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Annual Letter to Berkshire Shareholders (2019) [pdf] (berkshirehathaway.com)
154 points by jbonniwell 39 days ago | hide | past | web | favorite | 78 comments

After having seen so much nonsense accounting in the books of so many startups (especially recently, it feels like a growing trend) it's refreshing to see GAAP. The difference in standards between the startup universe and the 'real world' is actually scary. There have been far too many instances of people getting taken for a ride based on EBITDA when the company's financials were far from healthy.

Am I alone in thinking this?

The thing that stands out in Buffett's letters (including this one), is his commitment to clearly communicating the true health of the company in the most accurate way possible. That's missing in a lot of corporate communication, which try to spin results or invent creative metrics that make the company look better.

He always shares GAAP as well but will usually point out where he thinks it not useful.

>That's missing in a lot of corporate communication,

Instead of a lot, How about the other way around, name a Fortune Global 500 company that actually communicate the true health of the company in the most accurate way possible. Because honestly apart from Berkshire, I dont see one.

And I cant blame them, after all their job is to tell you everything is ok.

Not alone. Indeed Charlie Munger straightforwardly refers to EBITDA as a bullshit earnings metric.

“I don’t like when investment bankers talk about EBITDA, which I call bulls--- earnings”

“Think of the basic intellectual dishonesty that comes when you start talking about adjusted EBITDA. You’re almost announcing you’re a flake.”

Buffett thinks GAAP is almost useless now, and doesn't think accountants have a clue. He follows own "owners earnings" model, which is not a standard of any kind.

"Berkshire’s 2018 and 2019 years glaringly illustrate the argument we have with the new rule. In 2018, a down year for the stock market, our net unrealized gains decreased by $20.6 billion, and we therefore reported GAAP earnings of only $4 billion. In 2019, rising stock prices increased net unrealized gains by the aforementioned $53.7 billion, pushing GAAP earnings to the $81.4 billion reported at the beginning of this letter. Those market gyrations led to a crazy 1,900% increase in GAAP earnings!

Meanwhile, in what we might call the real world, as opposed to accounting-land, Berkshire’s equity holdings averaged about $200 billion during the two years, and the intrinsic value of the stocks we own grew steadily and substantially throughout the period."

GAAP is definitely an imperfect standard, so I don't begrudge them going their own way (and their way seems to be reasonable, from a cursory view). My comment mostly comes from the frankly ludicrous financials that have been making headlines in the last few years.

Agreed. Also noteworthy that Buffett points out the shortcomings of GAAP’s mark-to-market rule whether it makes Berkshire earnings look undeservedly good (2019) or bad (2018).

Probably. Berkshire itself doesn't seem to think this; the letter starts off by arguing that GAAP earnings are a misleading metric and encouraging shareholders to ignore them.

> The difference in standards between the startup universe and the 'real world' is actually scary.

The 'real world' is scary too. Also, you can't really compare the financial statements of startups with established blue chip companies. Investors do not expect nor are they looking for the same things from them. Just like people who buy into VC funds have different goals and expectations from those who invest in an index fund. VC funds, index funds, startups, blue chips all have different "standards".

> Am I alone in thinking this?

No, I'm sure a lot of people agree with you. It's just that Buffet and Munger aren't one of them.

Whatever the accounting standards, I believe it was buffet who said you won't know who has been swimming naked until the tide pulls out ( we won't know how healthy the balance sheets are until we have a recession ). Enron, Washington Mutual, etc all had "healthy balance sheets" until they didn't. And all of them even had the seal of approval from the 3 or 4 major auditing firms too.

I agree.

Although for anyone unfamiliar, GAAP isn't and never was perfect. Like any target it is gamed. Hence the origins of the meme "cash flow is a better indicator than net income."

In comparison, startup accounting has engaged in such fuckery that it makes GAAP look wholesome.

Startups are selling hockey stick growth, GAAP is pretty meaningless there.

I run a startup and we use GAAP.

