At each Annual Shareholder Meeting, a movie is played, and a movie clip from the Secret Millionaires Club with Warren Buffett is projected onto the giant screen: “Learning = Earning.”
From Saturday’s shareholder letter, I want to highlight some of my learnings and earnings. Undoubtedly, Carol Loomis worked with Buffett again in editing the 16-page letter. When recently speaking with Carol Loomis about her book "Tap Dancing to Work," she told me: “… I think that the person who is going to do best in business writing is going to be numerate.”
To be literate, and numerate, Buffett learned value (investing) from Graham, growth (investigating) from Fisher, and business (principles) from Munger. It is also well known that Buffett attributes (batting) averages and (happy) areas to Williams, (effective) public speaking to Carnegie, and certainly, writing (prose) were augmented by Loomis. Buffett had an all-star team of mentors. And today, Berkshire no doubt, has an all-star team of managers.
Since 1965, the year Buffett purchased Berkshire Hathaway Inc. (BRK.A)(BRK.B, Financial), various themes have reoccurred in the annual letters. Here are the topics that stand out most to me.
The scorecard
For 2017, Berkshire’s gain in net worth was a cool $65.3 billion. This increased per-share book value by 23%, and $211,750 per Class A equivalent share ($141.17 per Class B equivalent share). Note: as of today, Berkshire closed at $304,020.00 per Class-A share, or $202.76 per B-share. However, on Feb. 1, Berkshire hit an all-time high at $325,900.00 per Class-A share, and $217.25 per Class-B share. With 748,745 Class-A shares outstanding, and 1,344,332,039 Class-B shares outstanding, the market cap was $536,072,130,972. This $536 billion made Berkshire Hathaway the third-largest company in the world by market capitalization, and by revenue, the second-largest company in the world.
By many other metrics, and certainly in the eyes of the shareholders, Berkshire is first in the world. Did I mention that Berkshire has $116 billion in cash and U.S. Treasury Bills? This doesn’t even count all the cash hidden in different pockets across the 63 wholly owned subsidiaries (and other off-balance sheet assets). Applying the words of Albert Einstein would be appropriate here: “Not everything that counts can be counted, and not everything that can be counted counts.” So, let’s start with the accounting.
Accounting
When comparing against other indices, it is important to understand before- and after-tax return methodology. In addition, any savvy investor wants to know what returns are net of fees. The S&P 500 numbers are pre-tax (gross), whereas the Berkshire numbers are after-tax (and net of all fees). Of the $65 billion gain from 2017, $36 billion came from Berkshire’s operations, the remaining $29 billion was delivered in December when Congress rewrote the U.S. Tax Code. The after-tax returns reported each year by Berkshire imply that, when comparing apples-to-apples, Buffett’s investments far surpassed the S&P 500 delta that is conservatively presented. Here are the numbers:
| For Year Ending 2017 | After Tax In Per-Share Book Value of Berkshire | After Tax In Per-Share Market Value of Berkshire | Before Tax In S&P 500 with Dividends Included |
| Compound Annual Gain | 23.0% | 21.9% | 21.8% |
| Overall Gain (1964-2017) | 1,088,029% | 2,404,748% | 15,508% |
The United States
Buffett loves the U.S. In this year’s letter, Buffett said, “Almost 90% of our investments are made in the United States. America’s economic soil remains fertile … [in] America, equity investors have the wind at their back.” In the 2016 letter, Buffett said:
“Since 1776, and starting from scratch, America has amassed wealth totaling $90 trillion. Foreigners own or have claim on a modest portion of our wealth [due to the $20.7 Trillion national debt]. Those holdings, however, are of little importance to our national balance sheet: Our citizens own assets abroad that are roughly comparable in value (cancelling out the GDP debt in some regards).”
I too am an optimist. Please read the recent articles published in TIME Magazine, where Buffett and Gates expand on their wisdom and optimism. Such optimism is not limited to the U.S. According to nearly every measure, the world is getting better, every single day.
Real estate
According to Buffett, brokerage and real estate is one of the most fundamental of businesses. It is here to stay. In 2016, Berkshire Home Services participated in 244,00 sides, which totaled $86 billion in volume. By the end of 2016, HomeServices was the second-largest brokerage. In 2017, HomeServices is now close to leading the country in home sales with $127 billion of sides. HomeServices does about 3% of the country’s homebrokerage business. Clayton Homes, the country’s leading mobile home builder and mobile home financier, accounted for 49% of the manufactured-home market in 2017.
There is plenty of real estate inside of Berkshire too. Consider the plants, property, and equipment in each subsidiary. One company I would like to know more about is Berkadia, a commercial mortgage banker and servicer, and a joint venture between Berkshire Hathaway and Leucadia National (LUK, Financial). Berkadia was not mentioned in the 2017 letter. So how would Buffett (or Combs or Weschler) value real estate companies?
S|T|O|R|E Capital
S|T|O|R|E Capital (STOR, Financial), which stands for “Single Tenant Operational Real Estate,” is dedicated to real estate net-lease profit-center property investments. Berkshire invested $377 million in STORE Capital last year through its subsidiary, National Idemnity Co. The investment represented a 9.8% stake in the real estate investment trust. Here are some of the metrics.
- 90% EBITDA margin.
- At the time of investment, there was an implied cap rate of 7.3%, and this would apply an NAV premium of 8.4%, or trading at 14.6x of current AFFO.
- The total current yield is about 11.5% versus the 8.6% of the MSCI U.S. REIT Index, implying a 300-point better return than its peer index.
- The total return is built on both yield and growth.
