Buffett Extols Value of Stock Bets in a Year Without Big Deals

(Bloomberg) -- Warren Buffett sought to justify the importance of his $248 billion stock portfolio, saying the investments are more than just “dalliances” with the companies he takes stakes in.

The billionaire investor spent a portion of his annual shareholder letter, released Saturday, detailing how an accounting difference between his stock picks and his outright business takeovers creates a “standout omission” in Berkshire Hathaway Inc.’s financial results. The conglomerate’s equity investments will produce capital gains that are at least equal to Berkshire’s share of the individual companies’ retained earnings, Buffett argued.

“Overall, the retained earnings of our investees are certain to be of major importance in the growth of Berkshire’s value,” Buffett said in the letter. For its equity investments, “only the dividends that Berkshire receives are recorded in the operating earnings we report. The retained earnings? They’re working hard and creating much added value, but not in a way that deposits those gains directly into Berkshire’s reported earnings.”

The value of Buffett’s equity portfolio last year increased about 44%, helped by the best year for Apple Inc. stock since 2009 and gains on holdings such as Bank of America Corp. and Coca-Cola Co. His own Berkshire shares didn’t fare quite as well, posting their worst annual underperformance relative to the S&P 500 Index in a decade.

Buffett has been hunting for ways to deploy his $128 billion cash pile to generate higher returns, but has struggled to find a massive deal amid “sky-high” prices. He ended up taking another path in 2019, spending a total of $5 billion on repurchases and being an overall net buyer of the stocks of other companies.

Berkshires stock investments shouldn’t be seen as “dalliances to be terminated because of downgrades by ‘the Street,’ an earnings ‘miss,’ expected Federal Reserve actions, possible political developments, forecasts by economists or whatever else might be the subject du jour,” Buffett said in the letter. The equity stakes represent “an assembly of companies that we partly own and that, on a weighted basis, are earning more than 20% on the net tangible equity capital required to run their businesses.”

Click here for live commentary and analysis of Buffett’s television interview with CNBC, starting Monday at 6 a.m. ET

Here are five other takeaways from Buffett’s annual letter and Berkshire’s fourth-quarter earnings report:

1. Berkshire Gives Preview of Life After Buffett

Buffett waited until the very last page of his annual letter to reveal a big change: Investors will be hearing more from top lieutenants Ajit Jain and Greg Abel. The pair, seen as the top contenders to eventually replace Berkshire’s 89-year-old CEO, have often remained behind the scenes, tending to Buffett’s vast collection of businesses. But a quirk of last year’s annual Berkshire meeting, during which Jain and Abel both answered some shareholder questions, will become more formalized at the 2020 event.

Buffett said in the letter that he had received suggestions that Jain and Abel “be given more exposure at the meeting. That change makes great sense.” He gave no further clues about his eventual replacement, and no indication that he or Charlie Munger, his 96-year-old business partner, would step away any time soon.

Jain and Abel are “the clear-cut front-runners,” said Matthew Palazola, an analyst at Bloomberg Intelligence.

2. Buffett Spends Record $2.2 Billion on Buybacks

The Oracle of Omaha kicked his stock-buyback program into high gear, spending $2.2 billion on repurchases in the last three months of 2019, the most ever in a single quarter -- and said he’s looking to buy even more.

Berkshire, which loosened its repurchase policy almost two years ago after being stymied on the dealmaking front, has since taken a cautious approach to buybacks, acquiring only $6.3 billion of stock. Even with the increase in repurchases, Berkshire’s pile of cash hovered close to a record.

The repurchases should make it easier for Buffett’s eventual successor to make additional buybacks, according to Tom Russo, who oversees more than $10 billion, including Berkshire shares, at Gardner Russo & Gardner LLC. “I wanted them to have no uncertainty, for whoever succeeds both Charlie and Warren, that the share buyback is a perfectly legitimate and highly valued tool to deliver growth in intrinsic value on a per-share basis,” Russo said.

3. Berkshire’s Earnings Hurt by Insurance Losses

Berkshire’s operating earnings fell to $4.42 billion in the fourth quarter, down 23% from a year earlier, driven by underwriting losses at its namesake reinsurance group, which was hurt by typhoons in Japan, wildfires in California and Australia, and widening losses at its business writing retroactive reinsurance contracts.

Buffett’s company did better with its BNSF railroad, which posted a 3.8% gain in profit, just shy of record earnings in the previous three months, as a decline in expenses helped counter falling revenue across shipments of products such as coal, consumer items and agricultural goods.

A bigger problem for the conglomerate is Kraft Heinz Co., which counts Berkshire as its largest shareholder and had a tumultuous 2019, with writedowns, management shakeups and downgrades to junk. Berkshire carries its Kraft Heinz investment on its balance sheet at $13.8 billion, a figure unchanged since 2018’s fourth quarter, even as the market price of the stake dropped to $10.5 billion at the end of last year.

4. Buffett Chides CEOs for Wanting Cocker Spaniels

Buffett often uses his annual letter to talk not just about Berkshire, but also the wider corporate environment. This year, Buffett, who’s served as a director at 21 publicly traded firms over the years, used a portion of his missive to complain that too many companies seek board members who won’t challenge a CEO’s decisions.

“When seeking directors, CEOs don’t look for pit bulls,” Buffett said in Saturday’s letter. “It’s the cocker spaniel that gets taken home.”

Buffett’s discussion of corporate-governance issues also touched on board diversity. Goldman Sachs Group Inc., which counts Berkshire as an investor, said last month that it won’t take a company public unless there’s at least one board member who’s not a white male. Adding female directors “remains a work in progress,” Buffett said in this year’s letter. At his company, three of the board’s 16 members are women.

5. Buffett Avoids U.S. Politics in Letter to Investors

Buffett stayed out of the political fray in this year’s letter. He didn’t mention the words “election,” “Trump,” or any Democrat running for president.

The billionaire has trod carefully over the years as the U.S. has become more politically polarized. His 2019 letter focused on overall prosperity in the U.S., saying that America’s success over the decades has been achieved in a bipartisan manner.

Buffett has been known to campaign for candidates, including Democrat Hillary Clinton in the 2016 presidential election. He’s said more recently, though, that he prefers not to use his position at Berkshire to promote his political views -- or to impose his political opinions on Berkshire’s business activities.

To contact the reporter on this story: Katherine Chiglinsky in New York at kchiglinsky@bloomberg.net

To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, Daniel Taub, James Ludden

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