Warren Buffett, Berkshire Hathaway — 2019
Berkshire’s Performance vs. the S&P 500 Annual Percentage Change Year in Per-Share Market Value of Berkshire in S&P 500 with Dividends Included 1965.....................................................................49.510.0 1966.....................................................................(3.4)(11.7) 1967.....................................................................13.330.9 1968.....................................................................77.811.0 1969.....................................................................19.4(8.4) 1970.....................................................................(4.6)3.9 1971.....................................................................80.514.6 1972.....................................................................8.118.9 1973.....................................................................(2.5)(14.8) 1974.....................................................................(48.7)(26.4) 1975.....................................................................2.537.2 1976.....................................................................129.323.6 1977.....................................................................46.8(7.4) 1978.....................................................................14.56.4 1979.....................................................................102.518.2 1980.....................................................................32.832.3 1981.....................................................................31.8(5.0) 1982.....................................................................38.421.4 1983.....................................................................69.022.4 1984.....................................................................(2.7)6.1 1985.....................................................................93.731.6 1986.....................................................................14.218.6 1987.....................................................................4.65.1 1988.....................................................................59.316.6 1989.....................................................................84.631.7 1990.....................................................................(23.1)(3.1) 1991.....................................................................35.630.5 1992.....................................................................29.87.6 1993.....................................................................38.910.1 1994.....................................................................25.01.3 1995.....................................................................57.437.6 1996.....................................................................6.223.0 1997.....................................................................34.933.4 1998.....................................................................52.228.6 1999.....................................................................(19.9)21.0 2000.....................................................................26.6(9.1) 2001.....................................................................6.5(11.9) 2002.....................................................................(3.8)(22.1) 2003.....................................................................15.828.7 2004.....................................................................4.310.9 2005.....................................................................0.84.9 2006.....................................................................24.115.8 2007.....................................................................28.75.5 2008.....................................................................(31.8)(37.0) 2009.....................................................................2.726.5 2010.....................................................................21.415.1 2011.....................................................................(4.7)2.1 2012.....................................................................16.816.0 2013.....................................................................32.732.4 2014.....................................................................27.013.7 2015.....................................................................(12.5)1.4 2016.....................................................................23.412.0 2017.....................................................................21.921.8 2018.....................................................................2.8(4.4) 2019.....................................................................11.031.5 Compounded Annual Gain – 1965-2019.........................................20.3%10.0% Overall Gain – 1964-2019....................................................2,744,062%19,784% Note:Data are for calendar years with these exceptions: 1965 and 1966, year ended 9/30; 1967, 15 months ended 12/31. 2
BERKSHIRE HATHAWAY INC. To the Shareholders of Berkshire Hathaway Inc.: Berkshire earned $81.4 billion in 2019 according to generally accepted accounting principles (commonly called “GAAP”). The components of that figure are $24 billion of operating earnings, $3.7 billion of realized capital gains and a $53.7 billion gain from an increase in the amount of netunrealizedcapital gains that exist in the stocks we hold. Each of those components of earnings is stated on an after-tax basis. That $53.7 billion gain requires comment. It resulted from a new GAAP rule, imposed in 2018, that requires a company holding equity securities to include in earnings the net change in theunrealizedgains and losses of those securities. As we stated in last year’s letter, neither Charlie Munger, my partner in managing Berkshire, nor I agree with that rule. The adoption of the rule by the accounting profession, in fact, was a monumental shift in its own thinking. Before 2018, GAAP insisted – with an exception for companies whose business was to trade securities – that unrealizedgainswithin a portfolio of stocks wereneverto be included in earnings and unrealizedlosseswere to be includedonlyif they were deemed “other than temporary.” Now, Berkshire must enshrine in each quarter’s bottom line – a key item of news for many investors, analysts and commentators – every up and down movement of the stocks it owns, however capricious those fluctuations may be. Berkshire’s 2018 and 2019 years glaringly illustrate the argument we have with the new rule. In 2018, a down year for the stock market, our net unrealized gainsdecreasedby $20.6 billion, and we therefore reported GAAP earnings of only $4 billion. In 2019,risingstock prices increased net unrealized gains by the aforementioned $53.7 billion, pushing GAAP earnings to the $81.4 billion reported at the beginning of this letter. Those market gyrations led to a crazy 1,900% increase in GAAP earnings! Meanwhile, in what we might call the real world, as opposed to accounting-land, Berkshire’s equity holdings averaged about $200 billion during the two years, and theintrinsic valueof the stocks we own grew steadily and substantially throughout the period. Charlie and I urge you to focus on operating earnings – which were little changed in 2019 – and to ignore both quarterly and annual gains or losses from investments, whether these are realized or unrealized. Our advising thatin no waydiminishes the importance of these investments to Berkshire. Over time, Charlie and I expect our equity holdings – as a group – to delivermajorgains, albeit in an unpredictable and highly irregular manner. To see why we are optimistic, move on to the next discussion. The Power of Retained Earnings In 1924, Edgar Lawrence Smith, an obscure economist and financial advisor, wroteCommon Stocks as Long Term Investments, a slim book that changed the investment world. Indeed, writing the book changed Smith himself, forcing him to reassess his own investment beliefs. Going in, he planned to argue that stocks would perform better than bonds during inflationary periods and that bonds would deliver superior returns during deflationary times. That seemed sensible enough. But Smith was in for a shock. 3
His book began, therefore, with a confession: “These studies are the record of a failure – the failure of facts to sustain a preconceived theory.” Luckily for investors, that failure led Smith to think more deeply about how stocks should be evaluated. For the crux of Smith’s insight, I will quote an early reviewer of his book, none other than John Maynard Keynes: “I have kept until last what is perhaps Mr. Smith’s most important, and is certainly his most novel, point. Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back into the business. Thusthere is an element of compound interest(Keynes’ italics) operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders.” And with that sprinkling of holy water, Smith was no longer obscure. It’s difficult to understand why retained earnings were unappreciated by investors before Smith’s book was published. After all, it was no secret that mind-boggling wealth had earlier been amassed by such titans as Carnegie, Rockefeller and Ford, all of whom had retained a huge portion of their business earnings to fund growth and produce ever-greater profits. Throughout America, also, there had long been small-time capitalists who became rich following the same playbook. Nevertheless, when business ownership was sliced into small pieces – “stocks” – buyers in the pre-Smith years usually thought of their shares as a short-term gamble on market movements. Even at their best, stocks were considered speculations.Gentlemenpreferred bonds. Though investors were slow to wise up, the math of retaining and reinvesting earnings is now well understood. Today, school children learn what Keynes termed “novel”: combining savings with compound interest works wonders.
