Three weeks ago, I wrote an article that covered a few noteworthy sections from Warren Buffett (Trades, Portfolio)’s annual letter to shareholders (that sentence used to start with the word “Yesterday,” but I’ve been busy!). While that letter gets all the attention, it’s a summary by design; it does not make a deep dive into the results like an investor can with the 10-K. As such, there are likely to be nuggets in the annual report that don’t make it into Warren’s letter; this article will take a closer look at some sections worth further discussion, mainly from the 10-K.
Let’s start with something that a few readers have noticed – Warren made reference to the six-year trailing results in the opening of his shareholder letter (a period he considers representative of the stock market cycle), but didn’t address the five-year outcome. This remains the yardstick by which he judges Berkshire’s performance, as laid out in the Owner’s Manual (starting on page 103 of the annual report); however, he did not provide the updated five-year results for 2013.
Some quick math shows that Berkshire’s (BRK.A)(BRK.B) book value per share increased by 91% for the five years ending in 2013. The S&P, including dividends, returned 128% over that same period – marking the first time, after beating the S&P 500 for 43 consecutive five-year periods, Berkshire fell short of its goal. Of course, much of this is explained by Berkshire’s size and its stable of wholly owned businesses that do not fluctuate in reported value with the equity markets. When markets go down in a big way, Berkshire will all but certainly be on the right side of this divide – and in a big way: for the five years ending 2008 and 2009, Berkshire’s book value per share outpaced the S&P 500 by 9.1% and 8.2% per annum, respectively.
At the end of 2013, book value per A share was $134,973; dividing by 1500 provides us with the book value per B share of approximately $90. Adding in a 20% premium for the repurchase cap brings us to $162,000 per A share and $108 per B share; with the B shares under $125 at the time of writing, the stock needs to fall by about 13% to get under 1.2X book (here’s to hoping it gets there, though recent activity suggests that the market won’t let that happen anytime soon).
Balance Sheet & Investments
The balance sheet continues to be awash with liquidity – cash balances exceeded $40 billion at year end, in addition to fixed income securities worth approximately $30 billion; approximately 70% of these fixed income securities come due in the next five years, with $8.5 billion coming due in the next twelve months. Currently, Berkshire is making a pittance on those funds; if you’re a betting man (or gal), history suggests that Warren and Charlie will eventually put that cash to good use.
At year-end, Berkshire’s equity investments had a fair value of $117.5 billion; the largest positions are Wells Fargo (WFC)($21.9 billion, approximately 19% of the total), Coca-Cola (KO)($16.5 billion, 14% of the total), American Express (AXP)($13.7 billion, about 12% of the total), and IBM (IBM)($12.7 billion, about 11% of the total). More than half of Berkshire’s publicly traded equity portfolio is in these four names; add in the approximately $10.9 billion value from the Bank of America (BAC) warrants, and the five largest positions account for approximately 60% of the portfolio.
It’s interesting to contrast this with the turn of the century: Berkshire’s equity investments totaled $38 billion when the shareholder letter was published in 2000 (when Berkshire’s book value was about $60 billion), with one-third of that in a single name: Coca-Cola. Remember that Coca-Cola was trading at more than 50x earnings at its peak, compared to about 20x currently (the stock only appreciated 25% in total over the ensuing 13 years, excluding dividends). A comparison of Berkshire Hathaway’s equity portfolio at the end of 2013 to 2000 would undoubtedly lead one to conclude that things currently look more promising for the years ahead; by the way, book value per share still compounded at 9.7% per annum over the last 13 years, despite that headwind.
For the full year, Berkshire earned $19.5 billion – equal to $11,850 per A share and $7.90 per B share; this was about 30% higher than the reported per share earnings in 2012. However, the 2013 result included $6.6 billion in investment and derivative gains (pre-tax), compared to $3.4 billion in 2012 (pre-tax). The after-tax difference between the two years was a $2.1 billion benefit for 2013 (by comparison to 2012), largely attributed to a change in fair value for the equity index put option contracts; after adjusting for that gain, net income was up about 17%. If we go a step further and account for the change in underwriting profitability (the results should be normalized over time), comparable earnings for 2013 were about 11% higher than 2012.
