Warren Buffett, Berkshire Hathaway — 2018
Berkshire’s Performance vs. the S&P 500 Annual Percentage Change Year in Per-Share Book Value of Berkshire in Per-Share Market Value of Berkshire in S&P 500 with Dividends Included 1965.................................................23.849.510.0 1966.................................................20.3(3.4)(11.7) 1967.................................................11.013.330.9 1968.................................................19.077.811.0 1969.................................................16.219.4(8.4) 1970.................................................12.0(4.6)3.9 1971.................................................16.480.514.6 1972.................................................21.78.118.9 1973.................................................4.7(2.5)(14.8) 1974.................................................5.5(48.7)(26.4) 1975.................................................21.92.537.2 1976.................................................59.3129.323.6 1977.................................................31.946.8(7.4) 1978.................................................24.014.56.4 1979.................................................35.7102.518.2 1980.................................................19.332.832.3 1981.................................................31.431.8(5.0) 1982.................................................40.038.421.4 1983.................................................32.369.022.4 1984.................................................13.6(2.7)6.1 1985.................................................48.293.731.6 1986.................................................26.114.218.6 1987.................................................19.54.65.1 1988.................................................20.159.316.6 1989.................................................44.484.631.7 1990.................................................7.4(23.1)(3.1) 1991.................................................39.635.630.5 1992.................................................20.329.87.6 1993.................................................14.338.910.1 1994.................................................13.925.01.3 1995.................................................43.157.437.6 1996.................................................31.86.223.0 1997.................................................34.134.933.4 1998................................................. 48.352.228.6 1999.................................................0.5(19.9)21.0 2000.................................................6.526.6(9.1) 2001.................................................(6.2)6.5(11.9) 2002.................................................10.0(3.8)(22.1) 2003.................................................21.015.828.7 2004.................................................10.54.310.9 2005.................................................6.40.84.9 2006.................................................18.424.115.8 2007.................................................11.028.75.5 2008.................................................(9.6)(31.8)(37.0) 2009.................................................19.82.726.5 2010.................................................13.021.415.1 2011.................................................4.6(4.7)2.1 2012.................................................14.416.816.0 2013.................................................18.232.732.4 2014.................................................8.327.013.7 2015.................................................6.4(12.5)1.4 2016.................................................10.723.412.0 2017.................................................23.021.921.8 2018.................................................0.42.8(4.4) Compounded Annual Gain – 1965-2018.....................18.7%20.5%9.7% Overall Gain – 1964-2018................................1,091,899%2,472,627%15,019% Note:Data are for calendar years with these exceptions: 1965 and 1966, year ended 9/30; 1967, 15 months ended 12/31. Starting in 1979, accounting rules required insurance companies to value the equity securities they hold at market rather than at the lower of cost or market, which was previously the requirement. In this table, Berkshire’s results through 1978 have been restated to conform to the changed rules. In all other respects, the results are calculated using the numbers originally reported. The S&P 500 numbers arepre-taxwhereas the Berkshire numbers areafter-tax. If a corporation such as Berkshire were simply to have owned the S&P 500 and accrued the appropriate taxes, its results would have lagged the S&P 500 in years when that index showed a positive return, but would have exceeded the S&P 500 in years when the index showed a negative return. Over the years, the tax costs would have caused the aggregate lag to be substantial. 2
BERKSHIRE HATHAWAY INC. To the Shareholders of Berkshire Hathaway Inc.: Berkshire earned $4.0 billion in 2018 utilizing generally accepted accounting principles (commonly called “GAAP”). The components of that figure are $24.8 billion in operating earnings, a $3.0 billion non-cash loss from an impairment of intangible assets (arising almost entirely from our equity interest in Kraft Heinz), $2.8 billion in realized capital gains from the sale of investment securities and a $20.6 billionlossfrom a reduction in the amount of unrealized capital gains that existed in our investment holdings. A new GAAP rule requires us to include that last item in earnings. As I emphasized in the 2017 annual report, neither Berkshire’s Vice Chairman, Charlie Munger, nor I believe that rule to be sensible. Rather, both of us have consistently thought that at Berkshire this mark-to-market change would produce what I described as “wild and capricious swings in our bottom line.” The accuracy of that prediction can be suggested by our quarterly results during 2018. In the first and fourth quarters, we reported GAAPlossesof $1.1 billion and $25.4 billion respectively. In the second and third quarters, we reportedprofitsof $12 billion and $18.5 billion. In complete contrast to these gyrations, the many businesses that Berkshire owns delivered consistent and satisfactory operating earnings inallquarters. For the year, those earnings exceeded their 2016 high of $17.6 billion by 41%. Wide swings in our quarterly GAAP earnings will inevitably continue. That’s because our huge equity portfolio – valued at nearly $173 billion at the end of 2018 – will often experience one-day price fluctuations of $2 billion or more, all of which the new rule says must be dropped immediately to our bottom line. Indeed, in the fourth quarter, a period of high volatility in stock prices, we experienced several days with a “profit” or “loss” of more than $4 billion. Our advice? Focus on operating earnings, paying little attention to gains or losses of any variety. My saying that in no way diminishes the importance of our investments to Berkshire. Over time, Charlie and I expect them to deliver substantial gains, albeit with highly irregular timing.