At Berkshire, Charlie and I have long focused on using retained earnings advantageously. Sometimes this job has been easy – at other times, more than difficult, particularly when we began working with huge and ever- growing sums of money. In our deployment of the funds we retain, we first seek to invest in the many and diverse businesses we already own. During the past decade, Berkshire’s depreciation charges have aggregated $65 billion whereas the company’sinternalinvestments in property, plant and equipment have totaled $121 billion. Reinvestment in productive operational assets will forever remain our top priority. In addition, we constantly seek to buy new businesses that meet three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers. Finally, they must be available at a sensible price. When we spot such businesses, our preference would be to buy 100% of them. But the opportunities to make major acquisitions possessing our required attributes are rare. Far more often, a fickle stock market serves up opportunities for us to buy large,but non-controlling, positions in publicly-traded companies that meet our standards. Whichever way we go – controlled companies or only a major stake by way of the stock market – Berkshire’s financial results from the commitment will in large part be determined by the future earnings of the business we have purchased. Nonetheless, there is between the two investment approaches a hugely important accounting difference, essential for you to understand. 4
In our controlled companies, (defined as those in which Berkshire owns more than 50% of the shares), the earnings of each business flow directly into the operating earnings that we report to you. What you see is what you get. In the non-controlled companies, in which we own marketable stocks,onlythe dividends that Berkshire receives are recorded in the operating earnings we report. The retained earnings? They’re working hard and creating much added value, butnotin a way that deposits those gains directly into Berkshire’s reported earnings. At almost all major companies other than Berkshire, investors wouldnotfind what we’ll call this “non- recognition of earnings” important. For us, however, it is a standout omission, of a magnitude that we lay out for you below. Here, we list our 10 largest stock-market holdings of businesses. The list distinguishes between their earnings that are reported to you under GAAP accounting – these are the dividends Berkshire receives from those 10 investees – and our share, so to speak, of the earnings the investees retain and put to work. Normally, those companies use retained earnings to expand their business and increase its efficiency. Or sometimes they use those funds to repurchase significant portions of their own stock, an act that enlarges Berkshire’s share of the company’s future earnings. Yearend Ownership Berkshire’s Share (in millions) CompanyDividends(1)Retained Earnings(2) American Express18.7%$ 261$ 998 Apple5.7%7732,519 Bank of America10.7%6822,167 Bank of New York Mellon9.0%101288 Coca-Cola9.3%640194 Delta Airlines11.0%114416 J.P. Morgan Chase1.9%216476 Moody’s13.1%55137 U.S. Bancorp9.7%251407 Wells Fargo8.4%705730 Total$3,798$8,332 (1) Based on current annual rate. (2) Based on 2019 earnings minus common and preferred dividends paid. Obviously, the realized gains we will eventually record from partially owning each of these companies will not neatly correspond to “our” share of their retained earnings. Sometimes, alas, retentions produce nothing. But both logic and our past experience indicate that from thegroupwe will realize capital gains at least equal to – and probably better than – the earnings of ours that they retained. (When we sell shares and realize gains, we will pay income tax on the gain at whatever rate then prevails. Currently, the federal rate is 21%.) It is certain that Berkshire’s rewards from these 10 companies, as well as those from our many other equity holdings, will manifest themselves in a highly irregular manner. Periodically, there will be losses, sometimes company-specific, sometimes linked to stock-market swoons. At other times – last year was one of those – our gain will be outsized. Overall, the retained earnings of our investees are certain to be ofmajorimportance in the growth of Berkshire’s value. Mr. Smith got it right. 5
Non-Insurance Operations Tom Murphy, a valued director of Berkshire and an all-time great among business managers, long ago gave me some important advice about acquisitions: “To achieve a reputation as a good manager, just be sure you buy good businesses.” Over the years B