After reading all the positive comments about BRK in this thread I came across this article: https://www.nasdaq.com/articles/hypocrisy-berkshire-hathaway... For somebody with little knowledge of financial services (i.e., me), how would you recommend that I interpret this?

The BRK official position on Valeant is that they take advantage of sick individual's life-or-death need for drugs to price gouge them since purchasing decisions are not made on price (medication is "price inelastic").

Clayton homes is criticized for having bad or misleading loan terms. BRK (and many financial services individuals I know personally) often see just about any loan term as fair as long as no-one was forced into the loan at gunpoint. Is it the responsibility of the lessor or lessee to make sure the lessee is signing to something in their best interest? Loans are not life-or-death and purchasing decisions are frequently made on price (loans are "price elastic").

The article you've linked presents these two cases and makes the argument that they are equivalently immoral, making Munger a hypocrite. Personally, I think they're both fair criticisms, but they definitely come from different places. I don't see necessary cognitive dissonance in having the opinion that only one of these is immoral.

With regard to cutting costs: I see no indication that BRK criticized Valeant for firing people, so I suspect this is a personal issue for the author of the article, so I haven't addressed it here.

Criticisms on valeant don't seem fully justified. Sure valeant had questionable business practices in the past, but they've changed due to law enforcement. Plus, the other criticisms can be applied to almost every pharma company

There’s two main points in article:

1) berskhire owns clayton homes which takes advantage of poor people with high fees. Therefore it is hypocritical for Charlie to accuse a pharma company of taking advantage of people. 2) some of berskhire deals associated with 3G capital cost cut at sake of revenue growth

For number 1, it’s a fair question. I’ve heard of Clayton homes before and seems to be a head scratcher for Warren and Charlie who are quick to throw moral judgements around. However one key difference I’ll point out between Clayton and Charlie’s criticism of the pharma company is that jacking prices in pharmaceuticals can be literally a life or death matter. Clayton homes on the other hand people have choices - they can continue to rent a usual apartment vs trying to “buy” a home. Not saying it’s not sketchy but the degree of harm is different.

For number 2, the author leave out many specific details but I’m inclined to not give much weight. If you’ve read any of Warren’s letters their entire philosophy is to buy and hold, generating a healthy return on net tangible equity year after year. It makes no sense they would cut costs at expense of revenue growth. It does make sense they would cut costs, but not in the slash and burn manner this article is implying.

Berkshire’s job is finding stable, undervalued companies and buying them with the funds from massive insurance company floats (ie leverage).

The government’s job is to protect people from the negative side effects of the aforementioned activity.

Clayton homes is one party doing its job properly (Berkshire), and the other dropping the ball (the US government).

We cannot just hope and pray companies will follow our vague and differing ideas about what is right. If we want them to act a certain way, we have to write laws to make that happen.

The article's point is that Berkshire should follow the ideas of its own vice chairman.

I would say don’t try to interpret a single article to understand the whole of Berkshire Hathaway. It’s a complex organization with 300K employees in dozens of businesses who operate in a totally decentralized way (aside from capital allocation).

Last Week Tonight with John Oliver had episode about those practices including Clayton Homes. https://www.theguardian.com/culture/2019/apr/08/john-oliver-...

The point of the story is that

1) Mobile homes are horrible investments. They go rapidly down in value. “cars go down in value. Mobile homes go down in value. It’s a car you sleep in.”

2) Private equity groups such as the Carlyle Group, TPG and Blackstone now own large tracts of mobile home park and collect big fees.

3) Loans for the houses have large interest rates. They have to be. If you sell a product and give a loan that goes down in value very fast, only way to do that is to charge big interest because the risks are also big. Poor people don't have other collateral.

This kind of rent seeking form land and loans where poor people pay and pay means that people stay poor. This would be a job for government. Provide cheap rented land and basic infrastructure and cheap mobile housing.

It's not just mobile homes. All homes are horrible investments. It's just that mobile homes don't come with Real Property (in other words land), and Real Property goes up in value.

