In its latest annual letter, released at 8am on Saturday, Warren Buffett’s Berkshire Hathaway said Q4 profit hit an all time high, rising more than five time, as net income soared to a record $32.44 billion, or $19.790 a share, from $6.29 billion, or $3.823 the prior year, while operating EPS fell 24% to $3,338, hurt by losses in the company’s insurance operations, however it was enough to beat the $2,617 consensus estimate.
For the full year, Berkshire earned $44.940 billion, up 87% last year’s $24.1 billion, despite “only” an 8% increase in total revenue to $242.1 billion. Where did the delta come from? Largely from Trump’s tax reform, which needless to say Berkshire was not a big fan of.
As Berkshire admits in its annual report, while the gain in net worth during 2017 was $65.3 billion – which increased the per-share book value of both our Class A and Class B stock by 23% – $29.11 billion of its net income to the reduction of the U.S. corporate tax rate, to 21 percent from 35 percent.
As Buffett admits in starting the letter, “the format of that opening paragraph has been standard for 30 years. But 2017 was far from standard: A large portion of our gain did not come from anything we accomplished at Berkshire.”
The $65 billion gain is nonetheless real – rest assured of that. But only $36 billion came from Berkshire’s operations. The remaining $29 billion was delivered to us in December when Congress rewrote the U.S. Tax Code attributed roughly $29.11 billion of its net income to the reduction of the U.S. corporate tax rate, to 21 percent from 35 percent, that President Donald Trump signed into law in December.”
Next, on the increasingly sensitive topic of Berkshire’s mounting cash pile – which as discussed yesterday is invested mostly in Treasury bills – it grew to $116 billion at year-end, up from $109 billion in the third quarter.
* * *
First a few thoughts on what was not discussed in the letter: the most notable omission appears to be the lack of succession discussion – which is particularly notable given yesterday’s news that Buffett would retire from the board of Kraft Heinz.
Last month, Buffett elevated Ajit Jain and Greg Abel – the two most likely candidates to succeed Buffett and Charlie Munger atop the Berkshire Hathaway hierarchy – to vice chairmen, which the financial press widely interpreted as a signal that Buffett was toying with retirement.
Other things missing: any discussion on Wells Fargo, the recently announced Bezos-Buffett-Dimon employee health plan, Buffett’s traditional American bullishness… oh, and bitcoin.
* * *
Before moving on to discuss his company’s performance in greater detail, Buffett advised readers about a change in GAAP that could lead to significant distortions in Berkshire’s numbers:
After stating those fiscal facts, I would prefer to turn immediately to discussing Berkshire’s operations. But, in still another interruption, I must first tell you about a new accounting rule – a generally accepted accounting principle (GAAP) – that in future quarterly and annual reports will severely distort Berkshire’s net income figures and very often mislead commentators and investors.
The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period.
Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance. For analytical purposes, Berkshire’s “bottom-line” will be useless. The new rule compounds the communication problems we have long had in dealing with the realized gains (or losses) that accounting rules compel us to include in our net income. In past quarterly and annual press releases, we have regularly warned you not to pay attention to these realized gains, because they – just like our unrealized gains – fluctuate randomly.
That’s largely because we sell securities when that seems the intelligent thing to do, not because we are trying to influence earnings in any way. As a result, we sometimes have reported substantial realized gains for a period when our portfolio, overall, performed poorly (or the converse).
As Buffett points out, coverage of corporate earnings releases is often instantaneous, with media reports focusing on the year-over-year change in GAAP net income. Buffett said he would try to alleviate this problem by methodically explaining how the company’s per-share earning power – the key metric that he and Munger use to evaluate the company’s performance – changed during the quarter, and also by continuing their longtime practice of releasing earnings reports late Friday or early Saturday, when markets are closed – allowing investors more time to digest the material.
Acquisitions:
Addressing a topic near and dear to the company’s shareholders, Buffett lamented the lack of well-priced acquisition opportunities and reiterated his advice that individuals should avoid debt and invest passively. He also said that Berkshire needs to make “one or more huge acquisitions” to increase Berkshire Hathaway earnings, but admitted that finding a deal at “a sensible purchase price” has become a challenge.
“Prices for decent, but far from spectacular, businesses hit an all-time high” in 2017, preventing Berkshire from spending more cash on acquisitions, Buffett said, fondling his $116BN. “Our smiles will broaden when we have redeployed Berkshire’s excess funds into more productive assets.”
Buffett said that a debt-fueled “purchasing frenzy” binge by deal-hungry chief executives is making that task very difficult. “Price seemed almost irrelevant to an army of optimistic purchasers,” Buffett said. “The ample availability of extraordinarily cheap debt in 2017 further fueled purchase activity.”
In terms of M&A activity, Berkshire was notably inactive during 2017, largely thanks to one recurring factor: Buffett’s inability to find sensibly-valued companies:
While the rest of the world embarked on an M&A frenzy fueled by cheap debt and the incessant cheerleading of investment bankers, Buffett says he and Munger sleep well at night because of their aversion to taking on debt.
As Buffett says, it’s foolish to risk what you have – and something you need – for something you don’t.
In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price.
That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.
Why the purchasing frenzy? In part, it’s because the CEO job self-selects for “can-do” types. If Wall Street analysts or board members urge that brand of CEO to consider possible acquisitions, it’s a bit like telling your ripening teenager to be sure to have a normal sex life.
Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint. The ample availability of extraordinarily cheap debt in 2017 further fueled purchase activity.
After all, even a high-priced deal will usually boost per-share earnings if it is debt-financed. At Berkshire, in contrast, we evaluate acquisitions on an all-equity basis, knowing that our taste for overall debt is very low and that to assign a large portion of our debt to any individual business would generally be fallacious (leaving aside certain exceptions, such as debt dedicated to Clayton’s lending portfolio or to the fixed-asset commitments at our regulated utilities). We also never factor in, nor do we often find, synergies.
Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need. We held this view 50 years ago when we each ran an investment partnership, funded by a few friends and relatives who trusted us. We also hold it today after a million or so “partners” have joined us at Berkshire.
Berkshire’s one notable deal was the purchase of a 38.6% partnership interest in truck stop operator Pilot Flying J, which Buffett describes as “far and away the nation’s leading travel-center operator.” Berkshire, Buffett explains, is obligated to increase its partnership interest to 80% in 2023.
* * *
Check back for updates…
Read the report in its entirety below (pdf link):
via Zero Hedge http://ift.tt/2GHO9QZ Tyler Durden