Warren Buffett’s 2021 Letter to Shareholders: ‘Never Bet Against America’
Warren Buffett released his eagerly anticipated annual letter to shareholders today, something the 90 year old has done for six decades. Two of the takeaways in a year like no other are that his steadfast motto of holding steady is still key to investing, and that despite “severe interruptions in its history” and slow, “often discouraging” progress toward becoming a “more perfect union,” “never bet against America.”
The Oracle of Omaha’s Berkshire Hathaway earned $42.5 billion in 2020, according to the letter. This includes $21.9 billion of operating earnings, $4.9 billion of realized capital gains, a $26.7 billion gain from an increase in the amount of net unrealized capital gains and an $11 billion loss from a write-down in the value of a few subsidiary and affiliate businesses, according to the letter.
“As the COVID-19 pandemic accelerated beginning in the second half of March, most of our businesses were negatively affected, with the effects to date ranging from relatively minor to severe,” Buffett says in the letter.
He adds that revenues and earnings of most of Berkshire’s manufacturing, service and retailing businesses “declined considerably, and in certain instances severely, in the second quarter due to closures of facilities where crowds gather, such as retail stores, restaurants and entertainment venues as well as from public travel restrictions and from closures of certain of our businesses.”
However, in each of the third and fourth quarters of 2020, several of these businesses experienced significant increases in revenues and earnings as compared to the second quarter, he says. Berkshire’s businesses implemented various business continuity plans to protect employees and customers, including, temporarily closing certain retail stores and manufacturing facilities. Berkshire also implemented practices including work-from-home, staggered or reduced work schedules, increased cleaning and sanitation of workspaces, providing employee health screenings, eliminating non-essential travel and face-to-face meetings and providing general health reminders intended to lower the risk of spreading COVID-19, he says.
In terms of the loss Berkshire reported, which Buffett calls “that ugly $11 billion write-down,” he says that it is almost entirely the quantification of a mistake he made in 2016. “That year, Berkshire purchased Precision Castparts (‘PCC’), and I paid too much for the company. No one misled me in any way — I was simply too optimistic about PCC’s normalized profit potential. Last year, my miscalculation was laid bare by adverse developments throughout the aerospace industry, PCC’s most important source of customers.”
“In purchasing PCC, Berkshire bought a fine company — the best in its business. Mark Donegan, PCC’s CEO, is a passionate manager who consistently pours the same energy into the business that he did before we purchased it. We are lucky to have him running things. I believe I was right in concluding that PCC would, over time, earn good returns on the net tangible assets deployed in its operations. I was wrong, however, in judging the average amount of future earnings and, consequently, wrong in my calculation of the proper price to pay for the business. PCC is far from my first error of that sort. But it’s a big one,” he says.
Buffett also addresses the fact that Berkshire is often labeled a conglomerate, “a negative term applied to holding companies that own a hodge-podge of unrelated businesses.” Over time, he says, conglomerates have generally limited themselves to buying businesses in their entirety, a problematic strategy as “most of the truly great businesses had no interest in having anyone take them over.”
“Consequently, deal-hungry conglomerateurs had to focus on so-so companies that lacked important and durable competitive strengths. That was not a great pond in which to fish. Beyond that, as conglomerateurs dipped into this universe of mediocre businesses, they often found themselves required to pay staggering ‘control’ premiums to snare their quarry. Aspiring conglomerateurs knew the answer to this ‘overpayment’ problem: They simply needed to manufacture a vastly overvalued stock of their own that could be used as a ‘currency’ for pricey acquisitions. (‘I’ll pay you $10,000 for your dog by giving you two of my $5,000 cats.’).” In turn, when these tricks were successful, “the conglomerate pushed its own stock,” Buffett writes.
“Investing illusions can continue for a surprisingly long time. Wall Street loves the fees that deal-making generates, and the press loves the stories that colorful promoters provide. At a point, also, the soaring price of a promoted stock can itself become the ‘proof’ that an illusion is reality. Eventually, of course, the party ends, and many business ’emperors’ are found to have no clothes. Financial history is replete with the names of famous conglomerateurs who were initially lionized as business geniuses by journalists, analysts and investment bankers, but whose creations ended up as business junkyards,” Buffett notes.
Buffett adds that it took him a while “to wise up.”
“Our conglomerate will remain a collection of controlled and non-controlled businesses. Charlie and I will simply deploy your capital into whatever we believe makes the most sense, based on a company’s durable competitive strengths, the capabilities and character of its management, and price. If that strategy requires little or no effort on our part, so much the better. In contrast to the scoring system utilized in diving competitions, you are awarded no points in business endeavors for ‘degree of difficulty.’ Furthermore, as Ronald Reagan cautioned: ‘It’s said that hard work never killed anyone, but I say why take the chance?'”
