- Buffett did not make any big sales or acquisitions in 2020, so the business is little changed from 2019.
- Operating earnings, which excludes stock gains/losses, were down close to 10% in 2020 compared to 2019.
- Berkshire continues to accelerate the rate at which it is buying back its own stock, spending $24.7 billion on buybacks in 2020, compared to $5 billion in 2019.
- Buffett notes that Berkshire's insurance businesses are at a particular advantage over competitors because Berkshire can invest the float in equities instead of low yielding bonds.
- Buffett presents, for the first time, the business as a combination of four jewels: A 5.4% stake in Apple, Berkshire Hathaway Energy, BNSF Railway, and GEICO.
Why I own Berkshire and why you might not want to:
Note: An updated version of this post is maintained here.
Being known as the most famous investor in the world sets a high bar for what to write in your annual report. The 2020 report is not Buffett's finest, but he does provide new perspectives on where value lies in the business, and how he breaks down Berkshire shareholders into different groups.
If you've read about how I invest my money, you'll know I hold 30% of my liquid net worth in Berkshire stock, primarily because I believe in Berkshire's investing principles - documented in Buffett's long history of annual reports.
That said, tread carefully before making an investment in Berkshire because i) it is likely that Buffett's successors will not perform as well as he did, ii) Berkshire is now very large, which makes it harder to find good investments, iii) if you do what I'm doing, you're putting a lot of eggs in one basket - it's always possible for a company to be hit by fraud or a scandal that takes it down, iv) Berkshire doesn't do a lot of "tech", so maybe the business will fall behind the rest of the economy, and v) cybersecurity risks could impact the business - it's an under-appreciated risk but listed as the first risk in Berkshire's annual report!
Berkshire in 2020 in Brief:
Excluding any gains and losses from investments, Berkshire's operating earnings dropped from roughly $24 billion in 2019 down to $22 billion in 2020. This is nothing remarkable - good or bad - given the COVID background.
Berkshire bought and sold some equities in 2020, but nothing accounting for more than a few percent of the overall business's value*. The largest line item to report was the repurchase of its own shares, with Berkshire buying almost $25 billion worth of its own stock in 2020 (getting close to 5% of outstanding shares).
Compare this to 2019, when Berkshire repurchased only $5 billion of its own stock, and you can see that Berkshire is very likely to become a large net purchaser of its own stock over time. This is exactly what Charlie Munger - Buffett's sidekick - has said in annual meetings.
I wouldn't be surprised to hear that Berkshire buys back even $50 billion in 2021 if the stock price remains in the $200-$250 range (B shares).
A Note on a Moat
Buffett loves to talk up the businesses that Berkshire owns, and that can become fatiguing. One good point he makes this year, given interest rates have reached near zero, is that Berkshire's insurance business - which includes GEICO - is at a particular advantage over competitors. Pure-play insurance businesses can be restricted - for regulatory reasons - to investing the premiums they receive primarily in bonds (currently earning close to zero income). Berkshire - as a diversified company in many businesses - is able to weight the investment of the insurance premiums it holds much more towards equities.
Note: Buffett isn't earning a whole lot on the ~$130 billion in cash on the company's balance sheet. Ironically, the amount of cash he has is very close to the size of the insurance float ($138 billion) where he is emphasising his competitive advantage.
Buffett didn't get deep into politics in this year's report (no surprise there), but he did split up Berkshire shareholders into different groups for the purpose of emphasising his admiration for group 5:
- Himself - a shareholder group with a limited lifespan.
- Index funds - interesting that he would break out index funds as a category. Buffett has written favourably of the index investing approach in the past. However, the language in this report seems a bit more mixed: "Index funds, it should be emphasized, own Berkshire shares simply because they are required to do so". Maybe I'm reading too much into it this as a slight on index funds - or maybe I want to read too much into it!
- Money managers. An "honourable but difficult occupation", Buffett says in the report. Maybe because it's his own occupation too? (A bit harsh from me there. In fairness the whole thing about Buffett is that he has all his net worth behind what he invests in - that's very different from most money managers.)
- Individuals who dip in and out of Berkshire. Enough said.
- Long term individual shareholders in Berkshire. Clearly, this group is important to Buffett. He didn't mention it in this annual report, but he has previously emphasised how many individuals invest their life savings in Berkshire, and this greatly influences Buffett in how he runs the business.
The most notable thing about this breakdown for me is that #1 won't be around for ever, and, in a few decades time, we'll look back at this as evidence of how index funds became a class of shareholder.
The Crown Jewels
Buffett highlights that the Berkshire business rests on four crown jewels:
- Berkshire's stake in Apple (#1) - valued at $120 billion at 2020 year end.
- BNSF Railway (#2) and Berkshire Hathaway Energy (#3): Generating a combined $8.3 billion in earnings in 2020. [Conservatively, applying an earnings multiple of 15, that would value #2 and #3 at about $125 billion.]
- Insurance businesses including GEICO (#4): Worth $138 billion, if you value it purely off of float. [actually, Berkshire often runs a profit on insurance so it's likely worth more, although you could argue the float is worth less than cash because it cannot be invested quite as freely].
So, roughly speaking, the four crown jewels are worth around $360 billion in today's market.
Add to that about $130 billion in cash, $160 billion in stock holdings excluding Apple, and another $6 billion in operating earnings (worth $90 billion at a 15X multiple) excluding BHE, BNSF and investment income. This brings Berkshire towards a $740 billion market cap, which is equivalent to a price per B share of roughly $330.
At the time of writing, Berkshire is at a price of $250 per B share and a market cap of around $560 billion, so you can see why Buffett and Munger have been buying back the stock from 2020 lows of around $162 all the way up to the present time.
To be clear, I'm not saying it's obvious that Berkshire's stock price will go up soon. You could pretty much have done the same calculation as above for the past five years and gotten the same favourable result - but Berkshire stock prices have not seen strong growth over the last decade.
*Rough calculation: $6 billion = $22 billion in operating income less $8 billion from BHE+BNSF less $8 billion in investment income (e.g. dividends from equity holdings).
A note on the annual shareholder meeting:
I'm not really sure why, but the Berkshire annual meeting on May 1st will be streamed from Los Angeles rather than Omaha this year. The good news is that Charlie Munger will be back on stage to share a few zingers. Ajit Jain will also be on stage, which I'm looking forward to because I haven't really heard him speak much before. He heads up insurance operations for Berkshire.
*Quite awkwardly, Berkshire sold it's positions in JPMorgan (Todd Combs, who works for Buffett, is on the JPMorgan board) and also in CostCo (Charlie Munger is on the board). Neither positions were large, but the board connection struck me as awkward - certainly for the CEOs of JPMorgan and Costco to have board members who are selling all of their shares. Ouch!
Analyst's Disclosure: I am/we are long BRK.B.
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