Notes from the 2021 Berkshire Hathaway Letter to Shareholders
Updated: Feb 13
Berkshire Hathaway is a company that I and some of my clients own shares in. This article isn't a recommendation to buy or sell shares, and instead is just a collection of notes and interesting takeaways from the annual letter to shareholders.
Some background on Berkshire:
What I like about Berkshire Hathaway is that it is a collection of financial assets and real assets that can potentially perform well across a range of economic environments. The company is diversified across a variety of industries and management tends to be fairly conservative in allocating capital towards new investments and growth opportunities.
Although the company has evolved over time, it has always been fairly straightforward to understand what you own. Whereas the stock market is a relatively abstract concept for many investors (it is the aggregate of hundreds of companies who each have their own business models, operating histories, valuations, and growth profiles), Berkshire Hathaway can be understood as 5 pieces.
The first piece is well known to many investors and consumers, Apple. Berkshire Hathaway owns roughly $161 billion worth of stock in Apple, or a little under 6% of the company. This represents something like one fifth of the value of Berkshire's overall valuation.
Besides that, Berkshire has its long-standing insurance segment, comprised of Geico, Gen Re, and a collection of smaller insurance companies. There's also a pending, $10 billion acquisition of Allegheny (a property and casualty reinsurer). Insurance can be a moderately challenging business. It's competitive, economically sensitive, and capital intensive. The advantage Berkshire has in this space is largely structural. All insurance companies have to keep liquid assets to pay out claims. For a lot of companies, their pool of reserves is barely big enough to pay claims and therefore has to be invested conservatively in low-yielding investments. Berkshire, however, can spread risk across a larger pool of claims, and is better capitalized than most. This allows Berkshire to invest these cash reserves more aggressively for long term growth, and keep the resulting profits for itself. Berkshire pays less than nothing for its access to this capital.
The Berkshire portfolio also includes a large scale electric utility (Berkshire Hathaway Energy), which includes some power plants, wind farms, and transmission infrastructure. It's estimated that investments in this unit yield an ROI of around 10-12%. Given the assets involved, this is a predictable, stable home for invested capital. I speculate that Berkshire can borrow against this infrastructure at a pretty low interest rate, which further enhances the cash on cash return.
Investors in Berkshire also own the BNSF railroad, which is another highly predictable area of reinvestment. Railroads remain the most efficient way of transporting goods by land, and are mini-monopolies on their routes. They don't have much inbound competition, and have huge economies of scale. Each additional car added to a train is nearly pure profit. The downside is that they tend to be cyclical, but here again, the asset benefits from its place at Berkshire, which has huge cash reserves and cheap access to capital.
The fifth and final piece is a portfolio of publicly traded stocks.
The most notable holdings in the stock portfolio (aside from Apple) include a $46 billion stake in Bank of America, a $24 billion stake in Coca-Cola, a 26% stake in Kraft-Heinz, and a 38.5% stake in Pilot travel stations. Recent additions include $10 billion of Occidental Petroleum, and roughly $10 billion of Verizon Wireless. Most of these are household names, and don't require tremendous imagination or financial savvy to understand how they make money.
Buffett says, "time is the friend of the wonderful business," and at this point I have been a Berkshire shareholder long enough to see the truth of this statement. Many of the companies in the Berkshire portfolio could be described as "wonderful," particularly in concert with one another.
Even as someone whose job is predicated on the power of compound interest, I routinely underestimate the benefits of just sitting around and letting good investments grow. I first bought shares of Berkshire in 2016 around $135 a share. Today, those shares are worth roughly $350 each, which is nice. It's a fairly low-risk investment (in terms of the durability and predictability of the business units) that has produced good returns over time.
That said, the journey has been lumpy and occasionally painful. Although the stock did well from 2016 to 2018, I believe it underperformed several other, highly visible investments during that time. I'd have been better off buying Google, Amazon, or Apple stock. Furthermore, Berkshire was roughly flat from 2018 to the beginning of 2021, which wasn't particularly fun. Future performance is also uncertain, particularly compared to the S&P 500.
The good news is that the company has mostly kept pace with the S&P 500 in the past, at least on an after-tax basis. In addition to its tax-conscious approach to internal operations, the company doesn't pay a dividend. This makes it a decent candidate to hold in taxable accounts, at least in certain situations, because investors get to defer long-term capital gains until a time of their choosing. On investments held in taxable accounts, dividends are taxable to investors, and create a drag on wealth accumulation.
This Year's Letter:
Two takeaways were especially interesting to me.
First, is that over the last 2 years, Berkshire has repurchased 9% of its shares outstanding. This means that remaining shareholders own 9% more of the company today than they did 2 years ago. I rather like this, because it amounts to a roughly 4.4% annual shareholder yield over this time. That's a good yield, and comes with continued growth in Berkshire's assets.
Second, despite buying back this amount of stock, Berkshire's cash holdings have increased to roughly $144 billion. Buffett has suggested that the minimum of cash to keep on hand is about $30 billion, which leaves $114 billion available for acquisitions. On a $780 billion market cap, this $114B is about 15% of the value of the company, or about 11.4% of the estimated one trillion in total assets.
Part of the increased cash position came from selling off some of Berkshire's other stock holdings. This could imply that the managers saw Berkshire as more attractively valued than these other holdings. Alternatively, and more likely, it could mean that two separate decisions were made. One, to sell the other stocks, possibly because of an anticipated deterioration in those businesses that made them unattractive to hold long term. Second, to buy back shares of Berkshire Hathaway, presumably because management sees Berkshire as a worthy investment.
The biggest changes in Berkshire's stock portfolio included new or increased stakes in Verizon, Chevron, and Occidental Petroleum. Berkshire disposed of its stakes in Teva pharmaceuticals (which manufactures generic versions of drugs), and Sirius XM (due to acquisition by Liberty Media). Reading between the lines, I think this implies that Berkshire's management foresees higher inflation ahead, as all three of these new companies should do fairly well in an inflationary environment.
The final item of interest was essentially an advertisement, enticing founders to sell their businesses to Berkshire. Buffett tells the story of TTI, a company that was sold to Berkshire by its founder in 2006. In part, the decision to sell to Berkshire revolved around succession planning; the founder wanted his old employees and managers to keep their jobs, as well as for the operations of the company to remain intact rather than go through a series of corporate restructurings and layoffs. This is a benefit that very few acquirers can provide, and one that Buffett is notoriously happy to provide.