Berkshire Hathaway Inc. (NYSE: BRK-A) has released its annual report, and the results from the fourth quarter are putting dark clouds over Warren Buffett’s annual letter to shareholders. Berkshire Hathaway’s shares have been underperforming the broader market of late. And some big losses in the key stocks have not helped matters. At stake here was much more than just an earnings report for Berkshire Hathaway. There are some big changes that Buffett watchers should take note of.
Buffett has warned shareholders for years that the company’s book value per share matters to him much more than any quarterly or annual earnings per share results. He has pointed to the initial paragraph opening about book value per share for nearly three decades, but the 2018 report says that it’s now time to abandon that practice as the metric has lost the relevance it once had. Buffett’s annual letter, which was very difficult to get because the Berkshire Hathaway website couldn’t handle the traffic, said in bold: “Focus on the Forest – Forget the Trees.”
Investors need to be paying attention to what is happening inside Berkshire Hathaway’s investment portfolio to get a feel for what’s happening here. This week’s major bombshell report from Kraft Heinz Co. (NASDAQ: KHC) helped create a 2% loss on Friday, despite the broader market rally, as Berkshire Hathaway is a huge shareholder, along with 3G. Buffett and his team also had taken a beating on Apple Inc. (NASDAQ: AAPL), and Buffett gradually has pared down his massive stake in Wells Fargo & Co. (NYSE: WFC) and adding in additional stakes of Bank of America Corp. (NYSE: BAC), JPMorgan Chase & Co. (NYSE: JPM) and other large banks. Unfortunately, Buffett’s famous stock holdings took a beating with the market in late 2018, with his 13F filing with the SEC (the Buffett stocks) having a $221 billion balance as of September 30, 2018 — dropping down to $183 billion as of December 31, 2018.
Of the top equity holdings by gains, Berkshire Hathaway’s 2018 year-end balances were impressive, and it’s one reason that Buffett has been considered one of the greatest long-term investors of the modern era. Those 15 positions (from dozens of overall equity positions) had a purchase value of $102.867 billion and a marketable value at the end of 2018 as $172.757 billion.
Before getting into the tempo of Buffett’s annual letter to shareholders, it’s important to consider some issues from the earnings report. Berkshire Hathaway’s fourth quarter of 2018 brought a net loss attributable to shareholders of $25.392 billion, versus fourth quarter of 2017 earnings of $32.551 billion. And for all of 2018, Berkshire Hathaway’s net income was just $4.021 billion, compared with net income of $44.94 billion for all of 2017.
To show just how much the investments dragged down the numbers here, note that Berkshire Hathaway’s operating earnings from its actual companies and subsidiaries was $5.72 billion in the fourth quarter of 2018, versus $3.338 billion for the fourth quarter of 2017. And the annual numbers were better on operating earnings as well, with operating income of $24.781 billion in 2018 over $14.457 billion in 2017. Again, it’s the huge stock holdings as a drag. The earnings report even said:
In the table (above), investment gains (losses) in 2018 include losses of approximately $28.5 billion in the fourth quarter and approximately $20.6 billion for the full year of 2018 from a reduction in the amount of unrealized gains that existed in our equity security investment holdings and are net of taxable gains on sales of investments of approximately $460 million in the fourth quarter and approximately $2.8 billion for the full year. In 2017 and in prior years, while changes in unrealized gains/losses were reflected in our shareholders’ equity, they were not included in our earnings statements.
Now it’s time to get back to focusing on the forest and forgetting the trees in Buffett’s annual letter to shareholders.
On why the book value metric is being abandoned, or at least the public communication that the rationale, Buffett is communicating that Berkshire Hathaway has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Two additional reasons:
While our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years. … [And] it is likely that – over time – Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value.