Saturday, Feb. 27, brought with it the latest annual letter from Warren Buffett, whose wisdom investors have been following for the past 56 years. Over that time, his conglomerate Berkshire Hathaway (BRK.A 0.16%) (BRK.B 0.11%), has compounded wealth at a stunning 20% rate, versus a 10.2% rate for the S&P 500.
That track record is perhaps even more incredible than you might suspect. By compounding at nearly double the rate of the market every year for over a half-century, $1 invested in Berkshire in 1965 would be worth $27,173 by year-end 2020, versus just $230 if invested in the S&P 500.
Still, Berkshire's relative record used to be even better. In fact, Berkshire has lagged the market over the past one-, three-, five-, and 10-year periods:
BRK.A 1 Year Total Returns (Daily) data by YCharts
While Buffett didn't directly address Berkshire's relative underperformance over the past decade, he did acknowledge that Berkshire may not be appropriate for every type of investor. At the same time, Buffett seemed to hint that the market may be vastly underrating Berkshire's prospects, and that the stock is quite cheap at the moment, at a time when most stocks seem pretty expensive.
Buffett likened Berkshire to a hamburger and soda stand that investors are shunning for exotic French fare. Image source: Getty Images.
Hamburgers and Coke vs. French cuisine and exotic wines
In the letter, Buffett paraphrased Phil Fisher, one of his biggest investing influences:
In 1958, Phil Fisher wrote a superb book on investing. In it, he analogized running a public company to managing a restaurant. If you are seeking diners, he said, you can attract a clientele and prosper featuring either hamburgers served with a Coke or a French cuisine accompanied by exotic wines. But you must not, Fisher warned, capriciously switch from one to the other: Your message to potential customers must be consistent with what they will find upon entering your premises. ... At Berkshire, we have been serving hamburgers and Coke for 56 years. We cherish the clientele this fare has attracted.
Here, Buffett seems to be hinting that Berkshire's process, the types of investments it makes, and its extreme risk aversion will not change with the times, whatever the market is doing. Certainly, the market has gravitated toward "French cuisine and exotic wine" fare over the past decade. High-growth, emerging-technology stocks have dominated, and the risk-off, non-tech-oriented, and value-based Berkshire has largely steered clear of those types of investments.
Yet Buffett appears to think the market's tastes for hamburgers and Cokes may come back in fashion eventually, judging by the actions he took in 2020.
An all-time record for repurchases
Berkshire's largest acquisition in 2020 was... itself. In 2020, it spent $24.7 billion on share repurchases -- by far the most in Berkshire's history, and good enough for retiring 5.2% of the company's shares. Buffett also said Berkshire has continued to repurchase shares at a strong pace since year-end. While he didn't say it directly, it appears Buffett believes Berkshire repurchased its shares at a very cheap price and a good discount to intrinsic value:
Following criteria Charlie [Munger] and I have long recommended, we made those purchases because we believed they would both enhance the intrinsic value per share for continuing shareholders and would leave Berkshire with more than ample funds for any opportunities or problems it might encounter. In no way do we think that Berkshire shares should be repurchased at simply any price. I emphasize that point because American CEOs have an embarrassing record of devoting more company funds to repurchases when prices have risen than when they have tanked. Our approach is exactly the reverse.
That Buffett, a famous value investor, spent $24.7 billion on Berkshire is telling. The next largest 2020 Berkshire investment was the $8.6 billion Verizon (VZ 0.49%) purchase in the fourth quarter, or, if you include debt, the $10 billion acquisition of natural gas assets from Dominion Energy (D 0.16%).
Berkshire's largest investment in 2020 was in itself. Image source: The Motley Fool.
Berkshire doesn't get any respect
Buffett then elaborated why Berkshire is a terrific business that investors may be underappreciating.
First, Berkshire is a conglomerate, and Buffett acknowledges that conglomerates have a bad reputation, often for good reason. Buffett cites two ways Berkshire is better than a typical conglomerate. First, a typical conglomerate often seeks to own and, importantly, control, a collection of hodgepodge businesses.
While Berkshire also seeks to own great businesses, it doesn't particularly feel the need to control entire businesses, though Berkshire is perfectly fine owning non-controlling stakes of public companies just as much as owning an entire business itself. That greatly increases the pool of potential acquisitions, which means Berkshire can be more discerning.
Buffett also accuses other conglomerates of promoting their stock and using "imaginative" accounting maneuvers to make their results look better than they actually are. After pumping their stock up, these CEOs then use stock as currency to make acquisitions that are also wildly overvalued.
Basically, Buffett understands why others dislike conglomerates, but he also explains why Berkshire is vastly different and doesn't deserve a "conglomerate discount" applied to other similar enterprises.
The big four
Buffett then goes through great lengths in the letter to explain why Berkshire's "big four" businesses are each wonderful, competitively advantaged, durable assets. The four are Berkshire's insurance operations, Burlington Northern Santa Fe railroad, Berkshire Hathaway Energy, and Apple (AAPL +2.65%).
First up, Berkshire's insurance operations are far more well capitalized than those of their competitors, and they afford Berkshire the ability to buy higher-return equities, rather than bonds, which yield very little these days. Berkshire's insurance underwriting has been remarkably profitable most years, a rare feat among insurance companies that often operate at an underwriting loss to generate investment income.
Second, BNSF is the largest part of a U.S. railroad oligopoly that is hard, if not impossible, to displace. Even in the downturn last year, management found a way to increase BNSF's margin. "After 150 years or so of frenzied construction, skullduggery, overbuilding, bankruptcies, reorganizations, and mergers, the railroad industry finally emerged a few decades ago as mature and rationalized," Buffett said.
Berkshire Hathaway Energy is also competitively advantaged because of its sterling balance sheet and lack of a dividend, the latter of which allows it to invest in extremely capital-intense, long-term building projects other utilities won't undertake. Buffett gives the example of BHE's ongoing reconstruction of the western U.S. electricity grid, a badly needed infrastructure investment BHE began in 2006 and won't complete until 2030. With energy infrastructure projects badly needed for the foreseeable future, BHE looks like a strong long-term grower in an essential industry.
And public stock holding Apple is, well, Apple.
Image source: Getty Images.
Buffett appreciates long-term, loyal shareholders
Toward the end of the letter, Buffett noted the "special affection" he and Munger have for investors who stick with Berkshire for the long term. Buffett noted 100-year-old Stan Truhlsen, an Omaha doctor who first invested with Buffett in 1959 and has held Buffett partnership/Berkshire shares ever since. Buffett added:
Two of Stan's comrades from Emdee [Investment Group] are now in their high 90s and continue to hold Berkshire shares. This group's startling durability -- along with the fact that Charlie and I are 97 and 90, respectively -- serves up an interesting question: Could it be that Berkshire ownership fosters longevity?
Buffett seems to think "hamburgers and Cokes" are a fine diet for long-term investors, even if the cuisine has been out of style for a while. He also just backed up the sentiment by buying out $24.7 billion worth of his partners' shares. Perhaps, as the economy opens back up, Berkshire is in for a better-performing decade than the past one. Its founder and CEO seems to think so.