Long-time readers of our annual reports will have spotted the different way in which I opened this letter. For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice. The fact is that the annual change in Berkshire’s book value – which makes its farewell appearance on page 2 – is a metric that has lost the relevance it once had. Three circumstances have made that so. First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner. Second, while ourequity holdingsare valued at market prices, accounting rules require our collection ofoperating companiesto be included in book value at an amount far below their current value, a mismark that has grown in recent years. Third, it is likely that – over time – Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality. 3
In future tabulations of our financial results, we expect to focus on Berkshire’s market price. Markets can be extremely capricious: Just look at the 54-year history laid out on page 2. Over time, however, Berkshire’s stock price will provide the best measure of business performance.
Before moving on, I want to give you some good news –reallygood news – that is not reflected in our financial statements. It concerns the management changes we made in early 2018, when Ajit Jain was put in charge of all insurance activities and Greg Abel was given authority over all other operations. These moves were overdue. Berkshire is now far better managed than when I alone was supervising operations. Ajit and Greg have rare talents, and Berkshire blood flows through their veins. Now let’s take a look at what you own. Focus on the Forest – Forget the Trees Investors who evaluate Berkshire sometimes obsess on the details of our many and diverse businesses – our economic “trees,” so to speak. Analysis of that type can be mind-numbing, given that we own a vast array of specimens, ranging from twigs to redwoods. A few of our trees are diseased and unlikely to be around a decade from now. Many others, though, are destined to grow in size and beauty. Fortunately, it’s not necessary to evaluate each tree individually to make a rough estimate of Berkshire’s intrinsic business value. That’s because our forest contains five “groves” of major importance, each of which can be appraised, with reasonable accuracy, in its entirety. Four of those groves are differentiated clusters of businesses and financial assets that are easy to understand. The fifth – our huge and diverse insurance operation – delivers great value to Berkshire in a less obvious manner, one I will explain later in this letter. Before we look more closely at the first four groves, let me remind you of our prime goal in the deployment of your capital: to buy ably-managed businesses,in whole or part, that possess favorable and durable economic characteristics. We also need to make these purchases at sensible prices. Sometimes we can buy control of companies that meet our tests. Far more often, we find the attributes we seek in publicly-traded businesses, in which we normally acquire a 5% to 10% interest. Our two-pronged approach to huge-scale capital allocation is rare in corporate America and, at times, gives us an important advantage. In recent years, the sensible course for us to follow has been clear: Many stocks have offered far more for our money than we could obtain by purchasing businesses in their entirety. That disparity led us to buy about $43 billion of marketable equities last year, while selling only $19 billion. Charlie and I believe the companies in which we invested offered excellent value, far exceeding that available in takeover transactions. Despite our recent additions to marketable equities, the most valuable grove in Berkshire’s forest remains the many dozens of non-insurance businesses that Berkshire controls (usually with 100% ownership and never with less than 80%). Those subsidiaries earned $16.8 billion last year. When we say “earned,” moreover, we are describing what remains afterallincome taxes, interest payments, managerial compensation (whether cash or stock-based), restructuring expenses, depreciation, amortization and home-office overhead. That brand of earnings is a far cry from that frequently touted by Wall Street bankers and corporate CEOs. Too often, their presentations feature “adjusted EBITDA,” a measure that redefines “earnings” to exclude a variety of all-too-real costs. 4
For example, managements sometimes assert that their company’s stock-based compensation shouldn’t be counted as an expense. (What else could it be – agiftfrom shareholders?) And restructuring expenses? Well, maybe last year’s exact rearrangement won’t recur. But restructurings of one sort or another are common in business – Berkshire has gone down that road dozens of times, and our shareholders have always borne the costs of doing so. Abraham Lincoln once posed the question: “If you call a dog’s tail a leg, how many legs does it have?” and then answered his own query: “Four, because calling a tail a leg doesn’t make it one.” Abe would have felt lonely on Wall Street. Charlie and I do contend that our acquisition-related amortization expenses of $1.4 billion (detailed on page K-84) are not a true economic cost. We add back such amortization “costs” to GAAP earnings when we are evaluating both private businesses and marketable stocks. In contrast, Berkshire’s $8.4 billion depreciation charge understates our true economic cost. In fact, we need to spendmorethan this sum annually to simply remain competitive in our many operations. Beyond those “maintenance” capital expenditures, we spend large sums in pursuit of growth. Overall, Berkshire invested a record $14.5 billion last year in plant, equipment and other fixed assets, with 89% of that spent in America. Berkshire’s runner-up grove by value is its collection of equities, typically involving a 5% to 10% ownership position in a very large company. As noted earlier, our equity investments were worth nearly $173 billion at yearend, an amount far above their cost. If the portfolio had been sold at its yearend valuation, federal income tax of about $14.7 billion would have been payable on the gain. In all likelihood, we will hold most of these stocks for a long time. Eventually, however, gains generate taxes at whatever rate prevails at the time of sale. Our investees paid us dividends of $3.8 billion last year, a sum that will increase in 2019. Far more important than the dividends, though, are the huge earnings that are annually retained by these companies. Consider, as an indicator, these figures that cover only our five largest holdings. Yearend Ownership Berkshire’s Share in $ millions of CompanyDividends(1)Retained Earnings(2) American Express17.9%$ 237$ 997 Apple5.4%7452,502 Bank of America9.5%5512,096 Coca-Cola9.4%624(21) Wells Fargo9.8%8091,263 Total$2,966$6,837 (1) Based on current annual rate. (2) Based on 2018 earnings minus common and preferred dividends paid. GAAP – which dictates the earnings we report – does not allow us to include the retained earnings of investees in our financial accounts. But those earnings are of enormous value to us: Over the years, earnings retained by our investees (viewed as a group) have eventually delivered capital gains to Berkshire th