The 10 Most Important Parts of Warren Buffett's Letter to Shareholders

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Warren Buffett released his yearly letter to Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) shareholders on Saturday. Here's what you need to know.

1. He's bullish on America
"Money will always flow toward opportunity, and there is an abundance of that in America," Buffett writes. The media talk about uncertainty today like it's something new. It isn't. Only our perception of it is. "[T]hink back, for example," Buffett writes, "to December 6, 1941, October 18, 1987 and September 10, 2001. No matter how serene today may be, tomorrow is always uncertain. ... Now, as in 1776, 1861, 1932 and 1941, America's best days lie ahead."

2. His Burlington Northern deal is making it rain
"It now appears that owning this railroad will increase Berkshire's 'normal' earning power by nearly 40% pre-tax and by well over 30% after-tax," Buffett writes. It's a contribution that's "working out even better than I expected."

Burlington earned $2.5 billion in 2010, up from $1.7 billion the year before. Berkshire bought the whole company in a 2009 deal that valued the company at $44 billion.

Buffett is "enthusiastic about BNSF's future because railroads have major cost and environmental advantages over trucking, their main competitor." Measured in tons of freight carried per gallon of diesel, BNSF's rails are three times as efficient as trucks. That advantage becomes more valuable as the price of oil rises -- and it has lately.

3. Insurance float is booming
In the insurance business, you collect money up front and pay out claims later. The money held in the meantime is called "float," and it can be invested for your benefit.

Berkshire's float is now $66 billion -- more than double from a decade ago. If this float were a company, it'd be the 40th largest in the S&P 500.

Berkshire's insurance managers have done such a phenomenal job pricing policies that insurance claims and expenses have been covered by premiums alone, without tapping into investment income, for eight consecutive years -- almost unheard of in the industry. That makes its float like a $66 billion interest-free loan. Better than that, actually. Shareholders "benefit just as we would if some party deposited $66 billion with us, paid us a fee for holding its money and then let us invest its funds for our own benefit."

4. He expects the Goldman and GE investments to end this year
Berkshire invested $8 billion into Goldman Sachs (NYSE: GS  ) and GE (NYSE: GE  ) in the form of preferred stock during the height of the financial crisis at sweet terms -- 10% dividend, plus warrants.

That party's almost over. GE can redeem its preferred shares in October and "has stated its intention to do so." Goldman has to get permission from the Federal Reserve, but Buffett thinks that'll happen soon.

Both have to pay a 10% premium to redeem the investments, which will earn Berkshire about $800 million. Even so, hold the applause. Those dividends were heaven. "Our earning power will be significantly reduced" post-redemption, Buffett writes. "That's the bad news."

The good news? The redemptions will boost Berkshire's cash hoard. And not a moment too soon ...

5. He's hungry for more
Buffett's last elephant acquisition, and his biggest ever, was Burlington Northern. He needs these megadeals to make a dent in Berkshire's massive portfolio. He's now ready for more. "We're prepared. Our elephant gun has been reloaded, and my trigger finger is itchy."

Berkshire held $38 billion in cash at the end of 2010, and that sum will surge this year from earnings and the retirement of the Goldman and GE investments. Buffett said he likes to hold $10 billion to $20 billion in cash in reserves, so there'll be enough ammo in the near future to do a deal in the $20 billion to $30 billion range. My guess: Berkshire buys something huge in China, another U.S. utility company, or another conglomerate like Marmon Holdings. Maybe a new suit.

6. He's bullish on housing
"A housing recovery will probably begin within a year or so. In any event, it is certain to occur at some point," Buffett wrote.

While not mentioned in the letter, he's previously explained his rationale for an impending housing rebound: More than a million households are formed every year, yet current housing starts average less than half that amount. Demand is catching up with supply. Simple.

Another housing story: "Home ownership makes sense for most Americans, particularly at today's lower prices and bargain interest rates," Buffett wrote. "All things considered, the third best investment I ever made was the purchase of my home, though I would have made far more money had I instead rented and used the purchase money to buy stocks. (The two best investments were wedding rings.) For the $31,500 I paid for our house, my family and I gained 52 years of terrific memories with more to come."

7. He thinks banks will start paying dividends soon
The Federal Reserve put the kibosh on bank dividends over the past two years. Buffett thinks that'll end soon, meaning a big dividend increase from its largest bank holding, Wells Fargo (NYSE: WFC  ) .

He follows with a story about the power of dividends. Berkshire now makes $376 million in dividends from Coca-Cola (NYSE: KO  ) annually, recouping its original investment every 3.5 years. Within 10 years, "I would expect that $376 million to double," he wrote. "Time is the friend of the wonderful business."

8. He wants you to ignore net income
"Operating earnings, despite having some shortcomings, are in general a reasonable guide as to how our businesses are doing. Ignore our net income figure, however. Regulations require that we report it to you. But if you find reporters focusing on it, that will speak more to their performance than ours. Both realized and unrealized gains and losses are fully reflected in the calculation of our book value. Pay attention to the changes in that metric and to the course of our operating earnings, and you will be on the right track."

How do these metrics look today? As of Dec. 31, Berkshire's price-to-book value is 1.34, versus a 25-year average of 1.63. Operating earnings have compounded at 11.8% annually over the past decade. Connect those dots yourself.

9. Derivatives are doing fine
Years ago, Buffett wrote long-term put options on various global stock indexes. As markets crashed in 2008, many worried the contracts would cost Berkshire tens of billions of dollars when they came due between 2018 and 2026.

That's hardly a danger anymore. Three things have turned the story around: Markets rebounded, Berkshire renegotiated the terms of the contracts, and counterparties canceled eight of the contracts themselves. If markets remain at today's prices between 2018 and 2026, Berkshire will owe $3.8 billion after receiving $4.2 billion in premiums -- still a good profit. Buffett likes the odds. You should, too.

