In this episode of Industry Focus: Financials, host Michael Douglass and financial sector specialist Matt Frankel give a recap of the highlights of this year's meeting.
A full transcript follows the video.
This video was recorded on May 7, 2018.
Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Monday, May 7th, the Financials show, and we're talking all things Berkshire Hathaway. I'm your host, Michael Douglass. I'm joined by Matt Frankel.
Listeners, as you probably know, the Berkshire Hathaway annual meeting was this past weekend, also known as Woodstock for capitalists. It's a massive event. I've been to it personally twice. It's a really good time, particularly because you get this chance to hear Berkshire Hathaway's chairman, Warren Buffett, and vice chairman, Charlie Munger -- two of, in my opinion, the greatest investors alive today -- sit and dish on basically anything anyone asks about for about six hours. It's an incredible thing to hear, and it really leads to a lot of wisdom. It's certainly changed how I invest, and it's changed how millions of other people invest.
It was live-streamed on Yahoo Finance, and pretty much the entire business news world basically froze and made sure that they covered this over the weekend. We had a lot of coverage on fool.com. There were some great liveblogs, particularly The Wall Street Journal's. There's a lot of great background around this really fantastic annual meeting.
We're going to hop into the things that Warren Buffett talked about and some of the main takeaways for investors today as we're thinking about the stock market and about Berkshire Hathaway. But first, Matt, let's just give a really quick, 30-60 second synopsis, of Berkshire Hathaway and what it does.
Matt Frankel: Sure. Berkshire, at its core, is an insurance company. Warren Buffett loves the insurance business, basically, because it gives them a lot of cash that they can then deploy into other investments. Berkshire operates insurance subsidiaries such as Geico, that's probably its best-known one. But, its biggest insurance business is called reinsurance, which is essentially insurance for insurance companies.
Now, like I said, it uses the money from that to fund other acquisitions. It's built up quite a portfolio of about 60 different companies, ranging from real estate to retailers to consumer goods to aircraft parts, just to name a few. There's a ton of them. They also use their money to invest in common stocks. Berkshire's stock portfolio has become about 40% of the company in terms of market cap, and is one of the most followed, if not the most followed, stock portfolios in the world.
Douglass: So, when you think about Berkshire Hathaway, the bucketing ways to think about it are: core insurance business, other businesses that they've invested in, and stock portfolio. Those are the three main components, if you want to think about it that way, of the company. Warren Buffett has been at the helm at Berkshire for an extraordinary long time. He has presided over tremendous growth in this company over the years. In part because of this, and in part because of just the incredible stock investments he's made over the years, he's known as the Oracle of Omaha, and people go on this annual pilgrimage to Omaha to hear what he has to say.
Interesting that I spoke about growth, because the first thing we're going to talk about today is the fact that Berkshire actually reported a loss in earnings in the documentation leading up to the conference.
Frankel: Yeah. Buffett said in his letter this year, about three months ago, that shareholders shouldn't pay much attention to Berkshire's earnings going forward. Basically, there's an accounting change now that requires what they call unrealized gains on investments, meaning stocks they haven't sold yet, to be included in earnings figures. As most listeners know, the stock market did not have a great first quarter to 2018. This was especially true for some of Buffett's stocks. Wells Fargo (NYSE:WFC) had a particularly bad time. Coca-Cola, Kraft Heinz are all doing pretty poorly. This made Berkshire look like they lost over $1 billion, when in reality, their operating earnings, which is the earnings that are actually being generated by its businesses, grew to a record high level, up almost 50% year over year. It was actually about a $5 billion profit, and the change in value of the company's stock portfolio made it look like a loss.
Buffett had some comments. He reiterated his point that investors should not be too concerned with any one quarter's or even any one year's earnings, just because it includes figures from investments that Berkshire hasn't sold yet, and for all we know, has no plans to sell any time soon.
Douglass: Right. And one of the key things to really think about here is that a lot of people, I think, look at companies on a fairly general view, they look really at just top and bottom line numbers -- so, revenue and earnings per share, or revenue and net income, or something like that. Particularly when the stock market goes south, and you see someone's net income go down, their earnings per share go down, then you get a little bit nervous about that company. The thing with Berkshire is, you're really not going to want to watch that when the stock market goes down because they're absolutely going to show really terrible earnings per share. But that's going to be because of all of these investments weighing down what's fundamentally a very strong business.
Frankel: Right. This accounting change affects all companies, but there's no other companies -- that I know of, at least -- with $180 billion stock portfolio. This is really a Berkshire-specific accounting change, in many ways.