You will see people who do some renovations and kid themselves that this is an "investment" in their home - in practice the increase in market value of the home will typically be negligible, sometimes negative and only in some very unusual cases would it meet or exceed their costs in doing the work. This doesn't make renovating your house a bad idea, but you should have your eyes open that it's only an "investment" the way a nice meal or holiday trip is an "investment".

The reason Real Property (usually) goes up in value is that it's in some sense scarce. If I need fifty square metres of Manhattan Island, no amount of Ohio, whether fifty square metres or fifty square miles is a valid substitute.

The hmme can seem like it adds value because an equivalent amount of land nearby with no house on it is often worth much less - except if that equivalent amount of land comes with legal authority to put a house on it you'll find suddenly it is worth almost as much as the land with an actual house on it. That permission (where required) is very valuable, the timber and paint and so on not so much.

> All homes are horrible investments.

I beg to differ. Were I to sell my home at current market price I would not only have lived for free for the last decade, I would've been paid to live in it.

From the bottom of the first page in the report: Overall Gain – 1964-2019 .................................................... Berkshire: 2,744,062% S&P: 19,784%

Huh? 2 million percent vs. 19k ?

Yes, that is correct. Berkshire stock is worth 27440 times as much, in nominal dollars, as it was in 1964. Meanwhile, a hypothetical no-load S&P index fund would be worth 198 times as much, again in nominal dollars. That is why Warren Buffett became the world's richest person (for a while; later he hired Bill Gates to help him give his money away) and his shareholder letter is on the front page of HN. If you hadn't heard of him before, congratulations! You're one of today's lucky ten thousand!

Yeah, people who invested any money in Berkshire in 1964 are very rich now (if they didn't sell). People who invested in S&P in 1964 are not as rich.

Although interestingly heir performance in the last 10 years has roughly matched/slightly lagged the S&P index.

Tough game managing that much money.

10 years ago they were avoiding tech stocks, and I think they mostly still do.

Perhaps matching S&P without investing in some of the biggest gains is quite a notable outcome?

Buffett and Munger (the combination) are national jewels.

They demonstrate sound investing principals, and they exemplify humble and humorous manner. We're lucky to have them.

Any book recommendations for someone who would like to learn more about GAAP, accounting, operational earnings, and/or how to evaluate stocks?

* Best introduction: Financial Intelligence, Revised Edition: A Manager's Guide to Knowing What the Numbers Really Mean (Berman, Karen, Knight, Joe, Case, John, imusti)

* Then read this, all of it, except perhaps most of the exhibits: Most recent Costco annual report (10-k).

* Berkshire Hathaway annual letters, Transcripts from Berkshire annual meetings

* Great follow-up: Financial Shenanigans, Fourth Edition: How to Detect Accounting Gimmicks and Fraud in Financial Reports (Schilit, Howard, Perler, Jeremy, Engelhart, Yoni, McGraw-Hill Education)

* Absolute classic (but needs to be updated): The Intelligent Investor: The Definitive Book on Value Investing. (Graham)

* On investing in general: Margin of Safety (Seth Klarman)

* Great intro to valuation, with the caveat that modern finance and concepts like WACC may not necessarily be useful to your investing strategy: Valuation: Measuring and Managing the Value of Companies (Tim Koller, Marc Goedhart, David Wessels)

* Another classic (but needs to be updated): Security Analysis (Graham and Dodd)

I've read those in more-or-less that order, interspersed with plenty of other useful books that you'll discover depending how deep you go. The most important thing is reading 10-ks.

> Most recent Costco annual report (10-k)

Never thought of reading it. Thanks for the tip. Why do you recommend it so highly?

It's simple and there's enough information in it to value the business. The goal is getting up to speed reading 10-k's as fast as you can.

this is very helpful. Thank you stranger

Read the last twenty years of Buffet's letters.

No snark intended. His letters intended for investors are the best use of your time rather than a book someone wrote for vanity.

The Intelligent Investor by Benjamin Graham is a classic.

