On Buf­fett’s let­ter to share­hold­ers

Berk­shire Hath­away founder War­ren Buf­fett is not in favour of us­ing com­pany shares to buy as­sets. Si­mon Brown ex­plains why he agrees with this in­vest­ment guru.

Finweek English Edition - - MARKET PLACE - Ed­i­to­rial@fin­week.co.za War­ren Buf­fett’s full let­ter to Berk­shire Hath­away share­hold­ers can be ac­cessed here: http://bit.ly/2mhNP5b. The AGM we­b­cast will be ac­ces­si­ble at https://fi­nance.ya­hoo. com/brk­livestream from 7 May.

the last Satur­day of Fe­bru­ary is ea­gerly awaited by in­vestors around the world as it’s the day on which War­ren Buf­fett pub­lishes his an­nual let­ter to Berk­shire Hath­away share­hold­ers. (You can find it at berk­shire­hath­away.com, re­mem­ber you are look­ing for the 2016 let­ter as it is for their 2016 fi­nan­cial year-end.)

Fur­ther, the an­nual gen­eral meet­ing is be­ing we­b­cast on 7 May, so we can watch live with­out the long trek to visit Buf­fett’s home­town of Omaha, Ne­braska.

This lat­est let­ter in­cluded an up­date on his nearly decade-long bet that an S&P 500 in­dex tracker would beat a bas­ket of hedge funds. With just a year to go, the in­dex is miles ahead of the bas­ket of hedge funds, prov­ing his point about ex­ces­sive fees that kill re­turns, but also his point that ac­tive man­age­ment is very dif­fi­cult and re­turn af­ter costs are of­ten mod­est and be­low the mar­ket av­er­age.

He also dis­closed large hold­ings in Ap­ple and sev­eral US air­lines. Since the yearend, Berk­shire has also fur­ther in­creased its stake in Ap­ple. What is im­por­tant here is that Buf­fett has not been the one buy­ing ei­ther Ap­ple or the air­lines. He has two deputies (Todd Combs and Ted Weschler) who each man­age $10bn, and they have been buy­ing these stocks. Buf­fett fur­ther says that most times he only learns about the pur­chases when he reads the trades sheets at the end of the month. This is real trust and one of ei­ther Ted or Todd is likely to be his re­place­ment when he fi­nally leaves the CEO seat.

For me what stood out in this year’s let­ter were his com­ments on buy­ing as­sets us­ing shares in­stead of cash. His view is that if they buy as­sets us­ing Berk­shire shares, they end up pay­ing far more than the ac­tual price, as the new shares have a per­ma­nent claim on prof­its. Put more crudely – if you is­sue a share at, say, R100 to buy another com­pany, but the share price moves to R150, you have ef­fec­tively paid R150 for the com­pany and so it goes. For­ward say a decade or more, when the share is now worth R2 000 and War­ren Buf­fett, chair­man and chief ex­ec­u­tive of­fi­cer of Berk­shire Hath­away, plays ta­ble ten­nis on the side­lines of the Berk­shire Hath­away an­nual share­hold­ers’ meet­ing in Omaha, Ne­braska. pay­ing a div­i­dend of R100 per share. You’re now pay­ing full price for the com­pany you bought, but you’re pay­ing it ev­ery year in div­i­dends! (Buf­fett’s take on it: “To­day, I would rather prep for a colonoscopy than is­sue Berk­shire shares.”) I al­ways favour a com­pany us­ing debt to ac­quire other as­sets or busi­nesses, as debt is re­paid and there is no fur­ther obli­ga­tion. Now sure, some deals may sim­ply be too large to do ex­clu­sively with debt, but it seems al­most too easy for man­age­ment to run to the mar­ket for another rights is­sue or book build to raise the cash that di­lutes ex­ist­ing share­hold­ers. The one ex­cep­tion is per­haps if the com­pany’s share price is ab­surdly over­val­ued, then us­ing it to buy may not be the worst idea. But I re­main scep­ti­cal and al­ways pre­fer man­age­ment us­ing debt or even maybe start­ing by buy­ing, say, a 51% con­trol­ling stake for cash that they can in­crease over time. Buf­fett also crit­i­cises com­pa­nies that pub­lish “ad­justed” earn­ings that are bet­ter than the gen­er­ally ac­cepted ac­count­ing prin­ci­ples (GAAP) earn­ings. (GAAP is the US equiv­a­lent of our In­ter­na­tional Fi­nan­cial Re­port­ing Stan­dards (IFRS), and refers to gen­er­ally ac­cepted ac­count­ing prin­ci­ples. This is a bug­bear of mine as well. With head­line earn­ings per share (HEPS), only HEPS and di­luted HEPS are IFRS terms and hence I ig­nore any other HEPS num­ber that man­age­ment trots out that al­ways looks bet­ter than straight­for­ward HEPS. As soon as I see nor­malised or what­ever HEPS, I have no real un­der­stand­ing of what they mean, so I ig­nore them. So, mark the last Satur­day of Fe­bru­ary 2018 for Buf­fett’s next let­ter, and the first Satur­day in May for the we­b­cast AGM. While you wait, start read­ing this year’s let­ter.

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