Douglass: Yes. And I would say, maybe, Markel. I mean, they don't have a $180 billion portfolio, but they have a fair amount, and a lot of their stocks are fairly high-flying tech names. Markel is, in many ways, structured very similarly to Berkshire. It's not nearly the scale. It's also from my hometown, Glen Allen, Virginia. Anyways, the point is, it's structured similarly, so you would probably see a similar issue for them.
But, yeah, this is just something that's going to really affect these two companies, I'd say, going forward. It's just something you're going to have to keep in mind, particularly when the stock market swoons or goes up. You're really going to want to look at that underlying business performance and strip out the investment side of it.
With that, let's turn to topic No. 2: Warren Buffett's investments in Wells Fargo. Now, listeners, you've heard us talk quite a bit about Wells Fargo over the past, oh, I don't know, six to eight months, but particularly in the last couple of episodes. We've had quite a bit to say about the company. Warren Buffett, not surprisingly, was asked about Wells.
Frankel: Yeah. It's actually interesting, I don't know if you were watching the live stream during this, but, when they were asked the question, the question was worded to the effect of, "At what point do you just give up and get out of Wells Fargo?" And the audience cheered the question more than they cheered Buffett's response. This is a very common question that people have about Berkshire's Wells Fargo investment. But, Buffett kind of gave the indication that not only does he not want to sell, he thinks Wells Fargo is going to do particularly well in the coming years. In fact, this morning, he told CNBC that he thinks Wells Fargo will outperform the other big banks over the next 10 years. He stopped short of telling investors to buy any more.
Essentially, Buffett thinks that the fake accounts scandal, the overcharging for mortgages, giving people auto insurance they didn't need, all those problems weren't the big issue. The big issue, Buffett thinks, is that management didn't react quickly enough when they found out there was a problem. Buffett points out that Berkshire Hathaway has over 370,000 employees, and he's not sure how many people are doing things wrong, but it's not zero. There's bad apples at every company. The key is that when management finds out about the problem, they need to react quickly to prevent it from becoming a massive fake accounts scandal like in Wells Fargo's case.
But Buffett seems confident with the new leadership at Wells Fargo. He pointed out that in the past, he's made investments in financial companies that have done even worse things. He mentioned American Express and Geico, and these have turned out to be some of his best investments of all time. So, he's encouraging investors to sit by and let the process play out.
Douglass: And, fair enough. Although, he did also sort of stop short of suggesting people buy more. He didn't say, "Wells Fargo, screaming buy."
Frankel: And it's also fair to point out that when American Express and Geico were having their issues, it was before Buffett invested in them.
Douglass: Right. So, there's a lot to disentangle there. I think you know my viewpoint on the company, so I'll just leave it at that.
Frankel: You won't find it in Michael's portfolio any time soon.
Douglass: No, certainly not. Let's turn to succession. This is an issue that pops up, I would say, annually, but frankly, it's a lot more often than that. Warren Buffett is in his upper 80s -- he's 87, to be more precise. Charlie Munger, his vice chairman and partner in crime, is 94 years old. So, it's natural for people to ask, what happens after both of you are no longer running Berkshire Hathaway? And, per usual, it seems, we didn't really get any new details on that.
Frankel: We've gotten enough details, I feel, for the time being. We both hope that Buffett and Munger both live well into their hundreds.
Frankel: But there's no guarantee that they even want to run their company if they're around in their hundreds. This is something that could happen at any time, and shareholders are getting kind of anxious to know they're still going to be investing in Buffett, essentially, after Buffett's gone.
Buffett tried to set shareholders' minds at ease saying that the team is in place should anything happen. The two recently promoted vice-chairmen who pretty much combine to oversee all of Berkshire's businesses. One of them will be the CEO, we don't know who it is yet. And, his two investment managers -- Ted and Todd, everyone says -- are not only managing more and more money over time, but are starting to actually bring acquisition ideas to Berkshire's attention and the instrumental in that side of the business. So, he's very confident in his team, and Charlie Munger even doubled down on that and said, if anyone sells the stock after him and Buffett is gone, they're going to regret it and won't do any better elsewhere.
Douglass: Yes. Charlie Munger is known for hitting the nail on the head, and, as per usual, that's what he did. He also had a great quote. Buffett was talking about how he's sort of been semi-retired, is how he called it. And Munger was like, "Yeah, Warren's very good at doing nothing," which was your classic laugh/ applause line at Berkshire Hathaway, just to give you a feel for the meeting.