Graham's approach shaped Buffett's. Personally, I found The Intelligent Investor to be more clearly written than Buffett's letters. It more clearly left me with a framework for how to approach value investing.

Security Analysis by Graham and Dodd was what Buffett used, since II wasn't out yet. A more difficult read as well, also seemed a bit dated when I read through it a decade ago.

Excellent book, and a timeless classic to be sure. I do find Buffet's letters very useful for making sense of the current landscape though.

thank you

Whenever someone asks me about sources on investing, I say the same thing - though I phrase it as 'buy one share of Berkshire Hathaway, it comes with a lifetime subscription to the thoughts of the most successful investor alive today'

One share of BRKB, Berkshire Hathaway class B, is around $230, which makes it much more affordable than the A shares.

Whenever someone asks me about sources on investing, I say the same thing - though I phrase it as 'buy one share of Berkshire Hathaway, it comes with a lifetime subscription to the thoughts of the most successful investor alive today'

Since one share of BRK is almost $350,000 my guess is that not a lot of people you've said that to have followed your advice.

BRK.B costs only 1/1000th of the A class shares, and you still get the letters. I couldn't afford an A class share either if that was all that was available.

thank you.

I think the recommendations you're getting here to read Buffett's letters, The Intelligent Investor, etc. are good, but if you're completely new to accounting, I think starting with more basic texts would be a better idea.

Two that I liked and still refer to from time to time are How to Read a Financial Report by John A Tracy and Financial Statements: A Step-By-Step Guide to Understanding and Creating Financial Reports by Thomas R Ittelson.

awesome. I'll check them out. thank you

Unspoken in Buffets letter is the problem that these unrealized gains cannot be realized in a short period of time. The size of Berkshire Hathaway's holdings is such that, if they were quickly sold, they would fetch a lower price - they would saturate the available buy orders and move the reported valuation (average sale price) down.

And if you had to liquidate all of Apple's assets, or Google, or Microsoft, or any public company in a short period of time, you'd realize a much lower value than their reported book values. Your point?

> In 2019, Berkshire sent $3.6 billion to the U.S. Treasury to pay its current income tax. The U.S. government collected $243 billion from corporate income tax payments during the same period. From these statistics, you can take pride that your company delivered 11⁄2% of the federal income taxes paid by all of corporate America.

“Shareholders having at least $20 million in value of A or B shares and an inclination to sell shares to Berkshire may wish to have their broker contact Berkshire’s Mark Millard at 402-346-1400. We request that you phone Mark between 8:00-8:30 a.m. or 3:00-3:30 p.m. Central Time, calling only if you are ready to sell.”

$BRK.B holder myself — What is this? Is this essentially if you have a big enough position you can sell us your shares directly for a better price than on the open market? Doesn’t that seem unfair to retail/small investors who have to trade on the open market?

Selling 20 millions would cost you a little fortune in broker fees. In turn BRK are buying back and paying brokerage. It makes sense to sell directly. And I don't think you get a better price than the market even selling 20M, you just sell at market price.

This saves money to YOU, the shareholder, so you should be happy with it.

Broker fees? I assume you mean the individuals entity that manages their portfolio charges a fee. Obviously when you have that much wealth you aren’t using E*Trade or Schwab $0 commissions trades.

You can certainly have that many shares in a normal brokerage.

They are offering to buy back large blocks of shares at market or at a slight premium over market for long-term loyal investors.

It is a great offer to you because you may move the market down just by trying to sell such a large block.

I'm guessing they have a number of shares they want to buyback and it's simply not worth their time trying to wrangle them from investors with less than $20 million worth

I’d like to introduce you to the open market. Weekdays 9-4. Buy and sell any shares you’d like.

I am curious if anyone has called Mark Millard and requested what BRK's bid quote for >$20M shares is.

I thought that was bizarre too.

