The Berkshire Hathaway Annual Report
Despite four Hurricanes and an almost one billion dollar loss to
their foreign currency position, Berkshire still had a pretty good
year.
From the Chairman's Letter,
"In 2004 our float cost us less than nothing, and I told you that
we had a chance—absent a mega-catastrophe—of no-cost float in 2005.
But we had the mega-cat, and as a specialist in that coverage,
Berkshire suffered hurricane losses of $3.4 billion. Nevertheless,
our float was costless in 2005 because of the superb results we had
in our other insurance activities, particularly at GEICO."
In other words they just went thought the worst hurricane season
in history and still had an underwriting profit. How can that be
bad?
"So guided, we've concluded that we should now write mega-cat
policies only at prices far higher than prevailed last year - and
then only with an aggregate exposure that would not cause us
distress if shifts in some important variable produce far more
costly storms in the near future."
Notice particularly the "far higher" in the above paragraph and
dream a little about what will appear on Berkshire's bottom line if
we have another year like 2002 and 2003 that were mega-cat free.
As far as the intellectual content of the chairman's letter, I found
it to be one of the best, if not the best, of the 29 or so that I
have read. Four things that I liked best are:
- "Ratchet, Ratchet and Bingo" the fictional consulting firm that
receives "gobs of cash" for ill-designed compensation agreements.
The name is so outrageously funny and cunningly accurate that I will
never read another financial statement without thinking about
"Ratchet, Ratchet and Bingo!"
- "Fred Futile" the CEO of "Stagnant, Inc." who uses option
agreements and stock buybacks to receive $159 million for doing
nothing for ten years. These examples so clearly explain the
problems caused by stock options and buybacks that no investor can
afford not read and understand this passage.
- "Hyper-Helpers" or how Hedge Funds and Private Equity Funds will
inevitably lead to lower net returns for investors. The problem for
investors—if you do not know how to pick a good stock how are you
going to be smart enough to pick a good manager?
- Underlying the whole letter is an ominous undertone that many investors will ignore, but will surely bring us much grief. He again writes about his difficulties with Gen Re's Derivatives portfolio (the man who tries to carry a cat home by its tail). Berkshire has spent $404 million and five years trying to liquidate a small portfolio. Yet we now live in a world populated with contracts like these whose notational value now runs into the hundreds of trillions of dollars. This section along, with the piece about the dollar imbalance you can read between the lines and see that while Buffett is bullish about the future of Berkshire Hathaway he is clearly very bearish about the equity and bond markets.
Earnings Example—The Bad Stuff
Few people on Wall Street, and apparently some of the resident
heretics on this board, understand what a truly conservative animal
Warren Buffett is. When he presents an annual report, he tells us
all the bad news and lets us will figure out the good news for
ourselves.
In order to demonstrate this point I would like to present
Berkshire's 2005 earnings as they would have been presented if Fred
Futile (the guy who hires Ratchet, Ratchet and Bingo to set up his
option agreement) was the CEO.
First of all we have all of these one time charges, like hurricane
losses and currency losses. Sure they are loses, but they do not
happen every year so Fred would want to do a pro forma to show Wall
Street what the numbers would have looked like if all those bad
things had not happened.
(Earnings example: bad things)
Bad Things
- Hurricanes losses = $3.500 billion.
- Currency Losses = $955 million
- Gen Re Derivatives losses = $104 million
- Med Pro Reserve Strengthening = $125 million
Total one time Bad Things = $4.684 billion or 3.045 billion after
tax
So with a little accounting magic we have transformed Berkshires
Reported Earnings of $8,528 billion into a pro forma of $11.573
billion or $7,519.81 per share.
Look Through Earnings
On the next page is a table for Berkshire's 2005 look-though
earnings; this is the company's operating earnings plus their share
of the undistributed earning of the companies whose common stock
Berkshire owns.
I have added Diageo to the list even though the only support I have
for this position is an article from the US News – a source
which is not necessarily that reliable. They claim Berkshire filed a
report with an insurance board showing a 15 million share holding of
Diageo as of September 30, 2006. The problem is the article did not
say what kind of shares. I am showing data for the ADR but after
reading Buffett's letter, I would guess that if they own Diageo,
they are holding the local (foreign) shares. From the letter:
"We reduced our direct position in currencies somewhat during 2005.
We partially offset this change, however, by purchasing equities
whose prices are denominated in a variety of foreign currencies and
that earn a large part of their profits internationally. Charlie and
I prefer this method of acquiring non-dollar exposure."
The annual report lists equity positions of $46.721 billion, whereas
the total listed on the last 13f was $42.664 billion. The difference
has to be stuff from the confidential list or securities that are
not listed with SEC and are therefore not listed on the 13f. About
$2 billion of this is Petrochina H shares which are foreign
securities. But if we assume that WESCO, which is listed on the 13F,
is not included in the equity total in the annual report because it
80% owned and is therefore consolidated into Berkshire's assets and
liabilities, then we still have $4+ billion in equities that are
missing and unaccounted for. My guess it that most of this is the
foreign equities that Warren is talking about above.
