Warren Buffett's letter to Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) shareholders was brief this year, but the legendary investor still had enough to say about his business and the financial markets to fill 16 full pages.
When I read anything, I often ask myself what the writer would have included if he or she had to cut their word count in half -- what message does the author really want us to take away? In this case, three ideas really stole the show in Buffett's most recent letter.
1. Buffett seems a little irritated with his opportunity set
Besides a major investment in Pilot Flying J, neither Berkshire nor its subsidiaries did any really big deals in 2017. Berkshire Hathaway had about $30 billion more in cash at the end of the year than at the beginning. Buffett said that was mostly a function of prevailing prices for businesses, which he isn't excited about.
In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price.
That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.
Buffett is always cheerfully optimistic about stocks, especially Berkshire's stock, in his letter to shareholders, but this is about as close as he's gotten to voicing a bearish view on valuation in recent memory. Buffett isn't that eager to commit to buyouts at today's prices.
2. Ex-hedge fund manager slams hedge fund managers
Buffett's letter to shareholders has gone from a relatively obscure thing to something read by virtually every English-speaking investor in the world. As his readership widens, Buffett is spending more time talking about personal finance matters than corporate finance.
In 1986, Buffett's letter included an appendix to explain how purchase-price accounting and LIFO inventory methods affected his non-GAAP "owners earnings" estimates for Scott Fetzer. In 2017, Berkshire appended a lengthy explanation on why an index fund will likely beat an actively managed fund (hedge funds) that charges higher management fees and incentive fees, which appears just after his letter in the annual report.
In his letter, Buffett summed up his view on fund fees by writing that "performance comes, performance goes. Fees never falter." In his view, investors would simply be better served to take the average result of the S&P 500 than invest in high-fee funds.
Buffett's letters used to train analysts. Now they trash them, or at least the companies they work for. It's kind of amusing, since Warren Buffett, Charlie Munger, Ted Weschler, and Todd Combs -- basically, all of the people who make investment decisions at Berkshire -- got rich by running hedge funds that charged above-average fees. (To be fair, even after fees, investing with all four of these men would have been a very good decision.)
3. Berkshire is betting big on housing
Berkshire Hathaway is a lot of things -- an insurer, railroad, and utility -- but pieces of it are a royalty on housing and construction in the United States. His letter to shareholders this year really spells out just how important housing and building products have become to its earnings power, and why it will be even more important over time.
Berkshire Hathaway has exposure to homebuilders (Clayton Homes), flooring (Shaw), real estate brokerages (HomeServices), paints (Benjamin Moore), insulation (Johns Manville), bricks (Acme), and basically everything else from screws to construction software (MiTek). These are operating businesses Berkshire owns.
Buffett spent the better part of a page talking about acquisitions by Clayton Homes, Shaw, and HomeServices in his letter to shareholders. He seems particularly bulled up on real estate agents because real estate brokers are some of the few businesses available for sale at "sensible prices."
HomeServices is now close to leading the country in home sales, having participated (including our three acquisitions pro forma) in $127 billion of "sides" during 2017. To explain that term, there are two "sides" to every transaction; if we represent both buyer and seller, the dollar value of the transaction is counted twice.
Despite its recent acquisitions, HomeServices is on track to do only about 3% of the country's home-brokerage business in 2018. That leaves 97% to go. Given sensible prices, we will keep adding brokers in this most fundamental of businesses.
Buffett likes to pick and choose his spots, so it's curious to me that when it comes to housing, he seems to like anything that has even very tangential links to it.