Good traditions carry on. Every last weekend of February, value investors can count on one thing to happen that will make their weekend time very well spent: reading newly published annual letter from Mr. Warren Buffett, Chairman and CEO of Berkshire Hathaway.
Being students of Ben Graham/Warren Buffett’s school of value investing here at Fuji Investment Corporation, this is certainly one of the most important dates of the year. It is like a fan of certain movie waiting eagerly for its release, or loyal customers of Apple Inc lining up for its new iPhone, except instead of physically getting into a line, we just need to refresh our browser in the morning and start reading.
Just like the past years, there were lots of wisdom and insights in this year’s letter. Below are the 5 most important takeaways we wanted to share:
- Berkshire has over $110 billion cash to deploy
Such number was noted across various financial news outlets, but what lots of reporting agency did not mention, was that this amount represents roughly 20% of Berkshire’s market cap. In Ben Graham’s book “Intelligent Investor”, he suggested 75/25 allocation between stocks and bonds. In today’s Berkshire, essentially Mr. Buffett is allocating 20% (and growing) to be in cash or short-term treasury bills, giving himself enough dry powder in case of a market melt-down or when a significant acquisition opportunity arise. At FIC’s core fund as of Feb 27, 2018, we have approximately 12% in cash or cash equivalents. Part of the luxury we have but not Berkshire was that our capital size is significantly smaller and at our playfield, more sensible opportunities are available. (Putting $1m to work in a $1 trillion market is much easier than putting $100 billion to work in a $1 trillion market).
- Current market is not cheap – especially for large companies that fit Berkshire’s acquisition criteria.
Quoting Mr. Buffett, “If Wall Street analysts or board members urge that brand of CEO to consider possible acquisitions, it’s a bit like telling your ripening teenager to be sure to have a normal sex life.” From our experiences in private market today, it is exactly what’s happening. There was a lot of money raised by various funds, or cash accumulated at corporations’ treasury, that people started deploying capital with more liberal assumptions and largely relying on future growth. Today’s record low interest rate also starts to bake into people’s mind to be a “new norm”, just in time when it is really changing – new Fed Reserve Chief was signaling a gradual but consistent series of rate hikes this year and next year. All record low capitalization rates in commercial real estate deals today will be laughable in 5 years’ time. However, managers are the only one laughing now because their compensations are tied to the size of the portfolio they are managing or the transactions they have closed. Investors be aware!
- New Accounting rule change will make Berkshire’s future earnings seem more volatile
The new accounting rule will require corporations start including the unrealized gains and losses in their future earnings statements. Current practice was that such items appear in “Accumulated additional comprehensive income” on balance sheet, which does not distort earnings picture from each reporting period. I am certainly not an expert in accounting rule making but such rule change really puzzles me. What do we gain from here? More volatile earning figures based on unrealized gains and losses, which may lead to more short-term trading or “hedging your book to make quarterly numbers look better?”
- Buffett won the bet against hedge funds and made the strong case against fee heavy structure in asset management industry
For details of the bet, please refer to the attached annual letter. However, the spirit of this bet really highlighted something we strongly believed and wrote in recent post: for an average passive investor in the United States, you will be better off in a programmatic investing plan be deploying the capital in equal amount into a low fee S&P 500 Index Fund consistently across all market conditions. Here there are a few points that need to be implemented:
- The capital should be deployed in equal amount
- The capital should be deployed in any market conditions (up markets or down markets)
- The capital should be deployed into a low fee S&P 500 Index fund, it should not be any “smart beta” or other sorts of financially engineered ETF or ETN products. Just plain old S&P 500 Index fund, with low fee.
- Except Insurance segment, all other businesses in Berkshire are on solid footing
Except Insurance segment had an underwriting loss, due to 3 large hurricanes or tropical storms to Florida, Puerto Rico and Texas area, all other business segments are largely delivering strong operating results. These are a reflection to current fundamental pictures in US. We still believe that the market did not fully appreciate the impact of de-regulation and significant positive impact from lower tax rates in the new tax law.
Follow the link for a copy of the annual letter by Mr. Buffett (Obviously the entire letter’s rights belong to Mr. Buffett) : 2017ltr