Some of these may have been around for a while but Berkshire
purchased $1.7 billion of equities in the fourth quarter. About $500
of that appeared on the latest 13f (mostly Wells Fargo) but the
remaining $1.2 billion could be part of Warren's "nondollar
exposure." Maybe this is more Diageo. Maybe it is some Korean steel.
Who knows? This is something we are likely to find out only when
Buffett decides to tell us.
Investment wise, last year was a good year, as Buffett managed to
outspend his cash flow for the first time since 2002. Net equity
investments totaled $6.4 billion, and acquisitions totaled $7.5
billion if you include PacifiCorp which will not close until this
year.
Berkshire Hathaway Look-though Earnings 2005
| Company | Shares Held | Earnings Per Share 2005 | Dividends Per Share 2005 | Undistributed Earnings/Share | Look-through Earnings |
|---|---|---|---|---|---|
| American Express | 151,610,000 | $3.090 | $0.480 | $2.610 | $395,702,100.00 |
| Amer Standard | 10,498,000 | $2.560 | $0.000 | $2.560 | $26,874,880.00 |
| Ameriprise Financial | 30,322,000 | $2.380 | $0.440 | $1.940 | $58,824,680.00 |
| Anheuser Busch | 43,854,000 | $1.640 | $0.500 | $1.140 | $49,993,560.00 |
| H&R Block Inc | 18,538,000 | $1.640 | $0.500 | $1.140 | $21,133,320.00 |
| Cadbury Schwepps | 10,000,000 | $0.600 | $0.910 | $2.540 | $25,400,000.00 |
| Coca Cola Co. | 200,000,000 | $2.040 | $1.120 | $0.920 | $184,000,000.00 |
| Comcast Corp | 11,110,000 | $0.420 | $0.000 | $0.420 | $4,666,200.00 |
| Comdisco | 1,519,000 | $0.000 | $0.000 | $0.000 | $0.00 |
| Costco Wholesale | 5,254,000 | $2.230 | $0.430 | $1.800 | $9,457,200.00 |
| Diageo | 15,000,000 | $3.370 | $1.660 | $1.710 | $25,650,000.00 |
| First Data Corp | 10,000,000 | $2.020 | $0.240 | $1.780 | $17,800,000.00 |
| Gannett Co. Inc. | 3,448,000 | $4.980 | $1.160 | $3.820 | $13,171,360.00 |
| Gap Inc | 15,000,000 | $1.210 | $0.090 | $1.120 | $16,800,000.00 |
| Home Depot | 5,000,000 | $2.590 | $0.600 | $1.990 | $9,950,000.00 |
| Iron Mountain Inc. | 3,949,000 | $0.840 | $0.000 | $0.840 | $3,317,160.00 |
| Lexmark | 3,000,000 | $2.910 | $0.000 | $2.910 | $8,730,000.00 |
| Loews Corp | 390,000 | $7.260 | $0.600 | $6.660 | $2,597,400.00 |
| M&T Bank Corp | 6,708,760 | $6.730 | $1.800 | $4.930 | $33,074,186.80 |
| Moody's Corporation | 48,000,000 | $1.840 | $0.280 | $1.560 | $74,880,000.00 |
| Mueller Industries | 785,000 | $2.490 | $0.400 | $2.090 | $1,640,650.00 |
| Nike | 2,475,000 | $5.060 | $1.240 | $3.820 | $9,454,500.00 |
| Outback Steak | 1,818,800 | $1.950 | $0.520 | $1.430 | $2,600,884.00 |
| Petrochina Co. ADR | 659,000 | $9.300 | $3.730 | $5.570 | $3,670,630.00 |
| Petrochina Co H | 2,273,061,000 | $0.093 | $0.037 | $0.056 | $127,291,416.00 |
| Pier 1 Imports | 3,290,000 | -$0.130 | $0.000 | -$0.130 | -$427,700.00 |
| Procter & Gamble | 100,000,000 | $2.680 | $1.120 | $1.560 | $156,000,000.00 |
| Sealed Air Corp | 995,000 | $2.190 | $0.600 | $1.590 | $1,582,050.00 |
| SunTrust | 3,205,000 | $5.470 | $2.440 | $3.030 | $9,711,150.00 |
| Tyco International | 10,000,000 | $1.360 | $0.400 | $0.960 | $9,600,000.00 |
| USG Corp | 6,500,000 | $7.270 | $0.000 | $7.270 | $47,255,000.00 |
| Wal-Mart Stores | 19,944,000 | $2.680 | $0.600 | $2.080 | $41,483,520.00 |
| Washington Post | 1,727,765 | $32.590 | $7.800 | $24.790 | $42,831,294.35 |
| Wells Fargo & Co. | 95,092,000 | $4.500 | $2.080 | $2.420 | $230,122,640.00 |
| Zenith National | 53,955 | $5.070 | $1.090 | $3.980 | $214,740.90 |
| Total Undistributed Investee Operating Earnings | $1,665,052,822.05 |
| Tax on Investee Earnings | -$249,757,923.31 |
| Berkshire Operating Earnings | $5,422,000,000.00 |
| Total Look-through Operating Earnings 2005 | $6,837,294,898.74 |
| Per Share | $4,453.09 |