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Randy C. Norton
Randy C. Norton
Articles (2)  | Author's Website |

The Berkshire Hathaway 2018 Shareholder Letter: A Changing of the Scorecard

With the new accounting changes, and net of the scorecard methodology change, Berkshire beats the S&P 500 by 7.2%

My son, who is now 4 years old, proclaims that Warren Buffett (Trades, Portfolio) is his favorite super hero. Of course, this is because my son’s other super hero, his father, tells him Buffett is so.

My son regularly explains to me why Buffett is a super hero. The reason? Because Warren Buffett (Trades, Portfolio) can do things in his head. He is very astute. My son also likes the Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) annual shareholder meeting. The annual movie provides a caricature of the legendary Buffett as a super hero in a clip from the Secret Millionaires Club.

According to Buffett: “Learning = Earning.” As I did with last year's Berkshire Hathaway annual letter, I want to highlight some of my learnings and earnings from his 2018 missive. Undoubtedly, the American financial journalist, former Fortune senior editor at large Carol Loomis, a longtime friend and Berkshire shareholder, worked with Buffett in editing this year’s 15-page letter. In last year’s article, I referenced a conversation I had with Loomis regarding her book, "Tap Dancing to Work." Loomis told me: “… I think that the person who is going to do best in business writing is going to be numerate.” I also hope to be numerate here. 

Since 1965, the year Buffett purchased Berkshire Hathaway Inc., various themes have reoccurred in the annual letters. As with most books and documents, I learned more from re-reading the 2018 annual letter. With a fresh set of eyes, my criticism lightened, and my appreciation deepened. Buffett, the world’s all-time greatest capitalist-philanthropist-teacher, articulately wrote another chapter in the Gospel of Value Investing. This time, his work exemplified the writings of a super hero: teaching the neophyte and the adroit masterful lessons in accounting, tax and compound interest. Here are the topics that stood out most this year.

The scorecard

In 2018, the scorecard methodology officially changed. Buffett wrote in the annual letter that it is time to abandon the practice of highlighting per-share book value. For nearly three decades, per-share book value was the measuring stick.

According to Buffett, the per-share book value metric has lost its relevance for the following reasons: “Berkshire has morphed from marketable stocks to operating businesses,” “while equities are held at market prices, accounting rules require [Berkshire's] collection of operating companies to be included in book value, which is far below current value,” and “over time, Berkshire will become a repurchaser of its shares … the math being: each transaction makes per-share intrinsic value go up, while per-share value goes down.”

Therefore, according to Buffett, the book-value scorecard has become “increasingly out of touch with economic reality.” The new measuring stick? That will be Berkshire’s market price. The justification of this measuring stick switch does not sit well with many analysts, including me. The accounting rules have changed, and the new measuring stick will normalize returns per se, but I would have liked to continue the tried-and-true value investing methodology of per-share book value.


It is important to read the footnotes in every 10-K. To repeat part of my 2017 article, when comparing against other indexes, 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. As a reminder, the S&P 500 numbers are pre-tax (gross), whereas the Berkshire numbers are after-tax (and net of all fees).

Of the abysmal $4 billion gain from 2018, $24.8 billion came from Berkshire’s operations and $2.8 billion from realized capital gains. Losses of $3.0 billion came from a non-cash charge from the Kraft-Heinz investment and $20.6 billion from a reduction in unrealized gains in stocks. 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 2018

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




Overall Gain (1964-2018)




Remember, the end of 2018 was tumultuous. There was abundant fear in the market. And yet, with the new accounting changes, and net of the scorecard change, Berkshire still beat the S&P 500 by 7.2%. With Buffett, the losses are less, and the gains are more, not to mention the before- and after-tax calculation delta. It is a matter of what one keeps, not what one makes, as measured during a 12-month period of time, and in one’s lifetime.

Retained earnings

I often forget about the operational leverage that comes from retained earnings and dividend growth. Obviously, Berkshire does not believe in dividends, and will probably never pay a dividend. To some extent, I am okay with that.

Let’s use the illustrative example from the annual report. According to Buffett, the investments paid Berkshire $3.8 billion in dividends, but more important than dividends are the retained earnings of these companies. Look at the retained earnings from Berkshire’s top five holdings:




Berkshire Share of

Dividends (1)

Berkshire Share of

Retained Earnings (2)

American Express (NYSE: AXP)


Bank of America (NYSE: BAC)

Coca-Cola (NYSE: KO)

Wells Fargo (NYSE: WFC)






$ 237





$ 997





2018 Total


$ 2,966

$ 6,837

  1. Based on current annual rate.
  2. Based on 2018 earnings minus common and preferred dividends paid.

And here is the key: GAAP does not allow Berkshire to include the retained earnings of investments in the financial accounts. Since inception, the earnings retained from these investments have delivered capital gains to Berkshire that total more than one dollar for each dollar these companies reinvested. The key is for management to use most or a portion of retained earnings to repurchase shares. I believe this mathematical illustration is a foreshadowing of what is to come as Buffett repurchases more shares of Berkshire.