"In reviewing my uneven record, I've concluded that acquisitions are similar to marriage: They start, of course, with a joyful wedding – but then reality tends to diverge from pre-nuptial expectations. Sometimes, wonderfully, the new union delivers bliss beyond either party's hopes. In other cases, disillusionment is swift. Applying those images to corporate acquisitions, I'd have to say it is usually the buyer who encounters unpleasant surprises. It's easy to get dreamy-eyed during corporate courtships. Pursuing that analogy, I would say that our marital record remains largely acceptable, with all parties happy with the decisions they made long ago.

Despite the (2019) in the submission title, the letter was published today (2020-02-22).

Have to love the clarity and direct openness, as somebody with experience in the underwriting market, his honesty and pragmatic insight is spot on.

It's interesting that Berkshire seems to have entirely abandoned oil and gas equity positions though they did provide financing for Occidental's buyout. Wind and solar on the other hand, they do own a lot of. Warren's finally found a tech investment that he understands.

Who else here loves the Berkshire Hathaway website? Yes it's outdated and not exactly pretty but it's so 'cut to the chase' and easy to navigate. I see why they never changed it. A bit like Warren and his house that he has lived in since 1958!

"The result was significant property damage and a major disruption in Lubrizol’s business. Even so, both the company’s property loss and business-interruption loss will be mitigated by substantial insurance recoveries that Lubrizol will receive. But, as the late Paul Harvey was given to saying in his famed radio broadcasts, “Here’s the rest of the story.” One of the largest insurers of Lubrizol was a company owned by...uh,Berkshire."

Whoops. I wonder if they're going to introduce a policy against such self-insurance?

"Mistakes in assessing insurance risks can be huge and can take many years – even decades – to surface and ripen. (Think asbestos.) A major catastrophe that will dwarf hurricanes Katrina and Michael will occur – perhaps tomorrow, perhaps many decades from now. “The Big One” may come from a traditional source, such as wind or earthquake, or it may be a total surprise involving, say, a cyber attack having disastrous consequences beyond anything insurers now contemplate. When such a mega-catastrophe strikes, Berkshire will get its share of the losses and they will be big –very big. Unlike many other insurers, however, handling the loss will not come close to straining our resources, and we will be eager to add to our business the next day."

This is somewhat concerning. Property/casualty has been a relatively stable insurance market, as Buffett notes. (Major hurricanes not withstanding. I seem to recall reading that, if life insurance had been more common among gay men when the AIDS epidemic occurred, the life insurance industry would have been bankrupt.)

But, there are large-scale new things trundling down the pike. Global climate change, for one. I don't know if BH is involved with flood insurance damages, but large regions of the world are likely to be exposed to them that had not been before. There aren't any statistics to cover those changes. It's gonna be interesting.

"Over the years, many new rules and guidelines pertaining to board composition and duties have come into being. The bedrock challenge for directors, nevertheless, remains constant: Find and retain a talented CEO –possessing integrity, for sure – who will be devoted to the company for his/her business lifetime."

"Devoted to the company for his/her business lifetime?!" A CEO's business lifetime is much more than 18 months! This is clearly an outdated and obsolete (if not completely archaic) idea. How ridiculous!

(A significant chunk of my assets are in BH stock. No baby seals were harmed in the production of this comment.)

"Frequently,the possession of one such directorship bestows on its holder three to four times the annual median income of U.S.households. (I missed much of this gravy train: As a director of Portland Gas Light in the early 1960s, I received $100annuallyfor my service. To earn this princely sum, I commuted to Maine four times a year.)"

Uh, oh. Warning! Warning! Socialism incoming!

"In past reports, we’ve discussed both the sense and nonsense of stock repurchases. Our thinking, boiled down: Berkshire will buy back its stock only if a) Charlie and I believe that it is selling for less than it is worth and b) the company, upon completing the repurchase, is left with ample cash."

I just thought I'd copy that one.

But, there are large-scale new things trundling down the pike. Global climate change, for one. I don't know if BH is involved with flood insurance damages, but large regions of the world are likely to be exposed to them that had not been before. There aren't any statistics to cover those changes. It's gonna be interesting.

As long as they have a granular understanding of the perceived vs actual risk profile across geographies over time, they'll be able to make huge sums of money by staying just adjacent to the high-risk areas.

