Berkshire Hathaway Inc. (BRK.A) released its 2020 annual report on Feb. 27, 2021, and the letter to shareholders from Chair Warren Buffett contains items of interest to Berkshire shareholders and the general investing public alike. Investopedia studied this letter and found five observations by Buffett that should be of particular interest, as summarized below.
- Warren Buffett wrote in his annual letter to shareholders that Berkshire Hathaway was not able to "acquire large and favorably situated businesses" or increase its operating earnings in 2020.
- However, Berkshire's per-share intrinsic value increased during the year due to share repurchasing and retained earnings.
- Buffett admits to paying too much for metal manufacturing company Precision Castparts in 2016, which led to an $11 billion write-down in 2020.
- Buffett writes that, unlike many conglomerates, Berkshire doesn't need to own a controlling interest in a company because "a non-controlling portion of a wonderful business is more profitable, more enjoyable and far less work than struggling with 100% of a marginal enterprise."
- Berkshire Hathaway's top four most valuable assets include its property/casualty insurance operation, its 5.4% ownership of Apple, its 100% ownership of BNSF Railway, and its 91% ownership of Berkshire Hathaway Energy.
Two Goals Berkshire Did Not Meet
Buffett begins his annual letter with a quick rundown of Berkshire's performance in 2020. According to generally accepted accounting principles (GAAP), the company earned $42.5 billion for the year. This amount included realized capital gains of $4.9 billion and an increase in the amount of net unrealized capital gains from stocks held of $26.7 billion.
Operating earnings came in at $21.9 billion. While a sizeable segment of income, this amount did not meet the company's goals, which Buffett highlighted in his letter:
Operating earnings are what count most, even during periods when they are not the largest item in our GAAP total. Our focus at Berkshire is both to increase this segment of our income and to acquire large and favorably-situated businesses. Last year, however, we met neither goal: Berkshire made no sizable acquisitions and operating earnings fell 9%.
Importance of Retained Earnings
Despite a drop in operating earnings, the company did increase its per-share intrinsic value in 2020 by repurchasing approximately 5% of its shares and by retaining earnings. While retained earnings are not recorded in Berkshire's income under GAAP rules, they can benefit shareholders in the long term as they enable companies to expand and over time become more profitable.
What’s out of sight, however, should not be out of mind: Those unrecorded retained earnings are usually building value—lots of value—for Berkshire. Investees use the withheld funds to expand their business, make acquisitions, pay off debt, and often to repurchase their stock (an act that increases our share of their future earnings). As we pointed out in these pages last year, retained earnings have propelled American business throughout our country’s history. What worked for Carnegie and Rockefeller has, over the years, worked its magic for millions of shareholders as well.
In 2020, Berkshire Hathaway spent $24.7 billion to repurchase shares, an action that Warren Buffett says increased shareholders' ownership in all of the company's businesses by 5.2%.
Buffett Explains $11 Billion Loss
In 2020, Berkshire Hathaway took what Buffett calls "an ugly $11 billion write-down." The loss stems from the 2016 purchase Berkshire made when it bought metal manufacturing company Precision Castparts.
Buffett admits to paying too much for the company and being too optimistic about the firm's profit potential. The miscalculation became apparent during the pandemic when business from Precision Castparts' aerospace industry customers fell short of expectations.
Still, Buffett calls Precision Castparts a fine company with a strong manager. He believes the firm will "over time earn good returns on the net tangible assets deployed in its operations."
Not a Traditional Conglomerate
Buffett often uses his shareholder letters to go beyond simply detailing the company's previous year's performance. He shares insights that distill a lifetime of successful investing knowledge into compelling stories and anecdotes. This year is no exception. Buffett writes in great detail about the struggles and triumphs faced by the founders of several Berkshire companies.
Buffett's admiration for the managerial prowess of these founders is evident in this year's letter. So is his strategy of investing in companies that already have strong managers in place and then stepping back to let them do their jobs. According to Buffett, this hands-off approach has been key to building Berkshire as a non-traditional conglomerate.
Charlie and I want our conglomerate to own all or part of a diverse group of businesses with good economic characteristics and good managers. Whether Berkshire controls these businesses, however, is unimportant to us. It took me a while to wise up. But Charlie—and also my 20-year struggle with the textile operation I inherited at Berkshire—finally convinced me that owning a non-controlling portion of a wonderful business is more profitable, more enjoyable and far less work than struggling with 100% of a marginal enterprise.
Berkshire Hathaway owns American-based property, plant, and equipment (PP&E) with a depreciated cost valuation of $154 billion—a valuation exceeding the amount owned by any other U.S. company.
Berkshire's Big Four
Buffett identified what he calls "the family jewels," the four businesses where most of Berkshire's value resides. Their property/casualty insurance operation—which they've been building for over 53 years—is the company's largest in value. Buffett points out that the access to capital is a competitive advantage their insurance operation has over its rivals:
Overall, the insurance fleet operates with far more capital than is deployed by any of its competitors worldwide. That financial strength, coupled with the huge flow of cash Berkshire annually receives from its non-insurance businesses, allows our insurance companies to safely follow an equity-heavy investment strategy not feasible for the overwhelming majority of insurers.
Buffett ranks the second and third most valuable assets as a tossup between Berkshire's 5.4% ownership of Apple Inc (AAPL) and its 100% ownership of America's largest railroad, BNSF Railway Company. In the U.S., BNSF is responsible for carrying approximately 15% of all non-local ton-miles of transported goods. Since its acquisition in 2010, BNSF has paid Berkshire $41.8 billion in dividends.
Rounding out the big four is a 91% ownership of the utility business Berkshire Hathaway Energy. While the company pays no dividends on its stock, Buffett believes shareholders will reap future rewards as the company positions itself to be a leader in renewable and cleaner energy. Berkshire Hathaway Energy and BNSF Railway had a combined earnings of $8.3 billion in 2020. While both companies will require major capital expenditures over the coming decades, Buffett anticipates the firms will deliver investors "appropriate returns on the incremental investment."