10. He's as miserly as ever
"At Berkshire's 'World Headquarters' our annual rent is $270,212. Moreover, the home-office investment in furniture, art, Coke dispenser, lunch room, high-tech equipment -- you name it -- totals $301,363. As long as Charlie and I treat your money as if it were our own, Berkshire's managers are likely to be careful with it as well."

Contrast this to ex- Merrill Lynch CEO John Thain, who spent $1.22 million furnishing his personal office in a year Merrill would have gone bankrupt had it not been bought by Bank of America. Watch the pennies, and the dollars take care of themselves.

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Comments? Share 'em below.

Fool contributor Morgan Housel owns shares of Berkshire and Bank of America preferred. Berkshire Hathaway and Coca-Cola are Motley Fool Inside Value selections. Berkshire Hathaway is a Motley Fool Stock Advisor pick. Coca-Cola is a Motley Fool Income Investor recommendation. The Fool owns shares of Bank of America, Berkshire Hathaway, Coca-Cola, and Wells Fargo &. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (19) | Recommend This Article (138)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 28, 2011, at 12:14 PM, 123spot wrote:

    Thanks so much for the fine synopsis!

  • Report this Comment On February 28, 2011, at 1:03 PM, hiddenflem wrote:

    great article! Makes Berkshire look very compelling to me at today's prices.

  • Report this Comment On February 28, 2011, at 1:37 PM, bhughes1001 wrote:

    Thanks, a nice article, good background.

  • Report this Comment On February 28, 2011, at 4:39 PM, t0bes wrote:

    Thanks for the great summary

  • Report this Comment On February 28, 2011, at 4:59 PM, newageinvestor wrote:

    Great article. I just bought BRK-B and this makes me confident of my decision to buy.

  • Report this Comment On February 28, 2011, at 5:10 PM, jc09058 wrote:

    Well said.

  • Report this Comment On February 28, 2011, at 5:10 PM, moneycone wrote:

    I wrote about BRK-B in March of last year with an outrageous title :

    'If I were to bet all my savings on one stock this would be it!'

    Though I still think that is a bad idea, having a good dose of BRK in one's portfolio won't hurt!

  • Report this Comment On February 28, 2011, at 5:12 PM, JeanDavid wrote:

    With all that money, he could buy CSXand have a transcontinental railroad. It is probably a bad idea, though, and even if a good one, the regulators might not like it. But then the LA to Florida and Washington passenger service could be resumed.

  • Report this Comment On February 28, 2011, at 5:31 PM, talotu wrote:

    "Derivatives are doing fine"

    I found the derivative section of the shareholder report very misleading, and unworthy of the normal standards of a BRK report.

    Talking about the derivatives only in terms of their <i>Intrinsic</i> value paints a much rosier view than is warranted.

    If you write a 1 year at the money put option for $4.20, and the stock drops $3.80 in the next month, is it a good trade just because 11 months from now you would make $.40 if the stock stays at the same level?

    The market value of those derivatives is -$6.7 billion right now, which is a $2.5 billion loss currently. That is hardly "doing fine" in my book.

    I agree that -$6.7 billion is probably not the correct value for them, but it's far closer to correct than -$3.8 billion that was implied in the annual report (and repeated in this article)

  • Report this Comment On February 28, 2011, at 6:22 PM, Glycomix wrote:

    Mr. Housel must be an amazing speed reader in order to comment on so many things.


  • Report this Comment On March 01, 2011, at 7:41 AM, beechtree1 wrote:

    "A society grows great when old men plant trees whose shade they know they shall never sit in."

    Greek proverb.

  • Report this Comment On March 01, 2011, at 9:24 PM, hiddenflem wrote:

    ^Great proverb, will steal that from you beech

  • Report this Comment On March 04, 2011, at 11:50 AM, Amby208 wrote:

    What's the difference between BRK-A and BRK-B, besides price?

  • Report this Comment On March 04, 2011, at 11:54 AM, cmfhousel wrote:

    ^ BRK-B's have a tiny fraction of the voting power of BRK-A's.

  • Report this Comment On March 05, 2011, at 9:03 PM, suemwf wrote:

    Enjoyed the article and enjoy following what Mr. Buffett does, but if he is enjoying the extra earnings he gets from dividends so much, why doesn't he think enough of his investors to give them dividends? They certainly need them more than he does. That is one of the reasons I have not bought BRK-B. I have been watching it since it became available and it seems like it took it a long time to start growing (the other reason I did not invest in it).

  • Report this Comment On March 06, 2011, at 10:46 PM, irwann wrote:

    Does Buffer re-invest the dividends back into the company stock or does he keep the dividends in cash?

  • Report this Comment On March 12, 2011, at 5:27 PM, deltafox2 wrote:

    Railways are traditionally difficult to run at a profit. This has always been the case over the centuries. In Europe where railroads are much further developed than in the US, these are state-run in 9.5 cases out of 10. In Germany, despite a very sound railway infrastructure, freight trucking continues to outpace trains year over year due to higher flexibility and as you have to use trucks for the first and last miles anyway. So, superficially seen, Burlington's earnings make me wonder.

  • Report this Comment On March 15, 2011, at 1:41 PM, lantzer2 wrote:

    I own brk.b and I would be made very happy if there were a little bit of share the wealth going on. I unfortunately purchased at a high point and have yet to see a penny of increase over the last 2 years.


    How about some dividends!!!!!!!!!

  • Report this Comment On January 15, 2012, at 9:11 PM, trader82 wrote:

    Thinking of buying their stock. doing the reaserach now.

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