Warren Buffett’s Shareholder Letter 2015

Warren Buffett published his shareholders letter on 27 February of this year. They are usually full of words of wisdom on how to grow your wealth and invest. Last year, I had to break his shareholders letter into two separate blogs. This year, there will be no such problem and I must say, I was a little bit disappointed in the quality of his letter. No words of wisdom jumped out at me like it has in previous years. There were a couple of themes that stood out this year.

The accountant’s way of valuing a company

Throughout the letter, Buffett refers to to difficulty in valuing a business.

Though we sold no Kraft Heinz shares, “GAAP” (Generally Accepted Accounting Principles) required us to record a $6.8 billion write-up of our investment upon completion of the merger. That leaves us with our Kraft Heinz holding carried on our balance sheet at a value many billions above our cost and many billions below its market value, an outcome only an accountant could love.

As much as Charlie and I talk about intrinsic business value, we cannot tell you precisely what that number is for Berkshire shares (nor, in fact, for any other stock)

A partial offset to this overstated liability is a $15.5 billion “goodwill” asset that we incurred in buying our insurance companies and that increases book value…The cost of the goodwill, however, has no bearing on its true value.

Last year, for example, in a disappointing year for railroads, BNSF’s interest coverage was more than 8:1. (Our definition of coverage is the ratio of earnings before interest and taxes to interest, not EBITDA/ interest, a commonly used measure we view as seriously flawed.)

Serious investors should understand the disparate nature of intangible assets. Some truly deplete in value over time, while others in no way lose value. For software, as a big example, amortization charges are very real expenses. Conversely, the concept of recording charges against other intangibles, such as customer relationships, arises from purchase-accounting rules and clearly does not reflect economic reality. GAAP accounting draws no distinction between the two types of charges. Both, that is, are recorded as expenses when earnings are calculated – even though, from an investor’s viewpoint, they could not differ more.

There is plenty more in his letter as he slates the accounting methods used in doing the annual accounts for a company. As investors, we cannot just take the accounts for face value (look at Enron and mark to market) or accept just one method of valuing a company. We must look at a number of different methods and look under the bonnet and make sure it represents good value.

Productivity and Prosperity

Increase productivity and you will increase prosperity. Buffett goes on to give the example of output of corn. In 1900, corn was grown on 90 million acres, producing 2.7 billion bushels annually. Today, corn is grown on 85 millions acres, producing 13-14 billion bushels annually. He goes on to give a number of other examples of increased productivity and how it has resulted in greater benefits to society.

He does acknowledge a downside:

  • The productivity gains achieved in recent years have largely benefitted the wealthy.
  • Second, productivity gains frequently cause upheaval: Both capital and labor can pay a terrible price when innovation or new efficiencies upend their worlds.

Buffett has no sympathy for the wealthy who benefit. It’s the capitalist “job to take care of themselves”. When you invest, you get the full benefit of the upside and as such should not be protected against the losses if you make wrong choices. If you have a diversified portfolio and don’t constantly buy and sell, you’ll do alright.

For the workers who suffer from increased productivity (which usually means a human’s job becomes automated), he believes there should be a variety of safety nets in places to help those who are willing to work. The price of achieving ever-increasing prosperity for the great majority of Americans should not be penury for the unfortunate.

If you have any questions, send me an email at steven@bluewaterfp.ie