- My favorite metric of STORE Capital is: “Only 1% of companies in the S&P 500 have STORE Capital’s combination of dividend yield and EPS growth,” as Buffett said.
Shortly after the Berkshire investment, I spoke with STORE Capital’s CEO, Christopher Volk. Volk is a brilliant real estate professional. He is another all-star manager that will make Berkshire shareholders wealthier for a long time to come.
On stocks
Here is one lesson on how to make $15 billion in six years. Because of a savvy investment made in Bank of America (BAC, Financial) at a time when all banks were struggling, Buffett negotiated the deal of a lifetime. (Many of his investments have been a deal of a lifetime.) In this case, Berkshire customized an off-market transaction whereby $5 billion of preferred shares were purchased with a 6% annual dividend, or $300,000 million. In addition, the preferred stock came with 700,000 warrants, which could be purchased for $5 billion any time before Sept. 2, 2020.
In 2011, Bank of America was trading at $7.14 per share, and in June of 2017, the cashless conversion was exercised at $24.32 per share. On the Berkshire books, Bank of America cost $5 billion, and the market value at 2017 year-end was $20.6 billion. With the warrants exercised, Bank of America is the fourth-largest equity investment at Berkshire, behind only the World’s Largest Hedge Fund Apple (APPL), Wells Fargo (WFC, Financial) and Coca-Cola (KO, Financial). (Kraft-Heinz (KHC, Financial) shares are excluded because Berkshire is part of a control group and therefore must account for this investment on the equity method).
Made at the age of 80, the Bank of America investment may have been Buffett’s greatest trade ever. With trades like this, and through the power of compounding, Buffett has made 99% of his wealth since he was 60 years old.
Remember, when it comes to the stock market, two out of every five stocks has a negative lifetime return. And, one out of every five stocks had returns of -75% or worse. Historically, only 25% of the stocks were responsible for all market gains. Even Eugene Fama, the founder of efficient markets, stated that markets are only efficient 90% of the time.
Investors must have the right antecedents. Munger has made a life pursuit of understanding human misjudgment and human behavior. Of course, even Buffett and Munger have made plenty of mistakes in acquisitions. But according to Munger, “[Mistakes have] been with the economic projections, not the lease, contract or technicals.”
Berkshire buying opportunities
The new accounting rule says that the net change in unrealized investment gains and losses in stocks held must be included in all net income figures reported. That requirement will produce large swings to the GAAP bottom ine. Berkshire owns $170 billion of marketable stocks and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period. Here is the key: Such swings in valuations will distract from the truly important numbers that describe operating performance.
When the bad news comes, and it will, or when Mr. Market is depressed, this will provide buying opportunities, even for Berkshire shareholders. According to Buffett:
“Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure long term growth in value. For the last 53 years, the company has built value by reinvesting its earnings and letting compound interest work its magic. Year by year, we have moved forward.”
Berkshire shares have suffered four truly major dips, and here are the details:
| Period | High | Low | Percentage Decrease |
| 03/01/1973 – 01/01/1975 | 93 | 38 | (59.1%) |
| 10/2/1987 – 10/27/1987 | 4,250 | 2,675 | (37.1%) |
| 6/9/1998 – 3/10/2000 | 80,900 | 41,300 | (48.9%) |
| 9/19/2008 – 3/5/2009 | 147,000 | 72,400 | (50.7%) |
Berkshire culture
According to Munger, culture is a distinct competitive advantage at Berkshire. Because of its culture and reputation, many business owners choose Berkshire as their final resting place. In 2017 there were many firsts, including the first feature-length production of Becoming Warren Buffett. One of the many cultural traits at Berkshire is the importance of investing in yourself. In the 2017 HBO documentary, Buffett said:
“Imagine you’re going to be given a new car. Any car that you want is yours. It will be at the front of your house with a bow on it when you get home. There’s one catch. You’re only going to get one body and one mind in your life, so you better take care of it.”
This anecdote and many others are to be yours when attending the annual shareholder meeting.
In closing the letter this year, Buffett said: “Come to Omaha – the cradle of capitalism – on May 5th and meet the Berkshire Bunch.” Shareholders can also come early and attend the Columbia Business School – Heilbrunn Center for Graham and Dodd Investing Dinner on Friday, or the GuruFocus Value Conference on Thursday. If all else fails, come join me as friends and family celebrate my birthday on May 4. (May the 4th be with you.) More importantly, come see Berkshire’s collection of businesses. It is the best conglomerate of consumer monopolies in the entire world.
Those alive today are witnessing the world’s greatest capitalist. The world’s greatest philanthropist. The world’s greatest teacher. Albert Einstein (who was decent in math), said, “… Compound interest is the 8th Wonder of the World.” I never thought the 8th Wonder of the World would be a person and not a formula. As Munger often states in the annual meetings: “I have nothing to add. The formula never changes. It’s pragmatism. It’s just that simple. When something works keep doing it. We are the fundamental algorithm of life. Repeat what works.”
In the Fortune Classics of 1977, Buffett wrote one of the best articles on investing entitled: “How Inflation Swindles the Equity Investor.” The goal with investing is to find equity bonds. But how would one value or rate an equity bond? Munger has the secret formula: “…[rating] agencies are wrong and set in their ways. [Berkshire] should start at Quadruple AAAA rating.” Munger once said at a shareholder meeting: “…my family would be stupid to sell any Berkshire shares after I am gone.”
And so, may it be. The Norton family motto? In Warren Buffett (Trades, Portfolio) We Trust; All Others, We Monitor.
The Year of Firsts: My 3-year-old son Edison reading "My First Berkshire ABC" by Nancy Rips.
