The 13-page shareholder letter from Warren Buffett that appeared on the website of his investment vehicle Berkshire Hathaway on Saturday, is a fascinating reading every year. Buffett did not start the letter – which is the invitation to the shareholders’ meeting on Saturday May 2 – with a fulmination against the American GAAP accounting standards.
By changing the standards, Berkshire Hathaway recorded $ 53.7 billion of “unrealized net gains” on shares in portfolio. “Before the introduction of the new GAAP rule in 2018, unrealized gains on shares were never recorded, and losses only if they were considered non-temporary,” says Buffett. This accounting method follows the precautionary principle.
“Now we have to adjust net profit – an important indicator for analysts and media – every quarter with every upward and downward movement of the stocks we have, no matter how erratic those movements may be,” Buffett continued. “This new GAAP rule, which both my partner Charlie Munger and I disagree with, has increased our net profit by a crazy 1,900 percent!”
Berkshire’s group profit amounted to $ 81.4 billion in 2019, compared to $ 4 billion in 2018. “Meanwhile – in what we could call the real world, unlike accounting country – the average value of our portfolio was over the 200 billion dollars in the last two years. And the net asset value of our shares grew gradually and substantially. ”
Buffett advises investors to focus on operational profit at Berkshire. “And it remained practically stable in 2019.”
Buffett and Munger believe that the Berkshire equity portfolio will “make significant gains in the long run.” Buffett referred to the ‘power of retained earnings’, with a reference to the book ‘Common Stocks as Long Term Investments’ by Edgar Lawrence Smith, according to Buffett’s ‘obscure economist’.
The retained earnings are that portion of the earnings that are not distributed to the shareholder. When companies withhold and reinvest a significant portion of their profits each year, equity capital benefits from the compound interest.
“For Smith’s book, transferred earnings were undervalued. Shares were for speculators, bonds were for gentlemen, “writes Buffett. In the letter, he compared the dividends received for the ten most important equity investments against Berkshire’s interest in the profit carried forward. “These companies use transferred profits to expand the business or to boost the efficiency. Or they can buy their own shares with it. ” For most companies, the dividend is below the transferred profit.
Buffett repeated his positive view of US stocks. “If interest does not change appreciably in the coming decades and if corporate taxes remain low, then it is almost certain that equities will yield more than long-term bonds.”
And as if Buffett knew that a bad trading day would follow on Monday, he warned: ‘Anything can happen with the stock prices of tomorrow, sometimes there are declines of more than 50 percent. Keep your emotions under control. ”
Buffett is buying up its own shares
The Buffett vehicle bought $ 2.2 billion of its own shares in the fourth quarter. With that, the buy-in was accelerated. The company eased its buying policy two years ago because it could not make interesting acquisitions. Since then, Berkshire has purchased fairly cautiously by buying only $ 6.3 billion in treasury shares.
The acceleration of the buy-out program shows that Buffett is having trouble getting the huge cash mountain of $ 128 billion to put to work. The master investor would like to spend his cash on a large takeover – an ‘elephant’ – but the prices are ‘towering’ according to him. His last elephant dates from four years ago when he spent $ 32 billion on Precision Castparts.