After the Chapter 1: Indebtedness and the Chapter 2: Investment, let’s move on to Chapter 3: Berkshire Hathaway’s 2018 Letter to Shareholders. Here we’ll summarise some of the quotes and phrases with which Warren Buffett and Charlie Munger delighted shareholders this year. You can read the full letter, translated courtesy of our friends at the website Value School.
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Regarding the share buyback (treasury shares) currently being carried out by their company, Buffett and Munger had the following to say:
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For shareholders who stay on (those who do not sell their shares), the advantage is clear: if the market values the stake of a departing partner at, say, 90 pence on the pound, the remaining shareholders see an increase in intrinsic value per share with every buyback by the company. Obviously, buybacks must be price-dependent: blindly buying an overvalued share destroys value, something many CEOs overlook.
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When a company says it is considering share buybacks, it is vital that all shareholders receive the information they need to make an informed assessment of the intrinsic value. Providing that information is what Charlie and I aim to do in this report. We do not want a shareholder to sell shares to the company because they have been misled or inadequately informed.
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And on the subject of taxation and its decisive influence on the valuation of their holding company, the masters of value investing made some comments that are well worth noting:
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Let’s start with an economic reality: whether we like it or not, the US government «owns» a share of Berkshire’s profits, the size of which is determined by Congress. In fact, the US Treasury holds a special class of our shares (something like an AA class), which receives large «dividends» (or taxes) from Berkshire. In 2017, as in many previous years, the corporate tax rate was 35%, which meant that the Treasury was very happy with its AA shares. In fact, the Treasury’s «shares», which paid no «dividend» when we took control in 1965, have become a position that provides billions of dollars annually to the federal government.
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Last year, however, the 40% on the government’s «holding» (14/35) was refunded to Berkshire when the corporation tax rate was reduced to 21%. Consequently, our «A» and «B» shareholders saw a significant increase in the profit attributable to their shares.
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This development substantially increased the intrinsic value of the Berkshire shares that you and I hold. Furthermore, it also increased the intrinsic value of almost all the shares held by Berkshire.
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The tax benefits derived from our large utilities business were passed on to customers. Meanwhile, the tax rate applicable to the substantial dividends we receive from domestic businesses remained virtually unchanged, at around 13.1%. (This lower rate has long been logical because its subsidiaries already pay tax on the profit they subsequently distribute to the parent company.) Overall, the new laws have made the companies and shares we own considerably more valuable.
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Nevertheless, his gratitude towards the US is absolute, for without the dynamism and growth of its economy, he could never have amassed such a fortune. Whilst the Germans predicted the success of their troops during the war, the Americans were confident that their children and heirs would inherit a better world. The education of subsequent generations has been one of the keys to the US’s success in leading the global economy over the last century (remember what the economist Gay de Liébana on the merits of sending our children to study at American universities and the affordable costs that can be found with the right advice).
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Speaking of the accounting tricks that some executives routinely employ, Buffett said:
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Over the years, Charlie and I have seen all manner of corporate malpractice—both accounting and operational—driven by management’s desire to meet Wall Street’s expectations. What starts as an «innocent» lie to avoid disappointing analysts (such as «padding» sales at the end of the quarter, turning a blind eye to insurance losses or withdrawing profits from our «slush fund») can actually be the first step towards outright fraud. The CEO’s intention may be to fiddle the accounts «just this once», but it is rare for it to be just once. And if it is acceptable for the boss to cut corners, it is easy for his subordinates to adopt similar behaviour.
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The Russian roulette equation (you usually win, sometimes you die) might make financial sense for someone who benefits from a company’s good news but doesn’t suffer from the bad. This strategy would be madness for Berkshire; sensible people do not risk what they have and need for what they do not have and do not need.
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Buffett acknowledged that his fortune has been built almost exclusively on the growth and economic leadership of the US. However, he also noted that the world’s economic centre of gravity is shifting towards certain emerging economies, as in the coming years growth, coupled with the maturity of these markets, will no longer be the exclusive preserve of the US economy (it is worth noting here the investment guidelines Mark Mobius gave us a few weeks ago):
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There are also other countries around the world with bright futures. We should be pleased about this: we Americans will be more prosperous and safer if all nations prosper. At Berkshire, we look forward to investing large sums of money abroad.
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To round things off, here’s a medley of quotes and jokes taken from the letter to shareholders:
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- Abraham Lincoln once posed the question: «If you call a dog’s tail a leg, how many legs does it have?» And then he answered his own question: «Four, because calling a tail a leg doesn’t make it one.» Lincoln would have been misunderstood on Wall Street (there they would have argued over whether the dog has one or five).
- Even at the ages of 88 and 95 (I’m the younger one), that hope (of making a purchase) is what makes my heart and Charlie’s race. (Just writing about the possibility of a big purchase has set my pulse racing.).
- My plan to buy more shares is not a prediction of how the market will perform. Charlie and I have no idea how shares will perform next week or next year. We have never been interested in making that sort of prediction. Our focus, rather, is on calculating whether a stake in a good business is worth more than the market price suggests.
- Forget it: it would be foolish to sell any of our wonderful companies, even if the sale were tax-free. Good companies are extremely hard to come by. Selling a business that you’re lucky enough to own makes no sense at all.
- As things stand, Charlie and I have no interest in joining that group (people who are divesting). Perhaps we’ll become spendthrifts when we reach old age.
- However, some investors may disagree with our valuation, whilst others may have found investments they consider more attractive than Berkshire shares. Some of those in the latter group will be right: there are undoubtedly many shares that will deliver returns far higher than ours.
- A major disaster will strike that will make Hurricanes Katrina and Michael look like a joke – perhaps tomorrow, or perhaps decades from now. «The big mistake» could stem from a traditional source, such as a hurricane or an earthquake, or it could be a complete surprise involving, say, a cyberattack with disastrous consequences that insurers do not currently anticipate. When such a catastrophe strikes, we will bear our share of the losses, and they will be huge, absolutely huge. However, unlike many other insurers, we will be looking to acquire businesses the very next day.
- In late 1995, after Tony had revitalised GEICO, Berkshire made an offer to buy the remaining 50% of the company for $2.3 billion, roughly 50 times what we paid for the first half (and people say I’m a tightwad!).
- Christopher Wren, the architect of St Paul’s Cathedral, is buried inside this London church. On his tomb are the following words (translated from Latin): «If you seek my monument, look around you». Sceptics regarding the US economy would do well to heed this message.
- For 54 years, Charlie and I have loved our jobs. Every day, we do what we find interesting, working with people we like and trust. And now our new management structure has made our lives even more enjoyable.
- With everything in place—that is, with Ajit and Greg at the helm of operations, a strong business portfolio, a cash flow as robust as Niagara Falls, a team of talented managers and a strong corporate culture, your company is well-positioned for whatever the future may hold.
- Berkshire paid $47 million for half of GEICO, roughly the same as what a luxury flat in New York would cost today.