Cool. We'll turn to a few other major issues -- that is Apple (NASDAQ:AAPL), cryptocurrencies, and Berkshire's cash hoard -- in just a moment. Alright, Matt, let's not bury the lede, because these are the things people really wanted to talk to anyways, right? Apple. Berkshire just bought 75 million more shares, and Buffett was quite bullish on the stock at the meeting.
Frankel: Yeah. This makes Berkshire's stake in Apple about 5% of the company, which doesn't sound like much, but this is $45 billion worth of stock we're talking about. So, this is not only Berkshire's biggest stock investment now, this is one of the biggest parts of Berkshire in general. It's about 10% of the company's market cap. Buffett loves Apple for several reasons. It's really morphed into a Buffett stock, I guess I would say.
Frankel: It's not a capital-intensive business, which Buffett loves. It has a very, very loyal following of customers. As all listeners probably know, people either love Apple or don't love Apple, and the people who love Apple will never be convinced otherwise.
Douglass: [laughs] Yeah. My wife is a big Apple lover, so, yes.
Frankel: We're a split household, too. I'm using a Dell right now, and my wife is on her iPad. [laughs] So, we're a split household, also, and she's not going to give up her iPad for a tablet any time soon.
Frankel: So, it's a very sticky product, is how Buffett phrases that. He also loves Apple's management. It's really hard to overemphasize how much value Buffett places on good management, especially shareholder-friendly management that goes out of their way to return as much capital as possible to its shareholders -- in Apple's case, through buybacks. He loves Apple's massive buyback programs, especially in this environment where no one can find attractive companies to buy. He feels that this is by far Apple's best use of its cash. He said this morning that he owns 5% of Apple, and he knows that within ten years, he's going to own 6% of Apple, even if he doesn't put another dime in. Buffett and Munger both actually said today that they wish they had bought more, they probably weren't aggressive enough with Apple. So, I actually wouldn't be surprised to see Berkshire buy even more Apple over the next few quarters.
Douglass: Yeah. It was funny, actually, Buffett got on CNBC this morning and basically said, "We'd love to own 100% of the company," and then he walked that back a little bit and said, "Listen, if you're buying shares of a company, it's because you want to own the whole thing." So, let's not have any speculation about Berkshire buying Apple. A, not going to happen. B, they don't have enough money.
Frankel: Yeah. You don't say it that sentence too often, but with Apple, it certainly applies.
Douglass: [laughs] Right, for once. It was interesting, as well, he also said, "There are other stocks we like just as much as Apple, it's just that the companies aren't nearly as big. Berkshire can't buy nearly as much of them." Keep in mind, one of the key things here is, they need scale plays, and Apple is just about as big of a scale play as they get.
It's been a really interesting evolution on his part, I think, because a lot of us do think of Apple as kind of a tech company, and he really has pushed, I would say, really starting at last year's annual meeting, for people to think of Apple increasingly as a consumer goods company. So, Dylan, Vince, I don't know if you all are listening, but consider that. Maybe Vince gets to cover Apple from now on, and Dylan's going to have to limit himself to Spotify, Snap, and a few other tech stocks. I don't know! I'm not in the middle of that fight. I'm just throwing it out there. When Warren Buffett speaks, we all have to listen a little bit.
Frankel: That's very true. It's also worth noting that we'll find out what else Warren Buffett bought in about a week, when the company files their 13-F with the SEC.
Douglass: Yes, and we will have extensive coverage of that on fool.com. Listen, you don't just blindly follow what somebody else buys in the stock market, but it's really interesting to see what Buffett and some of these other really big investment managers think is potentially worth investing in. It's certainly helpful for me, at least, to source stock ideas.
Speaking of stock ideas, or, well, actually, things to stay away from, so, the opposite of stock ideas -- let's talk about cryptocurrencies! Warren Buffett, sometimes I wonder if he thinks about exactly what he's going to call something if he gets a question about when he knows he's going to get a question about it, because he led off by calling Bitcoin -- tell me if I'm quoting this wrong -- "rat poison squared."
Frankel: Yes. [laughs] That's very true. He had things to say about cryptocurrencies over the past few months, and this wasn't really surprising. He's said before, and he said again, that these are going to end badly. His reasoning is that these are not productive assets in the sense that, if you buy a stock, it generates profits, hopefully. If you buy a farm, it produces crops. These are productive assets. Whereas, gold is the classic example of an unproductive asset.
Buffett, and Munger, for that matter, both feel that cryptocurrencies are a fool's gold, in a way. They haven't really dug into how useful they are as actual currencies. Not surprisingly. I don't really think Warren Buffett goes out and pays for things in Bitcoin. [laughs] He's speaking strictly from an investment standpoint. It's probably fair to say he feels pretty much the same as he does about foreign currencies. That's why Berkshire doesn't hold $20 billion in euros in its portfolio. It's not a productive asset. He feels that people could put their money to use in better ways. And it's kind of turning into a bubble, almost.