Perpetual equity bonds

In continuation with the accounting and retained earnings concept, here is an excerpt from page 6 of the annual report:

“…drawn from the example table above: Berkshire’s holdings of American Express have remained unchanged over the past eight years. Meanwhile, [Berkshire’s] ownership increased from 12.6% to 17.9% because of repurchases made by the company. [In 2018], Berkshire’s portion of the $6.9 billion earned by American Express was $1.2 billion, about 96% of the $1.3 billion [Berkshire] paid for [the] stake in the company. When earnings increase and shares outstanding decrease, owners -- over time -- usually do well.”

Truly, good businesses (and assets) are exceptionally hard to find. And selling any shares (or assets) makes no sense at all.

Berkshire paying dividends

The debate with some shareholders and some analysts will continue: Should Berkshire be paying a dividend? The answer is no! In Buffett’s words, here is the math:

“Berkshire’s $349 billion [of equity capital] is unmatched in corporate America. By retaining all earnings for a very long time, and allowing compounding interest to work its magic, [Berkshire] amassed funds that have enabled [Berkshire] to purchase and develop the valuable [companies]. Had [Berkshire] instead followed a 100% payout policy, we would still be working with the $22 million with which [Berkshire] began fiscal 1965.”

Advantages of a conglomerate

Float is a source of financing that is almost cost-free. But maybe better than that, over time, are the advantages of a conglomerate that were succinctly explained by Buffett this year:

“Berkshire’s value is maximized by our having assembled the [investments] into a single entity. This arrangement allows us to seamlessly and objectively allocate major amounts of capital, eliminate enterprise risk, avoid insularity, fund assets at exceptional low cost, occasionally take advantage of tax efficiencies, and minimize overhead. At Berkshire, the whole is greater--considerably greater--than the sum of the parts."

Taxes and depreciation

Another advantage of Berkshire is its deferred income taxes, which are liabilities that are eventually paid, but until then are interest-free. Berkshire had $28.3 billion of deferred tax available due to the accelerated depreciation of assets, such as plant and equipment. As Buffett wrote:

"The front-ended savings in taxes that [Berkshire] record gradually reverse in future years. [Berkshire] regularly purchase additional assets, however. As long as the present tax law prevails, this source of funding should trend upwards. Over time, Berkshire’s funding base—that is the right side of [the] balance sheet—should grow, primarily through the earnings retained. [Warren and Charlie] is to put the money retained to good use on the left-hand side, by adding attractive assets.”

The American Tailwind

In 1942, when Buffett was 11 years old, he went all in and invested $114.75 in Cities Service preferred stock. Let me paraphrase Buffett’s analysis. During the two 77-year periods prior to 1942, the U.S. had grown from 4 million people, about one half of 1% of the world’s population, into the most powerful country on earth. Of course, 1942 presented a crisis: The U.S. and its allies were suffering heavy losses in a war that was entered three months earlier. Bad news arrived daily.

According to Buffett, if the $114.75 had been invested in a no-fee S&P 500 index fund, and all dividends had been reinvested, Buffett’s stake would have grown to be worth $606,811 pre-tax. A 5,288-for-1 gain. A $1 million investment by a tax-free institution of that time (e.g., a pension fund or college endowment), would have grown to a about $5.3 billion. Had one invested in gold for protection the same amount of gold would be worth $4,200, less than 1% of what would have been realized from a simple unmanaged investment in American businesses. The magic of metal was no match for the American mettle, said Buffett.

In 1788, going back to the U.S.'s starting point, there was only a small band of ambitious people and an embryonic governing framework aimed at turning dreams into reality. Today, the Federal Reserve estimates U.S. household wealth at $108 trillion. Retained earnings have been a key to Berkshire as they have been to the U.S. In the nation’s accounting, the comparable item is labeled "savings." Without savings, there would have been no investment, no productivity gains and no leap in living standards. Buffett loves the U.S. To my Canadian friends and family, I know Buffett includes you, too.

What are the perennial parenting takeaways? Identify durable competitive advantages. Find moats, and moat it be. Despite lackluster returns in 2018, my household motto will continue to be: In Warren Buffett we trust; all others, we monitor.

The year of compounding: My 4-year-old son Edison reading "How to Turn $100 Into $1,000,000" by James McKenna and Jeannine Glista, with Matt Fontaine.

About the author:

Randy C. Norton
Managing Partner at Green Mesa Capital; Author of Applied Value Investing in Real Estate; Contributor for Forbes and GuruFocus. Green Mesa Capital, LLC (the “Company”), is privately owned and independently operated as a single-family office. Headquartered in Nevada, the Company was founded in 2014 specializing in traditional and alternative investments.

Visit Randy C. Norton's Website

Rating: 3.0/5 (2 votes)



Valuator - 1 month ago    Report SPAM

I wouldn't show the per share book value anymore, if I failed to beat the S&P for too long, too. So much for being up front with investors.

Now, he wants everyone to focus on market cap when he only recently said that watching the stock price is not investing.

Rules for thee but not for me.

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