Cash flow from operations exceeded $27 billion in 2013; this cash was used to finance the Heinz investment ($12.25 billion), other equity investments ($8.5 billion), acquisitions of businesses ($6.4 billion), and the purchase of property, plant and equipment ($11 billion), with much of that capex spend coming from MidAmerican ($4.3 billion) and Burlington Northern ($3.9 billion); in the 10-K, management projects that the collective capex spend for BNSF and MidAmerican will increase by more than 35% in 2014, to $11.1 billion.
In 2012, Berkshire repurchased $1.3 billion in shares through a privately negotiated transaction in conjunction with boosting the repurchase cap to 120% of book; unfortunately, Mr. Market didn’t give the company the opportunity to repurchase additional shares in 2013.
Wedgewood Partners published a research report in 2013 that looked at GEICO’s history, and really opened my eyes to a business that I honestly didn’t know enough about at the time. Since then, I’ve taken a close look at Allstate (ALL) and Progressive (PGR) as well – and I’ve become even more enamored by GEICO’s success since being acquired by Berkshire in 1995.
At the time, GEICO was the seventh largest private passenger auto insurer in the country, with 3.7 million policies in force (approximately 3% market share). This update from the 2013 10-K shows just how far the company has gone in the ensuing 18 years:
“As a result of an aggressive advertising campaign and competitive rates, voluntary policies-in-force have increased about 40% over the past five years. GEICO was the third largest private passenger auto insurer in the United States in terms of premium volume in 2012. According to A.M. Best data for 2012, the five largest automobile insurers have a combined market share of 52%, with GEICO’s market share being approximately 9.7%. Since the publication of that data, management believes that GEICO’s current market share has grown to approximately 10.4% and that it is now the second largest private passenger auto insurer in the United States.”
In 2013, GEICO reported an underwriting gain of $1.1 billion; in the past three years, GEICO has reported a cumulative underwriting gain of $2.4 billion. Since becoming a wholly owned subsidiary of Berkshire Hathaway, GEICO has consistently gained market share in a major way; at the same time, GEICO has reported an underwriting gain in every single year since 2000.
For Berkshire as a whole, the insurance operations continue to report profitable growth; on a consolidated basis, float at the end of 2013 was $77 billion (an increase of one-third over the past five years). For the full year, the insurance businesses reported $2 billion in underwriting gains, as well as another $3.7 billion in after-tax investment income; in the past decade, the insurance operations as a whole have not reported a single year of underwriting losses - and as the chart on page seven of the 10-K shows, the accounting has consistently been conservative.
Burlington Northern Santa Fe
It’s been four years since Berkshire completed the acquisition of BNSF – and what a ride it has been. In 2010, the railroad reported $16.8 billion in revenues, with pre-tax income just shy of $4 billion (Berkshire claimed about 90% of these figures in 2010 – the portion after the deal closed on Feb.12). In the three subsequent years, BNSF has reported higher revenue and pre-tax net income each and every time; due to the combination of 30% revenue growth and operating leverage, per-tax income for Burlington Northern in 2013 was 50% higher than in 2010. Since being acquired by Berkshire, BNSF has reported a cumulative $20 billion in pre-tax income.
BNSF first showed up in Berkshire’s 13F filings in mid-2007, when Warren and Charlie bought a stake worth about $2.7 billion at an average cost of about $80 per share. Two and a half years later, after building up the position over time, Warren and Charlie made a grab for the remainder of BNSF at a 25% premium to their initial purchases and an all-in cost of $100 per share (it’s worth noting that the stock had reached a high of $112 per share in 2008). One final point – at the same 16.4X trailing earnings that Berkshire offered in 2009 (which is a pretty steep discount to the trailing multiple for Union Pacific (UNP) at this time), BNSF would currently be worth more than $62 billion in the open market; compared to the $34 billion price tag implied on the purchase, that looks pretty good.
There’s more to discuss, but I’ve tortured my readers with long articles too frequently as of late. I’ll keep this one short and sweet to get across the critical point that won’t come as a shock to anybody: Berkshire Hathaway is one of a kind; the collection of businesses that shareholders have claim to is truly extraordinary (I mentioned GEICO and BNSF, but there are many others that fit this description as well). Intrinsic value will continue to march steadily higher, at what I believe will be an attractive rate for the long-term investor with realistic expectations. Warren and Charlie have built a true powerhouse at Berkshire, one that has strengthened immensely in the last two decades. One can only hope that they’ll continue to do the same in the coming years.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of my portfolio (currently two). In the eyes of a businessman, I believe this is adequate diversification.