Douglass: Yeah. It's one of those things where, this is the difference between investing and speculation, I think, in a really core kind of way. Speculation is when you're saying, "I think this price is going to go up or down." You might think that about currencies, you might think that about soybean futures, you might think that about cryptos. Investing is when you say, "This business looks like it's going to prosper, and I think the rest will probably follow, naturally, from that."
The nice thing about investing is, when everyone is tacking right and you're tacking left, if you're confident in your thesis and you're right, you can make a lot of money. That's really how Warren Buffett has beaten the market by so much, historically. Here at The Motley Fool, it's pretty clear which side of that whole debate we're on. But, if you're ever uncertain about where you stand, I would consider the history here. People who have a really great record of beating the market tend to think this way about long-term investing as opposed to speculation. I think that's a good takeaway for all of us.
Finally, let's talk about Berkshire Hathaway's cash hoard. This is one of those other perennial major issues, because Berkshire Hathaway, as it gets bigger, it has to make bigger investments to, well, deploy its capital to do something. And they actually managed to drop it a little bit. It's $108 billion vs. $116 billion at the end of 2017.
Frankel: Yeah. This was the first time it had dropped in some time. It was a nice thing for shareholders to hear. You mentioned he needs big investments. This is why he likes Apple's stock so much. He can buy a lot of Apple stock without acquiring the company or anything like that.
Reading between the lines a little bit, this indicates -- to me, at least -- that investments are starting to look a little more reasonably valued than they did in the past quarter and the end of 2017, when Berkshire said they couldn't find anything to buy. It's looking like this might be turning around. The volatility in the market, rising interest rates are starting to produce some investments that are looking a little bit attractive. Like I mentioned before, we'll find out exactly what other stocks Berkshire bought in the coming days, but this gives me hope, at least, that they might find a nice acquisition sometime this year to put more of that cash to work. Buffett only wants to keep about $30 billion of it. That leaves about $80 billion to play with still.
Douglass: Right. That's a fair amount of play money. It's certainly more than I'm going to spend in my entire life time, times, I don't know, at least several million. And, actually, relatedly, let's talk briefly about healthcare here. One of the bigger pieces of news that we saw in the last few months was Buffett, Bezos, and Jamie Dimon from JPMorgan basically planning this healthcare initiative. The idea is that it's supposed to help bend the cost curve. Light on details. Buffett didn't really give much more in the way of details at the annual meeting, but he at least told folks that it looked like a CEO would be identified and in place in a couple of months, and that, at least, would give us kind of a sense as to what direction they're planning to go with this.
Frankel: Yeah, definitely. He elaborated on this in this morning's interview. He doesn't expect anything to change that quickly. He doesn't think his healthcare initiative is going to turn the industry upside down any time really soon. But, he did say, once a CEO is in place, and once they start having some success, this could become a really big thing. He said this morning that hundreds of companies are interested in joining once there's a viable plan in place.
Douglass: Yeah. I'll be very curious, both as a frequent healthcare investor and generally as a person who wants to make sure that our health insurance is good value for the extraordinary high price, to see what comes out of this. It'll be a very interesting few months we have ahead of us. Matt, anything else you want to chat about with Berkshire?
Frankel: Not particularly. I hope to make it to the meeting next year or one of these years. It seems like I'm watching the live stream, and every year that I have the chance to go, I have a baby or something like that.
Douglass: [laughs] Well, priorities.
Frankel: I imagine it's a lot nicer in person than on the live stream.
Douglass: It is pretty nice in person, just because, you can get a Dairy Queen ice cream bar for funsies sometime during the meeting, that just makes things fun. Actually, Matt, I'll mention this to folks just because I thought it was cool -- Matt, you mentioned a stat before we started recording, which is that Berkshire businesses earn $400 million every week. Just think about that. That's an incredible amount of money.
Frankel: That kind of tells you why they have problems putting their cash to work, if it's flowing in that quickly.
Douglass: Yeah. It's pretty wild. Folks, that's it for this week's Financials show. Questions, comments, you can always reach us at firstname.lastname@example.org. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so, don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Michael Douglass. Thanks for listening and Fool on!
Matthew Frankel owns shares of American Express, Apple, and Berkshire Hathaway (B shares). Michael Douglass owns shares of Apple and Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Apple, Berkshire Hathaway (B shares), and Markel. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends American Express. The Motley Fool has a disclosure policy.