approximately twenty eight billion dollar is from appreciation of assets such as plant, and it it let's think about on realized gains in the equity holdings because as an investor. I know that if I wanna make a lot of money in the future, then I know that I have two compound my money over the course of my life. And if I want to do it, effectively, then I have to be a long term investor because if I sell my stocks at a profit, then if she's a good thing, but I still have to pay taxes to know government. And if I don't wanna pay taxes, and if I wanna crew all this on the realized gain over the course of my life. If I want to use the compounding to my advantage, then it's way better to let my unrealized gain compound by. Self without selling my assets. I hope that I explained in a simple manner. But once you sell then you have to pay taxes, and those taxes cannot be compounded over the course of your life. But if you just put it there, and if you used by and hold strategy over the course of your holding period, the taxes that you don't pay we'll compound, and it's going to give you huge profit down the road. So that's the point that I wanted to get across. So those are the four funding sources that Berkshire Hathaway has the last topic that I want to touch upon on today's show is the American pale win. Warren Buffett is a big fan of American businesses, and he always has very positive outlook for American businesses. And a lot of may say or say that you know, there's going to be a recession and there's going to be downturn. Yes. They will be downturns for sure at some point. But if you look at thirty year forty year time period, even though there's going to be a lot of you know, gyrations and ups and downs in the stock market. If you look at the long term trajectory of the stock market it's going to be upward. That's why Warren Buffett is saying and Warren Buffett gave out good example. So seventy seven years ago in nineteen forty two warmth of a made his first investment in an American company with his money one hundred fourteen dollars one hundred fourteen dollars seventy seven years ago. Had he invested this SMP five hundred index fund then. This money would have become approximately six thousand six hundred thousand dollars on January thirty first two thousand nineteen. So that's approximately five thousand two hundred eighty eight times more than his initial investment on hundred fourteen dollars to put it differently. If you had invested one million dollars seventy seven years ago in SNP five hundred index then by now, you would have had five point three billion dollars. So what's more surprising is that once you put some tweak here, and you pay annual fee of one person on your asset. And let's say you just give that to your fund manager and on advisor than the final dollar mounted you've gotten by now is two point six five billion dollars. We approximate. Half of what you'd have gotten? If you didn't have to pay that one percent fee. So this one percen makes a huge difference in your final dollar mom, and you might think that won't percents just nothing. But over the course of seventy years more than seventy years very long-term on percent is going to cut your final investment amount in half. So that's a surprising fact. And up also mentioned golden vestment. He said that had he invested in gold with one hundred fourteen dollars seventy seven years ago by now that investment would have become or thousand dollars as opposed to six hundred thousand dollars from the stock market. So it's a huge difference. So he's definitely not a big fan of gold. But he's quite a proponent of investing in the stock market in the long term. Okay. So those are the five topics that I gleaned from two thousand eighteen Berkshire Hathaway annual litter, and I found it very very interesting and fascinating. Okay. So that's it. For today's episode. I hope you'll learn something out of this episode. I'm gonna cover more topics as released to warm buffet in the future. Because he's just legendary investor. We always look up to and there's a lot to learn from him and before and I just want to know that I created a website called share investment, ideas dot com, and I mentioned this website couple of times in the past because I uploaded some articles there I post this articles. They're they're about five to six articles by me. And you only need your Email and your name in order to sign up for a free membership. So just check out the website. And I'm gonna put the Lincoln the show. Just in case you want to know exact address share investment, ideas dot com. And that's it. I hope you enjoy your day and see you next time.