Berkshire Hathaway 2013

I am a shareholder of Berkshire and I wrote about my understanding of its business here. Few hours back Buffett published his 49th shareholder’s letter. As usual it is a treat and I throughly enjoyed reading it. Some of the highlights from the letter.

1. Business

Insurance float grew by 5.63% from $73.12 billion to $77.24 billion. The underwriting profit was $3 billion which makes 11 years in a row of underwriting profit. In June 2013, Berkshire Hathaway Speciality Insurance (BHSI) was formed. This division is led by Peter Eastwood and this group will underwrite commercial insurance. Its customers include several Fortune 500 companies.

$18 billion was spent on two major acquisitions. NV energy was purchased for $5.6 billion. It supplies 88% electricity to Nevada’s population.  Berkshire partnered with 3G capital and invested $12.25 billion in H.J. Heinz. Of this $8 billion is preferred stock with a coupon rate of 9% and the balance $4.25 billion is common stock. Berkshire also made 25 minor acquisitions for $3.1 billion. It spent another $3.5 billion to acquire remaining stake in Marmon and Iscar.

Todd Combs and Ted Weschler manage $7 billion each. Both of them outperformed S and P and they have Berkshire blood in their veins. Investments from big four companies (American Express, Coca-Cola, Wells Fargo, and IBM) earned $4.4 billion. Of which $1.4 billion is given back as dividends which is reported. The remaining $3.0 billion retained by these companies are not reported in Berkshire financial statements but they are very real and valuable. In 2007 Buffett bought $2 billion worth of debt in Energy Future Holdings. Most likely this company will file for bankruptcy and he sold all its debt. In the process he lost $873 million. Even Oracle makes mistakes.

The total cash from all its business total up to $48.18 billion as of 31^st December 2013.

Given below is the net earnings attributable to Berkshire Hathaway shareholders after taxes in the last 3 years.

(In millions)	2011	2012	2013
Insurance Underwriting Profit	$154	$1,046	$1,995
Insurance – investment income	$3,555	$3,397	$3,708
Railroad	$2,972	$3,372	$3,793
Utilities and energy	$1,204	$1,323	$1,470
Manufacturing, service and retailing	$3,039	$3,699	$4,230
Finance and financial products	$516	$557	$657
Other	-$665	-$797	-$714
Investment and derivative gains/losses	-$521	$2,227	$4,337
Net earnings	$10,254	$14,824	$19,476
Book Value	$168,961	$191,588	$224,485

2. Valuation

Buffett confirmed that he will buy back Berkshire shares aggressively if its price falls below 120% of book value. From the table given above we can see that the book value as of 31^st December 2013 is $224.48 billion. By multiplying it by 1.2 we get $269.38 ($224.48 * 1.2). The current market capitalization of Berkshire is $286.10 billion. Hence the stock is currently selling at 6% above the intrinsic value. I will buy BRK.B if it sells around $109. Excerpt from the letter.

As I’ve long told you, Berkshire’s intrinsic value far exceeds its book value. Moreover, the difference has widened considerably in recent years. That’s why our 2012 decision to authorize the repurchase of shares at 120% of book value made sense. Purchases at that level benefit continuing shareholders because per-share intrinsic value exceeds that percentage of book value by a meaningful amount. We did not purchase shares during 2013, however, because the stock price did not descend to the 120% level. If it does, we will be aggressive.

3. Did S & P Beat Berkshire?

2009 to 2013 is the first 5 year period in which S & P 500 index beat Berkshire’s book value. This comparison is not fair as S & P 500 returns includes dividends and Buffett is using Berkshire book value which we all know is less than intrinsic value. Also the S & P 500 returns are pre-tax and Berkshire numbers are after tax.

Using the above table $1 invested in Berkshire’s book at the beginning of 2009 grew to $1.914 [1.198 * 1.13 * 1.046 * 1.144 * 1.182] at the end of 2013. This gives a compounded return of 13.82%. $1 invested in S & P 500 at the beginning of 2009 grew to $2.283 [1.265 * 1.151 * 1.021 * 1.16 * 1.324] at the end of 2013. This gives a compounded return of 17.92%. Hence S & P 500 beat Berkshire book value by 4.1% in the five year period. Should I worry about this? No I would not as Buffett addresses this in the letter.

Charlie Munger, Berkshire’s vice chairman and my partner, and I believe both Berkshire’s book value and intrinsic value will outperform the S&P in years when the market is down or moderately up. We expect to fall short, though, in years when the market is strong – as we did in 2013.

4. Ignore the chatter

In this letter Buffett wrote about his thoughts on investing. It is a must read for everyone. The line that I liked the most is

Ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.

He also advices know-nothing investors like me to invest in low cost index funds.

I have good news for these non-professionals: The typical investor doesn’t need this skill. In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st Century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal. That’s the “what” of investing for the non-professional. The “when” is also important. The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur.The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs. Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results.

5. Book Recommendations

Buffett recommended couple of books in the letter. Berkshire Hathaway Letters to Shareholders by Max Olson. You can buy the kindle version for $2.99. He also recommends reading 40 Chances: Finding Hope in a Hungry World written by his son Howard Buffett.