Regarding his investors, Buffett says he feels a special kinship with “the million-plus individual investors who simply trust us to represent their interests, whatever the future may bring. They have joined us with no intent to leave, adopting a mindset similar to that held by our original partners.”
Buffett tells the story of one of the veteran investors, Stan Truhlsen, “a cheerful and generous Omaha ophthalmologist as well as personal friend, who turned 100 on November 13, 2020.” In 1959, Stan, along with 10 other Omaha doctors, formed a partnership with Buffett, Emdee, Ltd.
“Annually, they joined my wife and me for a celebratory dinner at our home. When our partnership distributed its Berkshire shares in 1969, all of the doctors kept the stock they received. They may not have known the ins and outs of investing or accounting, but they did know that at Berkshire they would be treated as partners. Two of Stan’s comrades from Emdee are now in their high-90s and continue to hold Berkshire shares. This group’s startling durability — along with the fact that Charlie and I are 97 and 90, respectively — serves up an interesting question: Could it be that Berkshire ownership fosters longevity?”
Of course, Buffett is also addressing matters of succession, and he says that he hopes that while “some turnover in partners will occur,” he hopes it will be minimal. “Who, after all, seeks rapid turnover in friends, neighbors or marriage?” Buffett asks. He says that when seats open up at Berkshire, he wants them to be occupied by newcomers who understand and desire what the company offers. “After decades of management, Charlie [Munger] and I remain unable to promise results. We can and do, however, pledge to treat you as partners. And so, too, will our successors,” he says.
He also reiterates what makes his investment style so unique: patience and holding still.
He quotes the 1958 Phil Fisher book on investing, in which the author analogized running a public company to managing a restaurant. Buffett explains that in essence, Fisher said that “if you are seeking diners, you can attract a clientele and prosper featuring either hamburgers served with a Coke or a French cuisine accompanied by exotic wines. But you must not, Fisher warned, capriciously switch from one to the other: Your message to potential customers must be consistent with what they will find upon entering your premises. At Berkshire, we have been serving hamburgers and Coke for 56 years. We cherish the clientele this fare has attracted,” he says.
Buffett acknowledges other investment styles, saying that investors will always find an array of CEOs and market gurus “with enticing ideas,” as well as “technicians” instructing them as to “what some wiggles on a chart portend for a stock’s next move.” He says that many of these investors will do quite well as after all, ownership of stocks is very much a “positive-sum” game.
“Indeed, a patient and level-headed monkey, who constructs a portfolio by throwing 50 darts at a board listing all of the S&P 500, will — over time — enjoy dividends and capital gains, just as long as it never gets tempted to make changes in its original ‘selections,'” Buffett says.
Another big lesson in his letter is to “never bet against America.” Buffett says that while much of finance, media, government and tech is located in coastal areas, it’s easy to overlook the many miracles occurring in middle America.
“In its brief 232 years of existence…there has been no incubator for unleashing human potential like America. Despite some severe interruptions, our country’s economic progress has been breathtaking. Beyond that, we retain our constitutional aspiration of becoming ‘a more perfect union.’ Progress on that front has been slow, uneven and often discouraging. We have, however, moved forward and will continue to do so. Our unwavering conclusion: Never bet against America.”
Regarding what Buffett calls the family jewels, where most of Berkshire’s value resides, they are in four businesses: three controlled and one in which Berkshire has only a 5.4% interest. “The largest in value is our property/casualty insurance operation, which for 53 years has been the core of Berkshire.” Unlike its competitors, which, for “both regulatory and credit-rating reasons, must focus on bonds.” Berkshire doesn’t.
“Bonds are not the place to be these days…Fixed-income investors worldwide — whether pension funds, insurance companies or retirees — face a bleak future. Some insurers, as well as other bond investors, may try to juice the pathetic returns now available by shifting their purchases to obligations backed by shaky borrowers,” Buffett says.
The second and third most valuable assets are “Berkshire’s 100% ownership of BNSF, America’s largest railroad measured by freight volume, and our 5.4% ownership of Apple. And in the fourth spot is Berkshire’s 91% ownership of Berkshire Hathaway Energy,” which Buffett calls a “very unusual utility business, whose annual earnings have grown from $122 million to $3.4 billion during our 21 years of ownership.”
Berkshire’s 15 largest investments include AbbVie, American Express, Apple, Bank of America, Bank of New York Mellon, Charter Communications, Chevron, Coca-Cola, General Motors, Itochu, Merck & Co., Moody’s, U.S. Bancorp and Verizon. Chevron and Verizon were revealed as Berkshire’s two new major investment moves earlier this month, when the company released its stock investments.
Berkshire will hold its annual gala virtually on May 1st, in Los Angeles, where Buffett and Munger will answer viewer questions. Better yet, Buffett writes, “will be the day when we see you face to face. I hope and expect that will be in 2022.”
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