Imagine three houses in a row. The risk of fire may be the same for all three. That changes as soon as the leftmost house catches fire. They would never insure that house; it's already on fire. The middle house has a statistically higher chance of catching fire than the rightmost house, yet the relative proximity to the fire drives fear up among both adjacent owners—actual risk vs perceived risk in a nutshell. Both are more likely to want to buy insurance, with the middle owner willing to pay more. The insurance provider can set premiums that take into account both the actual risk profile and the perceived risk profile.

It's reductive, but it illustrates a point: money is made when there is a delta between the perceived value and actual value. That usually happens when there's a fundamental transition that is unrecognized by the market. If you can spot the wave, you can ride it.

Climate change isn't a random event—it's an observable transition. And it's going to cause one hell of a wave.

I’ve been enjoying this letter when this weird outdated analogy stopped me cold in my tracks:

„In reviewing my uneven record, I’ve concluded that acquisitions are similar to marriage: They start, of course, with a joyful wedding – but then reality tends to diverge from pre-nuptial expectations. Sometimes, wonderfully, the new union delivers bliss beyond either party’s hopes. In other cases, disillusionment is swift.“

What’s bizarrely archaic about this is that if he had simply said „Dating“ or „relationships“ he would have been equally correct, if not more so. And unlike a marriage, he can trade portions of his company holdings back, which in a sense makes it more like dating than a marriage proper.

I'm missing your point here. Do you not like marriage analogies? Or you don't think his analogy and very well known life experience doesn't apply (he has an interesting personal experience with marriage)? Or do you think most of the people who read his letter have no background in marriage?

I find the analogy very appropriate and well stated. Much like a marriage he can't just give back a portion of an entity he's involved in without legal pain and the pain of explaining it to his investors and board members and the company he is having trouble with. I guess that's like dating but to me it's closer to a marriage and divorce.

I guess what’s strange to me is not the idea that, as you become more committed to a person you discover their flaws and the relationship gets worse. That seems self evident to me and seems to be a common theme both in theory and in practice.

But how many marriages resolve with discovering the person is way better than you imagined? I’m not familiar with this, either through the idealism of poetry or romantic movies, nor through practical experience provided by observing marriages around me. I thought most people assume that you have a honeymoon phase and hopefully that never ends.

That seems self evident to me and seems to be a common theme both in theory and in practice.

Only if everything you know about marriage and family you learn from television and the internet.

But how many marriages resolve with discovering the person is way better than you imagined?

My guess is almost all of them, because as people grow older, they grow wiser, more interesting, smarter, and have more life experiences on which to draw.

My wife today is not the person I married, and I'm happy for that because I've had the privilege of seeing her grow and become a better person. I the person I was back then met her today, I wouldn't even consider her in my league.

In my opinion a marriage is a safe place to raise children - the transformation from 'self' to 'family' can be an extraordinarily joyful and fulfilling experience.

A happy marriage over time becomes something that's hard to describe completely and I don't think it's ever what people imagine - it can be what is imagined, but it's also something else. His point isn't that the person is "better" than you imagined (though they are different from the time you marry them, that growth is part of the beauty), it's that the marriage is blissful in ways you never foresaw.

His analogy is good, imo.

> But how many marriages resolve with discovering the person is way better than you imagined?

Mine for sure. Keeps getting better and better as we grow closer. I find this to be the case in many happy relationships.

observing marriages and watching movies about marriages probably tells you as much about marriage as watching movies about computers and watching people type on computers will tell you about programming.

> And unlike a marriage, he can trade portions of his company holdings back, which in a sense makes it more like dating than a marriage proper.

Err…divorces are a thing? I can’t make sense of this complaint unless you’re somehow claiming that the concept of marriage itself is anachronistic…

Divorces leave permanent marks unlike company partnership exits.

As do breakups?

There is a legal binding contract in marriage. You can walk out of a relationship without having to settle/split assets etc. You cannot in marriage.

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