Strong Buffett 2013 Annual Report, Yet Book Value Not Keeping Up With Stock

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Warren Buffett has released the highly anticipated Annual Report for Berkshire Hathaway Inc. (NYSE: BRK-A), which also contains the highly visible Annual Letter to Shareholders. Buffett is often considered the greatest investor of modern times. What stands out, despite the stock’s strong performance, is another year where the book value growth is simply not keeping up with the stock price.

For starters, Berkshire Hathaway’s gain in net worth was $34.2 billion in 2013, and the book value per share rose by 18.2% to $134,973 per share (from $114,214 at the end of 2012). Berkshire Hathaway did not repurchase shares in 2013 because it did not reach the 120% of intrinsic value threshold.

Berkshire Hathaway’s share price ended 2013 at $177,900.00 versus $134,060.00 at the end of 2012. That is a share price gain of 32.7%. While Buffett keeps talking about the gains in intrinsic value, the raw math simply shows one conclusion – Berkshire’s share price rose by 32.7% in 2013, but the book value rose by 18.2%.

At the end of 2012, we had observed that Berkshire Hathaway’s book value grew by 14.4% and that the stock price premium to book value was 17.4%. At the end of 2013, Berkshire Hathaway’s premium was a whopping 31.8%. That being said, we observed in the full Buffett stock holdings for 2014 that the public stock holdings had reached a value of $104.8 billion – the first time we have seen this over $100 billion.

Again, Buffett talks up intrinsic value as the real yardstick. After all, he is not going to give short sellers and critics a reason to bash him. Berkshire Hathaway purchased additional shares of Wells Fargo & Co. (NYSE: WFC) to a 9.2% stake versus 8.7% a year earlier, and International Business Machines Corp. (NYSE: IBM) to a 6.3% stake versus 6.0%. Exxon Mobil Corp. (NYSE: XOM) is far from being one the “Big Four” holdings, but that may change in time.

Buffett explained the shortfall against the broad market. He said, “Charlie Munger, Berkshire’s vice chairman and my partner, and I believe both Berkshire’s book value and intrinsic value will outperform the S&P in years when the market is down or moderately up. We expect to fall short, though, in years when the market is strong – as we did in 2013. We have underperformed in ten of our 49 years, with all but one of our shortfalls occurring when the S&P gain exceeded 15%.”

In 2013, Berkshire Hathaway’s total assets rose to $484.931 billion, up 13.4% from the $427.452 billion at the end of 2013. Total year-end liabilities in 2013 were $260.446 billion, up 10.4% from $235.864 billion in 2012.

Berkshire Hathaway earned $3,035 per share in the fourth quarter, but the adjusted earnings per share was $2,297. Net income was $4.99 billion. Berkshire’s insurance float increased to $77 billion in 2013.

More highlights include:

  • Berkshire spent almost $18 billion to purchase all of NV Energy and a major interest in H. J. Heinz, and it would like to purchase more of Heinz if the 3G partners ever want to sell. With Heinz, “Berkshire now owns 8 1⁄2 companies that, were they stand-alone businesses, would be in the Fortune 500. Only 491 1⁄2 to go.”
  • New portfolio managers Todd Combs and Ted Weschler handily outperformed the S&P 500 in 2013. Each now runs a portfolio exceeding $7 billion. “They’ve earned it. I must again confess that their investments outperformed mine. (Charlie says I should add “by a lot.”) If such humiliating comparisons continue, I’ll have no choice but to cease talking about them. Todd and Ted have also created significant value for you in several matters unrelated to their portfolio activities. Their contributions are just beginning: Both men have Berkshire blood in their veins.”
  • Berkshire’s year-end employment (counting Heinz) went up 42,283 to a record 330,745 in 2013. Buffett joked, “The increase, I must admit, included one person at our Omaha home office. (Don’t panic: The headquarters gang still fits comfortably on one floor.)”
  • The company promised to always maintain supreme financial strength, operating with at least $20 billion of cash equivalents and never incurring material amounts of short-term obligations.
  • On utilities: “MidAmerican’s utilities serve regulated retail customers in eleven states. No utility company stretches further. In addition, we are the leader in renewables: From a standing start nine years ago, MidAmerican now accounts for 7% of the country’s wind generation capacity, with more on the way. Our share in solar – most of which is still in construction – is even larger.” MidAmerican earnings rose to $1.636 billion in 2013 from $1.47 billion in 2012.
  • On the railroad: “BNSF carries about 15% (measured by ton-miles) of all inter-city freight, whether it is transported by truck, rail, water, air, or pipeline. Indeed, we move more ton-miles of goods than anyone else, a fact establishing BNSF as the most important artery in our economy’s circulatory system. Its hold on the number-one position strengthened in 2013.” 2013 earnings of BNSF rose to $3.793 billion from $3.372 billion a year earlier, and revenue rose to $22.014 billion from $20.835 billion.
  • On taxes: the annual report claims that Berkshire files a 23,000-page Federal income tax return.

Lastly, for the M&A readers, Berkshire Hathaway’s acquisition criteria is as follows:

  • (1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),
  • (2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
  • (3) Businesses earning good returns on equity while employing little or no debt,
  • (4) Management in place (we can’t supply it),
  • (5) Simple businesses (if there’s lots of technology, we won’t understand it),
  • (6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).
  • The larger the company, the greater will be our interest: We would like to make an acquisition in the $5-20 billion range. We are not interested, however, in receiving suggestions about purchases we might make in the general stock market. We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast answer – customarily within five minutes – as to whether we’re interested. We prefer to buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give. We don’t participate in auctions. Charlie and I frequently get approached about acquisitions that don’t come close to meeting our tests: We’ve found that if you advertise an interest in buying collies, a lot of people will call hoping to sell you their cocker spaniels. A line from a country song expresses our feeling about new ventures, turnarounds, or auction-like sales: “When the phone don’t ring, you’ll know it’s me.”